China Milk Research Report

by DMG & PARTNERS (24 July)

CHINA Milk is currently benefiting from China's dairy consumption boom.

According to United Nations statistics, total dairy consumption in China reached 19 million tonnes in 2006. By 2008, it is expected to surpass 25 million tonnes.

This growth would peg China's total market size ahead of major European dairy markets such as France and Germany.

We believe that China Milk, which is currently the largest producer of pedigree bull semen, cow embryos, and raw milk in China, is going to benefit from these trends. We initiate coverage on China Milk with a target price of S$0.99.

The rationale for China Milk lies within its outlook, strategy, and plans going forward.

Our justification is simple.

Firstly, the company is in a strong net cash position of 726.5 million yuan (0.98 yuan per share) to expand its business even further.

With a total herd size of 18,390 as at end-March, the company is looking to double its current size by FY2010 through purchasing more Canadian and Australian Holsteins. The cost of one Canadian Holstein is nearly double that of an Australian Holstein's 28,000 yuan.

Currently China has an import ban on Canadian Holsteins due to the mad cow disease. We believe the government may lift the ban by FY2010.

On top of doubling its herd size, the company is expanding its business downstream through milk processing.

This will further strengthen China Milk as a major player in the dairy business. We expect further growth earnings in FY2009, fuelled by the increasing demand for dairy products in China.

Long-term outlook looks attractive with the group planning to increase its herd size which will enable them to produce more bull semen, cow embryo, raw milk, and processed milk.

We conservatively estimate earnings to grow 15 per cent to 552.5 million yuan in FY2009, and 11.2 per cent to 614.5 million yuan in FY2010.

We have a price target based on a forward FY2010 PE of 6 which is a FY2010 PE-to-growth ratio of 0.5. This implies an upside of 42 per cent from current levels. China Milk is currently trading at a FY2009 PE of 4.7 and a forward FY2010 PE of 4.2, which is considerably lower compared to its regional peers' FY2009 PE of 20.2.

-Research Report by DMG & PARTNERS (24 July)