Biostime International Holdings：Cash cow

l Equity Research l Important disclosures can be found in the Disclosures Appendix All rights reserved. Standard Chartered Bank 2013 http://research.standardchartered.com Hong Kong l Food & Beverages 1 January 2013 Biostime International Holdings Cash cow...  We initiate coverage of Biostime International Holdings with an Outperform rating and a price target of HKD 29.40, implying 21% upside. Our high-conviction OP call stems from its safe infant-formula products, which are produced in France and shipped directly to China. They pass through three layers of quality control: EU standards, Chinese customs and a strict internal process.  Semi-annual contracts with suppliers give immunity from short-term price volatility. The supreme-tier formula pioneer should enjoy gross margins above 65% until 2013E.  Investors should view Biostime‟s Mama100 reward program as a channel management tool. It effectively weeds out „grey channel‟ participation and ensures similar pricing and stable profits for its distributors.  OUTPERFORM (initiating coverage) The 3Rs: We believe Biostime‟s success comes from a three-pronged strategy: (1) Right time: It took advantage of the 2008 melamine incident to launch a French brand in China; (2) Right products: It pioneered „supreme-tier‟ infant formula, a segment that was initially free of competitors; (3) Right channel: It focuses on the „maternal‟ channel, which has grown much faster than the mass channel in the past few years. Highly visible growth momentum in the next two years: Given its dominance of the supreme-tier market and less direct competition from the top-four global brands, we expect Biostime to grow infant-formula sales by 40% YoY and 27.3% YoY in 2013 and 2014, respectively, as the company continues to expand its footprint through the maternal and mass channels. A reward scheme and an effective channel monitor: We differentiate ourselves in our perspective of Mama100, Biostime‟s unique membership reward system. While the market treats it as a loyalty platform to boost sales, we believe its essence lies in channel management. Mama100 provides useful data that allows the company to set similar selling prices for each distributor and eliminate „grey channel‟ participation. Risks: (1) Limited suppliers in France; (2) potential product-quality issues; (3) higher-than-projected cost; and (4) rising competition in the supreme- and high-tier segments. Source: Company, Standard Chartered Research estimates Share price performance Source: Company, FactSet PRICE as of 28 Dec 2012HKD 24.30PRICE TARGETHKD 29.40Bloomberg codeReuters code1112 HK1112.HKMarket cap12-month rangeHKD 14,860mn (USD 1,917mn)HKD 13.12 - 25.40EPS adj est changeNAYear-end: December20112012E2013E2014ESales (RMB mn)2,1893,1074,1955,246EBITDA (RMB mn)6549191,2551,520EBIT (RMB mn)6428951,2241,480Pre-tax profit (RMB mn)6599121,2421,503Net profit adj. (RMB mn)4726849321,127FCF (RMB mn)4775678201,063EPS adj. (RMB)0.861.121.521.84DPS (RMB)0.620.460.620.75Book value/share (RMB)3.283.634.645.84EPS growth adj. (%)48.229.736.121.0DPS growth (%)280.0-25.936.121.0EBITDA margin (%)29.929.629.929.0EBIT margin (%)29.328.829.228.2Net margin adj. (%)21.622.022.221.5Div. payout (%)71.440.840.840.8Net gearing (%)-91.7-87.1-85.9-86.9ROE (%)26.033.037.635.9ROCE (%)34.842.148.246.0EV/sales (x)2.23.22.21.6EV/EBITDA (x)7.310.97.45.5PBR (x)3.45.54.23.2PER adj. (x)12.617.712.810.3Dividend yield (%)5.72.33.24.0121926Dec-11Mar-12Jun-12Sep-12Dec-12Biostime International HoldingsHANG SENG INDEX (rebased)Share price (%)-1 mth-3 mth-12 mthOrdinary shares22279Relative to index-21246Relative to sector---Major shareholderBiostime Pharmaceuticals (China) (74.7%)Free float25%Average turnover (USD)1,844,264Charles Z. Yan, CFA Charles.ZX.Yan@sc.com +852 3983 8523 Tallan Zhou Tallan.Zhou@sc.com +852 3983 8520 1112 HK HKD 24.30 HKD 29.40 matthew.k.m.wong@hsbcpb.com Matthew Wong 01/01/13 02:46:39 PM HSBC - Hong Kong {IM} Biostime International Holdings l 1 January 2013 l Equity Research l 2 Contents Investment thesis 3 Valuation at HKD 29.40 per share 5 Earnings outlook 11 It‟s all about infant formula 12 Other products too small to make an impact 19 The 3Rs: Right time, right products, right channel 20 Mama100: Loyalty program and channel monitor 24 Investment risks 26 Company profile 27 Disclosures appendix 30 matthew.k.m.wong@hsbcpb.com Matthew Wong 01/01/13 02:46:39 PM HSBC - Hong Kong {IM} Biostime International Holdings l 1 January 2013 l Equity Research l 3 Investment thesis Biostime originally sold a niche product – infant probiotics. At the beginning of 2008, it launched its first infant-formula brand, penetrating this China market as a pioneer of „supreme‟ quality infant formula. It remains one of the leading players in the supreme-tier segment. We value Biostime at HKD 29.40 per share We initiate coverage of Biostime with an Outperform rating and a price target of HKD 29.40, which im