Downshifting to low gears: initiating on Tingyi (Sell) and UPC (Hold)

Deutsche Bank Markets Research Asia China Consumer Industry China Food & Beverage Date 19 October 2016 Initiation of Coverage Downshifting to low gears: initiating on Tingyi (Sell) and UPC (Hold) Change of market dynamics deepening ________________________________________________________________________________________________________________Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Charlie Chen Research Analyst (+852 ) 2203 6178 charlie.chen@db.com Key Changes Company Target Price Rating0322.HK NA to 6.62(HKD) NR to Sell0220.HK NA to 5.28(HKD) NR to HoldSource: Deutsche Bank Top picks Tingyi (0322.HK),HKD8.94 SellUni-President China (0220.HK),HKD5.56 HoldSource: Deutsche Bank Companies Featured Tingyi (0322.HK),HKD8.94 Sell 2015A 2016E 2017EP/E (x) 42.839.433.2EV/EBITDA (x) 13.09.48.5Price/book (x) 2.72.22.1Uni-President China (0220.HK),HKD5.56 Hold 2015A 2016E 2017EP/E (x) 28.327.923.6EV/EBITDA (x) 10.29.17.8Price/book (x) 1.81.71.6Source: Deutsche Bank China’s soft beverage market is still under-penetrated compared with other markets – we estimate that there is least 50-100% volume upside potential in China’s total soft drink industry. However, the volume growth rate is likely to remain at mid-single digits in the next few years, and volume growth is likely to come from health drinks, hybrid products, cross categories, and high-end products with better packaging, content, and brand image. To win in China’s beverage market in the future, consumer companies need to significantly enhance their product R&D capability to fight for consumers’ preference. Initiating coverage of Tingyi (Sell) and UPC (Hold) We initiate coverage on the China food & beverage sector and two Hong Kong-listed companies, Tingyi and UPC. We believe Tingyi’s fundamentals should keep improving after 3Q 2016 but may lack long-term growth drivers, as the company has had few successful product launches in the past several years. UPC, in contrast, may face short-term challenges in 2H16 and 1H17, but its strong product pipeline provides a better buffer for long-term growth. Competitive landscape creates an M&A-friendly environment Although the overall soft drink market in China is still fragmented, many subsectors are highly concentrated. This market situation leads us to believe M&A is likely to happen in the future. Although there is no definite timeframe, we believe the overall profitability in the soft drink market should improve in the long term as market consolidation continues. Valuation and risks We use DCF methodology to value both Tingyi and UPC because PE and EV/EBITDA valuations would be based on their 2017 earnings, which we expect to be below the normal level. Therefore, we use DCF to value the companies based on their long-term normalized cash flow. Our target prices are HK$6.62 for Tingyi (Sell) and HK$5.28 for UPC (Hold). The main downside risks to food & beverage companies relate to several factors, including food safety incidents, raw material price increases, and increasing competition in the market. On the other side, raw material price decreases, weaker-than-expected market competition, and successful new product launches may bring upside risks to our forecasts. Figure 1: Target price, rating, and valuation of Tingyi and UPC Rating TP (HK$) Val. 2016E 2017E Method PEEV/EBITDAPEEV/EBITDATingyi Sell 6.62 DCF 29.17.624.57.2UPC Hold 5.28 DCF 26.18.722.67.7Source: Deutsche Bank Distributed on: 19/10/2016 09:00:00 GMT 19 October 2016 Consumer China Food & Beverage Page 2 Deutsche Bank AG/Hong Kong Investment summary Soft beverages: still have ample room to grow The Chinese soft beverages market is still under-penetrated, with per capita consumption of total soft beverages at 66.5 liters in 2015 (on-trade and off-trade), substantially below comparable markets such as Taiwan, Hong Kong, Japan, and South Korea (ranging 90-140 liters). Our analysis has identified that most of the absolute volume growth in the next five years will still come from “hydration drinks”, in particular bottled water, and “functional drinks” such as sports drinks should enjoy higher growth rates off a smaller base. Three growt