China Dairy Group Ltd: Milking more value

China Dairy Group Ltd: Milking more value
Strong growth in China's dairy industry. Between 2000 and 2005, China's
dairy industry saw revenues almost doubled from RMB47.9b to RMB89.8b.
Growth for the industry is estimated at 95% to RMB175b between 2006
and 2010, according to a study done by McKinsey. With the increasing
affluence among the Chinese population and the growing pool of working
mothers opting for milk powder as an alternative to breast-feeding, demand
for milk products is expected to soar in the coming years. China's dairy
industry is at the growing stage of its product life cycle.
Well-positioned to ride China's booming economy. China Diary Group
(CDG) is the best performer among the middle-tiered players in China's
dairy industry. CDG targets consumers in the middle-income group and in
rural cities, which are the main sources of China's growth in consumption.
With this market positioning, we expect CDG to be in a good position to
ride China's booming economy and rising demand for more consumer
products.
Stronger performance expected in FY07. CDG posted muted FY06
profits despite strong growth in revenue. This was largely due to a reduction
in the average selling price of its products and an increase in promotional
spending due to competitive forces. With the tightening of regulations in
the dairy industry, we expect weaker players to be weeded out, leaving the
stronger players to potentially increase their market shares. Together with
the focus on the quality of milk products, we foresee a recovery in average
selling prices across the industry.
Initiate with BUY. CDG's liquid milk segment has been doing well. In
FY06, CDG's liquid milk revenue grew 34% YoY to S$136m. In FY07, we
forecast reasonable revenue growth of 22% to S$166m for the liquid milk
segment and a stable 2% growth to S$64.6m for the milk powder segment.
Overall, we forecast a 16% growth in FY07 net profits to S$16.1m. Since
the beginning of the year, the PrimePartners China Index has risen by
around 48% while CDG has fallen by around 8%. We feel this differential is
not warranted. Based on a substantial discount to its Hong Kong and China
listed peers, which are trading at around 60X PER, we derive a fair value of
S$0.59 for CDG based on a blended FY07/08 PER of 15x. We initiate
coverage on China Dairy Group with a BUY rating. (Carmen Lee & Research
Team)
(OCBC Investment Research Pte Ltd (OIR) produced this report under the
SGX-MAS Research Incentive Scheme. OIR is compensated S$5,000 per
annum for each company covered under the scheme.)