Phillip Securities Research

Regional Member Companies

(MICA (P) 027/06/2008)

China • Consumer Sector • Update report

Recommendation: China Milk Products Group Ltd

BUY Where is the milk?
10 October 2008
Previous Call: Buy

Price The melamine tainted milk from the PRC caused a huge uproar over food safety all
Previous Close S$0.505 around the world and brought a little known culprit into infamy. The milk scandal has
Fair Value S$0.91 affected much of the PRC F&B landscape and in particular the dairy industry.
Share Price Return 80.2% Consumption pattern may change because of the worry over food safety.

Share Statistics China Milk Products Group Ltd (CMP) derives 20% of its revenue from the sale of
Shares 738.6 mil raw milk while the rest are from sales of pedigree bull semen and cow embryo. CMP
Market Cap. S$372.99 mil has announced that its products are free from melamine and none of its customers
Trailing PER 3.85x are involved in any tainted milk products. Although the tainted milk scandal may have
Forward PER 4.30x a negative impact on CMP revenue, we do not think the impact is significant and long
P/BV 1.02x lasting.
52-wks Price S$0.385 –
Range S$1.45 What could be the root problem? China has a population of 1.3 billion with an
52-wks PE Range 2.94x – 14.68x approximate urban population of 600 million. Being a net importer of milk and dairy
Listing Bourse SGX-Mainboard products, there is an unseen pressure on the supply of local milk production. The
Liu Shuqing problem of the milk scandal begins with unscrupulous entities adding melamine to
(43.74%), milk products to boost the impression of high protein content, whether intentionally or
Major Shareholder Capital World not, in the case of illiterate rural farmers1. In order to understand this practice, it is
Investment
(3.01%)
necessary to go up the supply chain and look at the dairy farming industry. The
animal husbandry industry in PRC is very fragmented with 95% of the farms owning
Price Chart less than 20 heads of cows. These farms very often are lacking in logistical support
1.6
as well as specialize knowledge in dairy farming, therefore resulting in inferior raw
1.4 milk quality. Furthermore, in order to boost production volume, the raw milk could
1.2 have been diluted with water. In order to pass quality checks, chemicals are then
1
0.8
added to this inferior milk. For the PRC government to restore confidence in local
0.6 dairy products, huge efforts are needed to shore up the infrastructure at the ground
0.4 level, and in our opinion, that is where CMP will benefit out of this crisis.
0.2
0
In our opinion, CMP may in fact benefit. CMP has one of the largest herds of
10/9/07

12/9/07

2/9/08

4/9/08

6/9/08

8/9/08

10/9/08

Canadian Holstein in the PRC and Canadian Holstein is well known for their milk
producing ability of 8-10 tonnes of raw milk per year. Furthermore, the company
feeds its cattle with a specially blended diet to ensure high quality of raw milk
Company Profile
produced. For the PRC dairy farming industry to improve the quality of raw milk, it
China Milk Products produces raw would require in part, genetic modification of the local dairy cows coupled with
milk, pedigree bull semen and nutritious feedstock. In this aspect, CMP stands to gain both from its sales of
pedigree dairy cow embryos for
embryo transfer pedigree bull semen and cow embryo as well as its raw milk and processed milk.
CMP sells bull semen and cow embryo to government agencies and we feel that this
Analyst is one area that the PRC government will concentrate its effort on as it strives to
improve the quality of local breed. Secondly increase demand for better quality dairy
Lee Kok Joo, CFA
 +65 6531-1685 products and public scrutiny will call for more stringent regulations and inferior
Fax +65 6536-4435 products will be weeded out.
leekj@phillip.com.sg
Valuation and recommendation. We remain fairly optimistic of CMP positioning in
the value chain and feels that as ‘made-in-China’ products undergo a consolidation

1
Melamine use ”rampant” in China feed industry –Reuters 25th Sep 2008
China Milk Products Group Ltd 10 October 2008

phase, the PRC government will be spending considerable amount of efforts to bring
up the reputation and standard to match international requirements. As a result of the
milk scandal, which has an industry wide impact, we take a 25% cut to our revenue
assumption for raw milk and processed milk for FY09F and it translates to a 7%
decrease in total revenue. Our fair value is lowered to $0.91 from $0.94. In view of
recent broad market movement, we advise caution investing in the stock market
during these troubled times.

Exhibit 1: Revenue breakdown (RMB mil)

Old 2009F New 2009F % change
Pedigree bull semen 426.1 426.1 0.0
Pedigree dairy cow embryos 67.9 67.9 0.0
Raw milk 125.3 93.9 (25.0)
Processed milk 55.4 41.6 (25.0)
Total 674.7 629.5 (7.0)

Risks. How soon the dairy industry recovers depends on how fast the PRC
government acts. In the event that more dairy products are found tainted with
melamine or other health threatening substances, this could spell another round of
unrest. Consumption patterns of consumer may also have shifted because of this
event and they might switch to substitute products such as Soya milk.

Exhibit 2: Financial Summary

Financial Year Ended 30 April 2007 2008 2009F 2010F 2011F
Revenue (RMB mil) 442.9 546.8 629.5 769.8 851.5
Fair value of agriculture produce (RMB mil) 460.1 560.9 629.5 769.8 851.5
Gains in fair value (RMB mil) 54.2 65.3 49.5 34.7 38.2
Other Income (RMB mil) 19.3 39.4 59.0 62.6 68.0
Raw materials and consumables used (RMB mil) (72.4) (92.2) (110.7) (120.1) (130.6)
Other Operating Expenses (RMB mil) (56.7) (78.3) (106.3) (132.3) (167.0)
Attributable to Equity Holders (RMB mil) 378.5 480.6 430.5 515.0 550.5
EPS (RMB) 0.51 0.65 0.58 0.70 0.75
Diluted EPS (RMB) 0.44 0.56 0.50 0.60 0.64
EPS (SGD) 0.10 0.13 0.12 0.14 0.15
Gross Profit Margin (%) 83.6% 83.1% 82.4% 84.4% 84.7%
Net Profit Margin (%) 85.5% 87.9% 68.4% 66.9% 64.6%
ROE (%) 32.4% 30.3% 21.2% 20.5% 18.1%
Source: Company, Phillip Securities Research

2
China Milk Products Group Ltd 10 October 2008

Financials
Profit model (RMB mil) 2008 2009F 2010F 2011F Balance sheet (RMB mil) 2008 2009F 2010F 2011F

Revenue 546.8 629.5 769.8 851.5 Interests in subsidiaries 0.0 32.0 32.0 32.0
Fair value of agriculture produce 560.9 629.5 769.8 851.5 Goodwill 0.0 108.0 108.0 108.0
Gains arising from changes in fair value 65.3 49.5 34.7 38.2 Property, plant and equipment 472.5 543.4 624.9 718.7
626.3 679.0 804.5 889.8 Land use rights 258.0 252.4 246.8 241.2
Dairy livestocks 300.7 350.2 384.9 423.1
Other Income 39.4 59.0 62.6 68.0 Deposits 46.3 46.3 46.3 46.3
Raw materials and consumables used (92.2) (110.7) (120.1) (130.6) Total Non-current assets 1077.5 1332.2 1442.9 1569.3
Staff costs (26.4) (30.3) (33.6) (36.8)
Amortisation of land use rights (5.6) (5.6) (5.6) (5.6)
Depreciation (11.3) (23.6) (27.2) (31.2) Inventories 14.8 17.3 20.2 23.7
Minimum lease payments (11.3) (11.2) (12.4) (12.4) Trade receivables 59.1 54.7 84.5 69.5
Other Operating Expenses (23.7) (35.5) (53.5) (81.0) Prepayments and other receivables 5.4 5.9 6.5 7.2
Profit from operation 495.1 521.1 614.7 660.2 Amount due from a subsidiary 0.0 0.0 0.0 0.0
Change in fair value of derivative financial 76.9 0.0 0.0 0.0 Cash and Bank Balances 1736.7 2031.8 2483.3 3056.0
Finance costs (91.5) (90.5) (99.7) (109.7) Total Current assets 1816.1 2109.7 2594.5 3156.4
Profit before Income tax 480.6 430.5 515.0 550.5
Trd payables, accru liabilities and other
payables 31.5 58.9 39.6 67.6
Income tax/ credit 0.0 0.0 0.0 0.0 Amount due to a director 33.1 33.1 33.1 33.1
Profit after tax 480.6 430.5 515.0 550.5 Derivative financial instruments 57.0 57.0 57.0 57.0
Attributable to Equity Holders of the
parent 480.6 430.5 515.0 550.5 Total Current liabilities 121.6 149.0 129.7 157.7
Core net profit 403.7 430.5 515.0 550.5
EPS (RMB) 0.65 0.58 0.70 0.75 Convertible bonds 953.3 1043.8 1143.5 1253.2
Diluted EPS (RMB) 0.56 0.50 0.60 0.64 Total Non current liabilities 953.3 1043.8 1143.5 1253.2
Growth & margins (%) 2008 2009F 2010F 2011F
Revenue growth 23.5% 15.1% 22.3% 10.6% Issued capital 381.6 381.6 381.6 381.6
Gross profit growth 22.7% 14.1% 25.2% 11.0% Reserves 1437.1 1867.6 2382.6 2933.1
Net profit growth 27.0% -10.4% 19.6% 6.9% Proposed dividend 0.0 0.0 0.0 0.0
Core net profit growth 6.7% 6.7% 19.6% 6.9% Total Shareholder's equity 1818.6 2249.2 2764.2 3314.7
Gross profit margin 83.1% 82.4% 84.4% 84.7%
Net Profit margins 87.9% 68.4% 66.9% 64.6%
ROA 17.8% 13.6% 13.8% 12.6% Key Ratios 2008 2009F 2010F 2011F
ROE 30.3% 21.2% 20.5% 18.1% Gross Gearing 0.37 0.35 0.32 0.30
Net Gearing -0.23 -0.24 -0.30 -0.35
Interest Coverage 5.41 5.76 6.17 6.02
Cash flow statement (RMB mil) 2008 2009F 2010F 2011F Net debt/EBITDA -1.35 -1.63 -1.93 -2.46
(Loss)/ Profit before Tax 480.6 430.5 515.0 550.5 Debt ratio 0.34 0.32 0.29 0.27
Interest income (20.8) (20.8) (24.4) (29.8)
Gains arising from changes in fair value (65.3) (49.5) (34.7) (38.2) Sales to inventory Ratio 36.88 36.45 38.10 35.89
Change in fair value of derivative financial (76.9) 0.0 0.0 0.0 Assets to Sales Ratio 5.29 5.47 5.24 5.55
Excess of acquirer's interest in the net val 0.0 0.0 0.0 0.0 Average Receivable Turnover 13.13 10.17 11.33 12.06
Amortisation of land use rights 5.6 5.6 5.6 5.6 Average days Receivable 27.79 35.89 32.23 30.26
Depreciation 11.3 23.6 27.2 31.2 Average Payable Turnover 15.50 13.93 15.63 15.88
Convertible bonds issuance expenses 0.0 0.0 0.0 0.0 Average days Payable 23.54 26.21 23.35 22.98
Interest on convertible bonds 91.5 90.5 99.7 109.7 Inventory Turnover 32.29 39.23 41.08 38.77
Operating profit before WC changes 425.9 480.0 588.4 629.0 Average days Inventory 11.30 9.30 8.88 9.41
Net change in WC (23.0) 28.8 (52.6) 38.9 Cash turnover 0.05 0.05 0.05 0.04
Net Cash flows from operations bef int/tax 402.9 508.8 535.8 667.9 Average assets Turnover 0.20 0.20 0.21 0.19
Income Taxes Paid 0.0 0.0 0.0 0.0 Average Equity Turnover 0.34 0.31 0.31 0.28
Net cashflows from operating activities 402.9 508.8 535.8 667.9
Quick Ratio 14.81 14.04 19.85 19.86
Purchase of plant and equipment (240.2) (94.5) (108.7) (125.0) Current Ratio 14.94 14.16 20.01 20.01
Acquisition of land use rights (26.1) 0.0 0.0 0.0 Cash Ratio 14.28 13.64 19.15 19.38
Others (40.6) 20.8 24.4 29.8 Current assets to equity ratio 1.00 0.94 0.94 0.95
Net Cash Flows from investing activites (306.9) (73.7) (84.3) (95.2) Current liabilities to equity ratio 0.07 0.07 0.05 0.05
Current liabilities to inventory ratio 8.20 8.63 6.42 6.65
Advance from a director, net 19.1 0.0 0.0 0.0 Total liabilities to equity ratio 0.59 0.53 0.46 0.43
Others 0.0 0.0 0.0 0.0
Dividends paid (22.8) 0.0 0.0 0.0
Net cashflows from financing activities (3.7) 0.0 0.0 0.0 Valuation 2008 2009F 2010F 2011F
Net change 92.3 435.1 451.4 572.7 P/E basic (X) 3.85 4.30 3.59 3.36
P/B (X) 1.02 0.82 0.67 0.56
Source: Company, Phillip Securities Research

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China Milk Products Group Ltd 10 October 2008

Ratings History

China Milk Products Group Ltd

Closing Fair
Rating Date Remarks
price (S$) value (S$)
BUY 10 October 2008 $0.505 $0.910 Update
BUY 21 August 2008 $0.680 $0.940 Initiate coverage

BUY >15% upside from the current price

HOLD Trade within ± 15% from the current price
SELL >15% downside from the current price
Phillip Research
Stock Selection We do not base our recommendations entirely on the above quantitative return
Systems bands. We consider qualitative factors like (but not limited to) a stock's risk
reward profile, market sentiment, recent rate of share price appreciation,
presence or absence of stock price catalysts, and speculative undertones
surrounding the stock, before making our final recommendation.

4
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