biostime international (1112 hk) · turning point in mama 100 monetization the market for mom &...

Biostime International (1112 HK)

June 12, 2015 Equity Research | Consumer Staples

Buy (initiation)

Target price: HK$ 38.00

Leading infant milk formula innovator at a turning point in the monetization of its online platform; initiate at Buy

Alex Fan, CFA SFC CE No. ADJ672 [email protected] +852 3719 1047 Yang Ke SFC CE No. BEZ121 [email protected] +86 755 83024461 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Asset-light model with cash management income Biostime is principally a provider of imported infant milk formula (IMF) and baby care products in China. It achieved great success following China’s melamine scandal in 2008, as parents no longer trusted domestic IMF producers. The company has also gained significant profit from cash management, accumulating substantial cash flow from its downstream operations. Beneficiary of euro depreciation and declining raw milk prices in the EU Among all IMF operators listed in the mainland and Hong Kong, Biostime is the only producer that sources all its raw materials from the EU. According to the company’s calculations, a 3% decline in the euro would translate into a 1% increase in its GPM. In addition, the EU abolished milk production quotas on April 1 this year, which has led to an increase in supply and further ASP declines. The company’s upstream suppliers are expected to reduce farm-gate prices of raw milk by 5% during 2015. Above-peer performance metrics Over the past five years, turnover and net profit growth have mostly far exceeded Yashili (1230 HK, NR) and Beingmate (002570 CH, NR), while GPM and NPM have also consistently outpaced. As of end-2014, its cash and time deposits had reached Rmb 6,586m, accounting for 62% of its total assets, the highest of these three IMF companies. Biostime is trading at a significant discount to Yashili’s and Beingmate’s current respective 27x and 79x 2015E P/E. Increased focus on online expansion The company’s weakening performance in traditional brick-and-mortar stores can be partially explained by the increased popularity of online shopping. To counter this issue, Biostime has adjusted its strategy for online expansion, incorporating B2C, C2C and O2O models. Its O2O operations have seen rapid growth, contributing 10% of revenue in 2014. By the end of that year, its active O2O customer base had reached 85,000 per day, and GMV through the platform had reached Rmb810m, with 20,000 mom & baby product stores opened. The company expects B2C and O2O sales to account for 15% of total revenue in 2015. Turning point in MAMA 100 monetization The market for mom & baby products in China reached Rmb1,654bn in 2014, up 15.7% YoY. With about 2.2m active members on Biostime’s MAMA 100 platform by the end of 1Q15, the company hopes to establish this as a vertical and specialized platform for mom & baby products. For providers of platforms such as this, the key to success is the ability to scale up. We believe successful monetization of this online platform would boost Biostime’s valuation as major Chinese online retailers listed in the US are trading at more than 50x P/E. Leading infant milk formula innovator; initiate at Buy We expect Biostime’s earnings to grow at a CAGR of 14-20% during 2015-17. The stock is currently trading at 12.8x 2015E P/E and 4.1x P/B. We believe the company will continue to benefit from declining raw milk prices in the EU and depreciation in the euro during 2015. In addition, we believe the market has not factored in the monetization of its MAMA 100 platform. We initiate coverage with a Buy rating and a target price of HK$38.00, equivalent to 20x 2015E P/E, a ~25% discount to Yashili and a significant discount to Beingmate. Risks Increasing raw milk prices in the EU, tougher IMF competition and food safety issues.

Stock valuation

Sources: Company data, GF Securities (HK) Note: Calculated based on diluted shares.

Turnover Net profit EPS EPS YoY P/E BPS P/B ROE Net Gearing

(Rmb m) (Rmb m) (Rmb) (%) (Rmb) (%) (%)

2013 4,561 820 1.36 9.6 14.3 2,516 4.7 32.6 9.6

2014 4,732 801 1.33 (2.3) 14.6 2,917 4.0 27.5 5.5

2015E 5,193 917 1.52 14.5 12.8 2,883 4.1 31.8 cash

2016E 5,864 1,012 1.68 10.3 11.6 3,697 3.2 27.4 cash

2017E 6,750 1,220 2.03 20.6 9.6 3,356 3.5 36.4 cash

Stock performance

Source: Wind

Key data

Source: Bloomberg

Jun 10 close (HK$) 24.60

Share in issue (m) 602.3

Major shareholder Biostime Pharma (74.47%)

Market cap (HK$ bn) 14.8

3M avg. vol. (m) 3.2

52W high/low (HK$) 56.8/14.62

mailto:[email protected]

mailto:[email protected]

June 12, 2015

Company report

Business model Asset-light model has provided rapid growth Biostime is principally a provider of premium

pediatric nutritional and baby care products in China. Infant milk formula (IMF) currently contributes 80% of its total revenue. The company has adopted an asset-light formula, selling IMF under its own “Biostime” brand which has been produced overseas by OEM suppliers, meaning the company has not needed to spend significantly on dairy farms or factories. In 2014, PP&E accounted for just 8% of its total assets, while cash and deposits accounted for the largest share, at 62%. COGS made up the largest portion of total costs, representing 67.4%. Remuneration comes in second, at 26.7%, since revenue is mainly driven by its distribution network and incentive mechanism. After China’s melamine scandal in 2008, parents no longer trusted domestic IMF producers and people preferred buying imported IMF for their children. This was the primary reason why foreign IMF operators have seen a rapid rise in their market shares in recent years. Biostime has benefitted from this trend, seeing significant profit from an increase in ASP and sales volume. Income from cash management Biostime is a downstream operator with its own distribution

channels. Since distributors must pay in cash when goods are delivered, Biostime has accumulated a substantial amount of cash along with rapid sales growth. This money has been partly invested in loans, time deposits and other financial products for cash management, and its cash management income has also grown rapidly over the past three years, contributing Rmb105m in 2014 (11.5% of profit before tax).

Figure 1: Revenue breakdown (Rmb m) Figure 2: Revenue breakdown (%)

Sources: Company data, GF Securities (HK)

Figure 3: Breakdown of total costs (%) Figure 4: Breakdown of total costs in 2014 (%)


0%

20%

40%

60%

80%

100%

2007 2008 2009 2010 2011 2012 2013 2014

Probiotic supplements IMF

Baby food & nutrition supplements Baby care products

COGS67.37%

D&A1.84%

R&D1.86%

Lease2.10%

Auditors0.11%

Employee26.73%

June 12, 2015

Company report

Figure 5: Breakdown of total assets (%) Figure 6: Breakdown of total assets in 2014 (%)


Figure 7: Other income as a proportion of total profit before tax(%) Figure 8: Breakdown of other income/profit (%)


Industry analysis

Supply and Demand Number of newborn babies per year has remained stable over the past ten years IMF is

consumed by babies from newborn to 3 years. From 2003 to 2012, the number of newborn babies each year was broadly stable at about 16m. The birth rate in China declined from 18.2% in 1980 to 12.1% in 2012 due to the one-child policy. According to surveys by the National Bureau of Statistics, women aged 20 to 30 (childbearing age) have the highest fertility rate. In calculating the population of childbearing age from 2010 to 2022, meaning people born from 1980 to 2002, we found this number would decline after 2014, which means the number of new babies will probably drop as well. Given China’s aging population, the Chinese government eased the one-child policy last year, allowing people who are themselves only children to have a second child. However, the latest statistics show that second and third births among new babies rose just slightly. We believe this may be due to the financial burden or people’s career development – many people do not want to have more children even though they are allowed to do so. In fact, the situation is especially striking in developed countries. If the number of newborn babies remains at the current level of 16m per year, annual IMF consumption should be approximately 1.11m tonnes.

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2009 2010 2011 2012 2013 2014

Deferred tax assets

Receivables and prepayment

Investments

Goodwill and intangible assets

PPE and prepaid

Time deposits and related intems

Inventories

Cash and cash equivalents


50%

Time deposits12%

Inventories17%

PPE and prepaid for PPE8%

Receivables and prepayment

3%

Goodwill and intangible assets

2%

Deferred tax assets6%

Investment2%

2.59%

1.30%

10.05%

5.42%

9.16%

11.45%

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2%

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14%

2009 2010 2011 2012 2013 2014 0%

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2009 2010 2011 2012 2013 2014

Others

Government subsidies

Service income

FX gain

Interst from loans

Bank interest

June 12, 2015

Company report

Figure 9: Newborn babies (million) and birth rate (%) Figure 10: YoY change in new babies (%)

Sources: National Bureau of Statistics of China, GF Securities (HK)

Figure 11: Women’s fertility rate by age (%) Figure 12: Population of aged 20 to 30


Figure 13: New babies by birth order (%) Figure 14: IMF consumption volume by age


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New born babies (m) Birth rate (‰, RHS)

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81

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YoY change of new babies (%)

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15-19 20-24 25-29 30-34 35-39 40-44 45-49

2007

2008

2009

2011

2012

-4%

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-2%

-1%

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1%

2%

3%

190

200

210

220

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260

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Population of age from 20 to 30 (m) YoY change (%, RHS)

66.83% 67.53% 67.08% 66.38% 65.14%

29.50% 28.80% 29.33% 29.30% 30.42%

3.67% 3.68% 3.59% 4.33% 4.39%

0%

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100%

2007 2008 2009 2011 2012

1st child 2nd child 3rd child

Age Volume Volume Babies Total volume

(g/day) (kg/year) (million) (tonne)

0-0.5 100.0 18.0 16.0 288,000.0

0.5-1 85.0 15.7 16.0 251,600.0

1-2 56.0 20.4 16.0 327,040.0

2-3 42.5 15.5 16.0 248,200.0

Total 283.5 69.7 64.0 1,114,840.0

June 12, 2015

Company report

Competition The increase in IMF imports intensifies competition According to data from the China Dairy

Association, the amount of imported milk powder has risen rapidly from 2007 to 2013. ASP and volume have been rising since 2009. In 2H13, major dairy companies purchased more milk powder than usual due to a milk shortage panic, which directly led to inventory destocking and an ASP slump for raw milk in China during 2014. Imported milk powder includes IMF, whole milk powder (WMP), skimmed milk powder (SMP) and others. WMP and SMP can be made into other dairy products besides IMF, such as yogurt and milk beverages. Due to destocking, imported milk powder for dairy products has been declining since 2H14. Competitors’ overseas upstream expansion New entrants include Evergrande (3333 HK, NR),

a real estate developer which acquired an IMF company in New Zealand and has started to sell IMF in China. Other domestic rivals also have overseas strategic plans. Yili (600887 CH) invested Rmb3bn in dairy production in New Zealand. In the US, Yili set up a JV to produce IMF with Dairy Farmers of America (DFA), the largest dairy company in the country. Mengniu (2319 HK, Accumulate) introduced Danone (France) and Arla (Denmark) as strategic investors to Yashili (1230 HK, NR), expecting synergy in IMF. Beingmate (002570 CH) has signed contracts for OEM supply of IMF from Ireland. Meanwhile, foreign operators have started to go upstream in China, primarily to source local raw milk. Fonterra and Abbott announced that they would build five dairy farms in China, investing US$300m. Nestle signed an agreement with China Modern Dairy (1117 HK, Underperform) for the supply of raw milk supply for IMF production. Given intense competition in the industry, we expect profit margins at IMF operators to decline. Another threat comes from overseas online purchases.

Figure 15: Imported volume and ASP of milk powder Figure 16: Value of imports and YoY change in ASP and volume

Sources: Wind, China Diary Association, GF Securities (HK)

Figure 17: IMF volume by source (tonne) Figure 18: IMF volume by source (%)

Sources: Wind, China Diary Association, GF Securities (HK)

3,298

3,941

2,352

3,353 3,661

3,364

4,196

4,803

0

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2007 2008 2009 2010 2011 2012 2013 2014

Imported volume (tonne) ASP (USD/tonne, RHS)

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2007 2008 2009 2010 2011 2012 2013 2014

Imported amount (USD m) YoY change of ASP (%, RHS)

YoY change of volume (%, RHS)

-500,000

0

500,000

1,000,000

1,500,000

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2010 2011 2012 2013

Production volume (tonne) Import volume (tonne)

Export volume (tonne) Total supply (tonne)

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2010 2011 2012 2013

Production volume (tonne) Import volume (tonne)

June 12, 2015

Company report

Government policies Encouraging M&A among IMF companies China’s State Council issued a plan to encourage M&A

among IMF companies in June, 2014, which stated that the annual revenue of each of the top ten IMF companies should reach Rmb2bn by the end of 2015, while their total sales should account for 65% of the industry’s total. By 2018, the government hopes to see three to five large IMF groups with annual sales of more than Rmb5bn, while the concentration ratio of the leading ten should be 80% in terms of revenue. There have also been recent M&A. In Aug 2014, Fonterra purchased a 20% stake in Beingmate for Rmb3.68bn. In 2013, Mengniu became the largest shareholder of Yashili with a stake of 76.58%, hoping to develop its IMF business on Yashili’s platform. In Oct 2014, Danone announced it would purchase a 25% stake in Yashili in a private placement totaling HK$4.39bn, expecting synergy from IMF cooperation. At the same time, Huishan Dairy (6863 HK, NR) established a 50-50 JV with Friesland Campina to manufacture and sell IMF in China. Strict policies for IMF imports After China’s melamine scandal in 2008, Chinese parents no longer

trusted domestic IMF producers, with people preferring imported IMF for their children. This allowed overseas operators to increase their market shares over the last few years. Some companies imported overseas IMF in large packages and then divided them into retail cans, even though the quality of the IMF could not be guaranteed. Some companies dissolved raw milk powder in water and then produced IMF, which is harmful for babies’ health due to the reheating process. According to new regulations from China’s General Administration of Quality Supervision, Inspection and Quarantine for IMF produced by overseas enterprises, which took effect from May 2014, only IMF produced by overseas companies, which have been registered in China, can be imported. IMF in large packages cannot be imported if it will be divided into small packages in China, meaning IMF should have been canned in retail packages. Also, IMF cannot be imported if it will be out of date within three months. The strict policies show the official attitude for safety and quality control, and benefit formal IMF operators in China. Fine for the violation of the Anti-Monopoly Law (AML) to control price increases Retail prices

of IMF have been increasing since 2009. Due to safety concerns, Chinese parents have increasingly turned to overseas IMF brands, and were also insensitive to prices. Some even regarded the high prices of imported IMF as a guarantee of quality. This provided huge opportunities for foreign brand owners, who frequently raised retail IMF prices from 2008 to 2013. This led to increasing living costs and performance declines for domestic IMF operators, neither of which was favored by the Chinese government. In Jul 2013, six major overseas IMF operators were fined Rmb669m by the National Development and Reform Commission (NDRC) for violating the Anti-Monopoly Law, since they provided fixed prices for products in agreement with distributors.

Figure 19: Retail prices of domestic and overseas IMF (Rmb/kg) Figure 20: ASP increases by major foreign IMF operators


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Retail price of domestic IMF (Rmb/kg) Retail price of overseas IMF (Rmb/kg)

Year Month Company Price increase (%) Reasons

2008 Sep Mead Johnson 15% Formula upgrade

2009 JulWyeth, Abbott,

Dumex7-10% Cost rise, package upgrade

Jan Nestle 5-10% Cost rise

Feb Mead Johnson 8% Cost rise of raw materials and operation

Mar Abbott 30% Formula upgrade

Apr Mead Johnson 11% Cost rise

Jun Abbott 10% Package upgrade

Jul Dumex 10% Cost rise of raw materials

Apr Nestle 20% Cost rise of raw materials

Jul

Wyeth, Abbott,

Dumex, Friso,

Similac (Abbott)

10-15% Package upgrade

Dec Abbott, Nestle 8% Formula upgrade

Apr Nestle 10% Cost and duty rise

Apr Mead Johnson 13% Cost and duty rise

May meiji 15% Cost rise

Jul Dumex 10% Formula upgrade and R&D rise

2013 Apr Wyeth 10% Cost rise

2010

2011

2012

June 12, 2015

Company report

Figure 21: Anti-Monopoly fines for IMF operators in 2013 Figure 22: IMF imported in retail cans in 2014


Financial analysis

A leader among domestic IMF operators Biostime has become a leader among listed IMF

companies in mainland China and Hong Kong. In the past five years, turnover and net profit growth has mostly far exceeded that of Yashili and Beingmate. 2013 was an exception, as Biostime was fined Rmb162.9m by the Chinese government, while the other two were not punished financially. In 2014, Beingmate and Yashili reported -90% and -43% YoY net profit growth, while this dropped just 2% for Biostime. The company’s GPM and NPM has also consistently outpaced these two competitors. In addition, its cash and time deposits accounted for 62% of total assets, the highest among the three IMF companies. The proportion of PP&E related assets is lowest in Biostime’s assets breakdown, meaning it has the most asset-light business model. Biostime’s debt-to-asset ratio reached 56% since it issued a zero coupon convertible bond totaling HK$3.1bn for M&A in 2014.

Figure 23: Turnover comparison (Rmb m) Figure 24: YoY change in turnover (%)


Company Fine (Rmb m) Percentage of revenue Country

Biostime 162.90 6.00% France (China)

Mead Johnson 203.76 4.00% US

Dumex 171.99 3.00% France

Abbott 77.34 3.00% US

Friesland 48.27 3.00% Holland

Fonterra 4.47 3.00% New Zealand

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Volume (tonnes) Amount (USD m)

559

1,234

2,189

3,382

4,561 4,732

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2009 2010 2011 2012 2013 2014

Biostime Yashili Beingmate

120.68%

77.46%

54.49%

34.87%

3.73%

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2010 2011 2012 2013 2014


June 12, 2015

Company report

Figure 25: Net profit comparison (Rmb m) Figure 26: YoY change in net profit (%)


Figure 27: GPM comparison (%) Figure 28: NPM comparison (%)


Figure 29: Asset breakdown comparison (2014) Figure 30: Sum of cash flow comparison from 2009 to 2014 (Rmb m)


Slowdown in offline organic growth Biostime’s revenue from its network expansion has been

lower than expected in recent years. Turnover per store and per active member on the MAMA 100 platform decreased by 35.6% and 1.8% YoY in 2014, respectively. At the same time, revenue growth declined from 34.9% YoY in 2013 to 3.9% YoY in 2014, while net profit posted a negative YoY change. According to Dupont analysis, its ROE increase was due to its higher asset turnover ratio and higher leverage while its ROA decline was a result of declines in net profit. Meanwhile, its net profit margin has shrunk and its leverage has increased. We believe this reflects intensified competition in the industry. Since the ASP increase has been halted by the government’s anti-trust

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2009 2010 2011 2012 2013 2014


137.76%

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58.71%

9.57%-2.28%

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2010 2011 2012 2013 2014


70.84% 71.11%

66.52% 65.91% 65.23%

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2009 2010 2011 2012 2013 2014


19.38%

21.54%

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17.99%17.05%

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2009 2010 2011 2012 2013 2014


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Cash and bank balances

Pledged deposits

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Bond or loan receivables

Deferred tax assets

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PPE and related

3,476

-2,929

1,827

2,375

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CFO CFI CFF CF


June 12, 2015

Company report

fine, Biostime hopes to increase its market share with an aggressive offline expansion. A main reason was its low penetration rate in mom & baby stores and supermarkets, about 60%, which means more room for market share growth. But, sales volume increase in the offline channels was slower than expected, leading to a decline in operation efficiency per store during 2014.

Figure 31: Biostime’s turnover and net profit Figure 32: Biostime’s GPM and NPM


Figure 33: IMF turnover per store and YoY change Figure 34: IMF turnover per active member and YoY change


Figure 35: Cash flow (Rmb m) Figure 36: Sum and average value from 2007 to 2014 (Rmb m)


137.76%

83.07%

58.71%

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2009 2010 2011 2012 2013 2014

Revenue (Rmb m) Net profit (Rmb m)

Revenue growth (RHS, %) Net profit growth (RHS, %)

70.84% 71.11%

66.52% 65.91% 65.23%61.86%

19.38%21.54%

24.09%21.97%

17.99% 17.05%

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2009 2010 2011 2012 2013 2014

Gross profit margin Net profit margin

139 165

177 181

117

18.25%

7.72%

2.24%

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2010 2011 2012 2013 2014

IMF turnover per store (Rmb '000) YoY change (RHS)

1,705

2,041 1,938

2,071 2,034

19.76%

-5.05%

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IMF turnover per active member (Rmb) YoY change (RHS)

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CFO CFI CFF CF

3633

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454-370 225 310 416

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CFO CFI CFF CF Net profits

Sum (Rmb mn) Average (Rmb mn)

June 12, 2015

Company report

Figure 37: CFO/Net profit Figure 38: YoY change in sales, net profit and CFO

Sources: China Internet Network Information Center, GF Securities (HK)

Figure 39: End cash, CFI, dividend paid and debt increased (Rmb m) Figure 40: Expenses and gross profit (Rmb m)


Figure 41: Expense sum/gross profit (%) Figure 42: Turnover days of inventory and accounts payable


141.18%

65.71%

101.85%

143.23%

97.91%

127.46%

80.39%

120.45%

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2007 2008 2009 2010 2011 2012 2013 2014

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YoY change of CFO

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CFI Dividends paid Debt increased End Cash

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5,000

2007 2008 2009 2010 2011 2012 2013 2014

S&D expenses Admin expenses Finance expenses

Revenues COGS Gross profits

76.09%79.75%

69.19%

61.23%

54.33% 53.70%57.18%

63.20%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2007 2008 2009 2010 2011 2012 2013 2014

(S&D+Admin+Finance expenses)/Gross profit

94 99

128

170176

53

33

52

7165

0

20

40

60

80

100

120

140

160

180

200

2010 2011 2012 2013 2014

Inventory days Accouts payables turnover days

June 12, 2015

Company report

Figure 43: ROE breakdown Figure 44: ROE and ROA


Outlook

Upstream investment to ensure OEM supply Since milk source is crucial for downstream

operations, Biostime has taken measures to guarantee a stable and safe upstream supply. In 2012, Biostime invested HK$108m for Arla Food, the seventh largest dairy company in the world, for IMF capacity expansion in Denmark, accounting for 50% of Arla’s total investment. Biostime signed a supply agreement for IMF with Arla, for a term of ten years. In 2013, Biostime purchased a 20% stake in Isigny Sainte Mere (ISM) for HK$25.47m. Biostime has also purchased bonds from ISM to the value of HK$176m. These transactions should guarantee ISM’s supply to Biostime for 15 years. At present, Biostime has three OEM suppliers for IMF production, Arla in Denmark, ISM and Laiterie de Montaigu in France. All of these three have finished their registration for IMF imports with the Chinese government. These upstream financial investments help Biostime to maintain its asset-light operation. Increased effort in online expansion Due to changing customer habits, baby specialty stores now

account for 70% of all distribution channels, achieving the largest share by 1Q15. The proportion of supermarkets is shrinking given high entrance fees collected from brand operators. Since supermarkets with large networks have strong bargaining power with brand owners, the profit margin from this channel has been declining, according to Biostime. From the YoY changes in stores and IMF turnover, we have seen higher growth in turnover than that in stores from 2011 to 2013, meaning channel expansion has driven faster sales growth. However, this was not the case in 2014. Stores increased by 64.7% YoY, while sales only rose by 6.1% in 2014. Meanwhile, IMF turnover per store and per active member on MAMA 100 declined by 35.6% and 1.8%, respectively. Revenue was probably driven by offline expansion rather than organic growth. The performance decline in offline stores could be partially explained by the increase in online shopping. To counter this issue, Biostime has adjusted its strategy for online expansion, incorporating B2C, C2C and O2O models. Its O2O operations have seen rapid growth, contributing 10% of revenue in 2014, about Rmb1bn, and accumulating 2.2 m registered members by 1Q15. The number of active customers has also reached an all-time high, 85,000 per day. GMV on this platform was Rmb810m with 20,000 mom & baby stores opened by the end of 2014. Biostime expects B2C and O2O sales to account for 15% of total revenue in 2015.

0%

5%

10%

15%

20%

25%

30%

0.00

0.50

1.00

1.50

2.00

2.50

3.00

2007 2008 2009 2010 2011 2012 2013 2014

Asset turnover Leverage ratio Net profit margin (%, RHS)

0%

10%

20%

30%

40%

50%

60%

70%

2007 2008 2009 2010 2011 2012 2013 2014

ROE ROA

June 12, 2015

Company report

Figure 45: Distribution channel breakdown Figure 46: Distribution channel breakdown (%)


Figure 47: YoY changes in stores and IMF turnover (%) Figure 48: Sales contribution from the MAMA 100 platform (%)


Online shopping on the rise Biostime is increasing its e-commerce efforts, since more customers

in China now prefer to shop online. Biostime’s products have been sold on major e-commerce platforms, such as Taobao, Jingdong and Yihaodian. Some baby specialty stores have even opened online shops, reflecting the O2O trend. E-commerce is now seeing the fastest growth of all sales channels. Online sales of IMF and baby diapers grew 38% and 46% in 2014, according to the Nielson Index.

Figure 49: Online shopper numbers and penetration Figure 50: Online shopping value and YoY change in China

Sources: China Internet Network Information Center, Nielson Retail Index/Baby Panel/E-commerce Panel, GF Securities (HK)

79.52%

49.63%

35.16%

64.65%

11.39%

70.22%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2010 2011 2012 2013 2014 1Q15 1Q14 1Q15

Baby specialty stores Retail organization

Pharmacies YoY change of total outlets (RHS, %)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014 1Q2015

Baby specialty stores Supermarkets Pharmacies

79.52%

49.63%

35.16%

64.65%

112.29%

61.18%

38.18%

6.13%

0%

20%

40%

60%

80%

100%

120%

2011 2012 2013 2014

YOY change of stores (%) YOY change of IMF turnover (%)

78.00%

84.70%

88.90%

77.00%

70%

72%

74%

76%

78%

80%

82%

84%

86%

88%

90%

2011 2012 2013 2014

Sales contributed by Mama 100 (%)

34 4674

108

161194

242

30224.5%

22.1%24.8%

28.1%

35.1%37.8%

42.9%

48.9%

0%

10%

20%

30%

40%

50%

60%

0

50

100

150

200

250

300

350

2006 2007 2008 2009 2010 2011 2012 2013

Online Shoppers (m) Penetration Rate (RHS, %)

25.8 54.2 120.8 250.0

523.1

756.6

1,311.0

1,847.7

64.0%

110.1%

122.9%

107.0% 109.2%

44.6% 73.3%

40.9%

0%

20%

40%

60%

80%

100%

120%

140%

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2006 2007 2008 2009 2010 2011 2012 2013

Online shopping amount (Rmb bn) YoY growth (RHS, %)

June 12, 2015

Company report

Figure 51: IMF and baby diaper sales growth in 2014 (%) Figure 52: IMF retail sales by distribution channel

in 2014 (%)

Sources: Nielson Retail Index/Baby Panel/E-commerce Panel, GF Securities (HK)

1. New IMF brand “Adimi” for low-end customers In 2013, Biostime acquired a 100% stake in

Changsha Yingke, an IMF producer, for Rmb350m, which it paid in cash. Biostime hopes to import raw materials from Europe and produce low-end IMF under the Adimi brand using Changsha Yingke’s production license. As competition in first-tier cities has become increasingly intense, the company hopes this strategy will allow it to capture the part of the market that has been ignored by competitors. We expect revenue from this IMF series to grow rapidly, from a low comparable base. 2. JV for baby diaper production In 2014, Biostime set up a JV with Coco Healthcare for baby

diaper production. With a stake of 60%, Biostime will invest Rmb40m in the JV. Biostime is seeking new growth in baby care products given the increasingly intense competition in IMF. It has accumulated big data on customers from the MAMA 100 platform, which will help cross selling of baby care products in different channels. 3. Monetization of MAMA 100 Platform

1. Business Model: In 2014, the mom & baby product market in China was worth

Rmb1,654bn, up 15.7% YoY, while online sales of Rmb132bn accounted for 8.0% of the total. According to iResearch, revenue in 2018 contributed by mom & baby goods will increase to Rmb3,020bn, meaning significant opportunities for online retailers. With about 2.2m active members on the MAMA 100 platform, Biostime hopes to establish this as a vertical and specialized online platform for mom & baby products. Biostime’s e-commerce operations began in Jan 2015, and will be opened to external brand operators, while earning transaction fees, generally 1-2% per transaction. Its profit model is similar to Taobao, but focuses on mom & baby products. For providers of platforms such as this, the key to success is the ability to scale up. A potential conflict is that Biostime’s e-commerce model is based on its members. It is therefore not as open as other online-shopping operators, while aiming to stimulate sales under the Biostime brand. Major IMF competitors will therefore not want to sell on such a channel. Biostime’s management plans to separate the platform from Biostime in terms of business, personnel and equity ownership in the future. We believe the separation is mainly to solve potential conflicts between Biostime and other competitors, while it hopes to set up an open and independent online platform.

-8%

8%

38%

7%

-4%

9%

46%

9%

-20%

-10%

0%

10%

20%

30%

40%

50%

Retail organizations Baby Specialty stores E-commerce Total

IMF sales growth Baby diaper sales growth

Retail organizations

34%

Baby Specialty

stores42%

E-commerce24%

June 12, 2015

Company report

Figure 53: The value chain for online operators in mom & baby products

Sources: GF Securities (HK)

Figure 54: Sales model comparison

Sources: Jumei’s Prospectus, GF Securities (HK)

Figure 55: Market size of mom & baby products in China (Rmb bn) Figure 56: E-commerce sales of mom & baby products in China (Rmb bn)

Sources: iResearch, Wind, GF Securities (HK)

Brand owners

Mom’s social networking platform

Online education platform

Comprehensive online operators

Vertical operators of Baby & Mom platform

Customers

Marketing Platform

Transaction Platform

Online retailing Flash sales

Products Branded products Branded products

Duration Long-term offering Short-term offering

Breadth of offering Wide Selected focus ing on brands

Pricing Attractive price Deep discount

Merchandize a wider selection of

productsSelect brands

Act mainly as principal ; or as service

provider for third-party merchants

Act as service provider for third party

merchants

Operators ' role

1,004 1,1091,257

1,4301,654

1,9172,228

2,592

3,020

10.41%

13.31% 13.84%

15.65% 15.86% 16.23% 16.35% 16.50%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E

Market size of Baby & Mom products in China(Rmb bn)

YoY change (%)

June 12, 2015

Company report

Figure 57: China’s online sales distribution of mom & baby products in 3Q14

Figure 58: Online customer distribution of mom & baby products by age in 2Q14

Sources: iResearch, EnfoDesk, Wind, GF Securities (HK)

Figure 59: China’s IMF online B2C sales distribution by brand in 2Q14

Figure 60: China’s IMF online C2C sales distribution by brand in 2Q14

Sources: iResearch, EnfoDesk, Wind, GF Securities (HK)

Figure 61: Online IMF sales breakdown by ASP (%) Figure 62: Biostime’s MAMA 100 app

Sources: Company data, iResearch, EnfoDesk, Wind, GF Securities (HK)

Tmall55.50%

Jingdong17.40%

Dangdang4.60%

Suning4.30%

Yihaodian3.60%

Amazon China1.70%

Weipinhui1.60%

Others11.30%

9.40%

17.00%

25.70%

25.60%

17.30%

5.00%

0 0.05 0.1 0.15 0.2 0.25 0.3

>40

36-40

31-35

25-30

19-24

<18

Online customer distribution of Baby & Mom products by age in 14Q2 (%)

Friso (Friesland)

24.3%

Wyeth (Nestle)16.9%

Abbott11.7%

Nutrilon (Danone)

9.5%

Karicare (Danone)

8.1%

Beingmate5.6%

Meadjohnson4.6%

Nestle4.6%

Dumex (Danone)

2.2%

Feihe 1.8%

Others10.7%

Nutrilon (Danone)

17.9%

Friso (Friesland)

9.1%

Wyeth (Nestle)7.3%

Beingmate6.4%

Meadjohnson5.8%

Karicare (Danone)

4.8%

Aptamil (Danone)

4.1%

Abbott3.7%

Yili3.3%

Nestle2.4%

Others35.2%

4.1%

8.9%

6.0%

15.8%

56.9%

32.9%

23.4%

29.3%

25.9%

10.4%

3.5%

7.5%

7.8%

4.8%

38.5%

22.9%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

B2C

C2C

Total

<100 100-200 200-300 300-400 400-500 >500

June 12, 2015

Company report

Figure 63: Asset breakdown comparison of major Chinese online retailor listed in the US


2. External financing to be completed this year According to Biostime, A-round financing

will be conducted among employees, while the B-round is for external investors. Its current strategy is to accelerate GMV (gross merchandise volume), increase revenue and achieve operating income, which are crucial for external financing and future development. We estimate external investors will probably require a separate listing of MAMA 100 in the future.

3. Competitive landscape

1. Brand operators prefer large online platforms Given their substantial GMV, large

platforms have strong bargaining power with brand owners.

2. Weak user stickiness Mom & baby products are mainly purchased by moms –

women aged 19-40. However, their user stickiness to online operators is relatively weak, especially compared with social network platforms. Since it costs very little for a user to switch to another platform, it is easy for them to be attracted by low prices. As companies fight for sales expansion, competition will lead to price wars. Biostime currently has about 2.2m active members, whose every purchase is recorded on the MAMA 100 platform. The company has also launched an app for social networking among members, something which has led to improved user stickiness. We see Biostime as a leading innovator compared to other IMF companies.

3. Intense competition comes from online retailers and vertical operators Most

comprehensive online retailers have been listed, including Alibaba (BABA), Jingdong (JD) and Dangdang (DANG) and Jumei (JMEI). Compared with Jingdong, Dangdang and Jumei, which all purchase goods from brand operators and then sell on to customers, Alibaba has a relatively asset-light model as a platform provider. Unlike the other three, it does not keep inventory or need significant logistics capex. All of these companies have accumulated substantial cash flow for investment, which has contributed significantly to their profits. Each operator has its own business unit for mom & baby products.

Further competition comes from vertical and specialized online retailers, most of which have PE/VC support. During 2014, major vertical and specialized mom & baby product online operators completed several rounds of financing and expanded rapidly. Raised funds will be used for domestic or overseas logistics, staff recruitment, GMV expansion etc. We see more intense competition in 2015, and expect large efficient players to increase their market share.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

BABA.N JD.O JUMEI.N DANG.N

Others

Goodwill

Intangible assets

Land use rights

Prepaid expenses and deposits

Construction in progress

Property and equiptment

Prepayments, receivables and other assets

Amount due from related parties

Deferred tax assets

Investment in equity investees

Prepayments, receivables and other assets

Advance to suppliers

Investment securities

Inventories

Loan receivables

Restricted cash and escrow receivables

Short-term investments


June 12, 2015

Company report

Figure 64: Comprehensive online retailer comparison

Sources: Company data, Wind, GF Securities (HK) Note: * As of Jun 10 close. *Jun 10 close.

Figure 65: Vertical online operator comparison

Sources: MoF, GF Securities (HK)

4. New entrants on the way The size of the market has also attracted new entrants,

including Jumei (JMEI), which is China’s largest online retailer of beauty products. Most of its customers are women aged between 20 and 30, which overlaps with the purchasers of mom & baby products.

Earnings outlook and valuation We expect Biostime’s revenue to grow at a CAGR of 14-20%

during 2015-17 given its increasing recognition by the market. The rise in GPM will mainly be a result of depreciation in the euro and declining raw milk prices in the EU. However, gross profit will be offset slightly by rising selling, distribution and administrative costs due to intense competition. We estimate net profit will rise by 14-21% during 2015-2017. The stock is trading at 12.8x 2015E P/E or 4.1x 2015E P/B, a significant discount to Yahili’s and Beingmate’s current respective 27x and 79x. We also believe the market has not factored in the monetization of the MAMA 100 platform. We initiate our coverage with a Buy rating and a target price of HK$38.00, equivalent to 20x 2015E P/E, representing a ~25% discount to Yashili and a~ 75% discount to Beingmate. Risks Increasing raw milk prices in the EU, tougher IMF competition and food safety issues.

Company Ticker 2014 Revenue Market Cap* 2014 Net Profit Share Price** NPM ROE P/E P/B P/S P/CF GMV Annual Active P/GMV

(Rmb m) (Rmb bn) (Rmb m) (USD) (%) (%) (2014) (2014) (2014) (2014) RMB (m) Buyers (m)

Alibaba BABA 76,204 1,375,469 24,149 88.90 31.7% 15.3% 57.0 8.7 18.0 238.5 2,444,000 334.0 0.6

Jingdong JD 115,002 307,426 -4,996 36.26 -4.3% -13.3% -57.3 8.2 2.7 302.9 260,200 96.6 1.1

Dangdang DANG 7,957 5,036 88 10.05 1.1% 13.0% 52.9 7.4 0.6 19.0 N/A 24.3 N/A

Jumei JMEI 3,873 20,571 343 22.85 8.9% 10.2% 64.4 6.1 5.3 48.9 6,642 13.3 3.3

Company Website Valuation GMV Business model Targeted PE/VC

(USD m) (Rmb) customers Round Amount Time

>100 mn Flash sales A Several mill ion USD Jan 2014

by Oct 2014 B USD20m May 2014

C USD60m Dec 2014

>60 mn

B2C

Platform/Flash

sales

B Rmb150m Aug 2014

by Sep 2014Cross-border

online retailingC USD100m Jan 2015

B2C Platform

>10 mn/monthCross-border

online retailingAngel seed

Several mill ion

RmbMar 2014

A USD5m Jul 2014

B USD30m Nov 2014

700 Angel seed Rmb5m Dec 2011 Tisiwi

A Several m Rmb Jan 2015

SAIF, Grand

Yangtze, Shanghai

International

Group

Flash sales B USD100m Jan 2014

Parents Angel seed Several m Rmb Dec 2012

A Several m Rmb Aug 2013

B USD20m Jul 2014

C USD100m Mar 2015

A USD10m 2007

Mar 2008

Jan 2011

Online retaill ing

Baby & Mom

product

purchasers

C Rmb150m Jan 2014

H capital, Sequoia,

Zhenfund, China

RenaissanceCross-border

online retailing

Financing

Miyabaobei www.miyabaobei.com 400

Baby & Mom

product

purchasers (High-

end)

Customers prefer

international

products

Longling

investment,Matrix

partners, Morning

Side,China

Renaissance

Beibei www.beibei.com 1,000

Customers in

second or third

tier cities

Capital today, New

Horizon, IDG, Banya

fund

Lamahui www.lamahui.com N/A N/A

Baby & Mom

product

purchasers

A Rmb90m Aug 2014SAIF,DT

Capitals,Telescope Cross-border

online retailing

by Dec 2014 Flash sales

Ymatou www.ymatou.com 1,000

Cross-border

online retailing

Metao www.metao.com 100

Customers prefer

international

productsby Dec 2014

Lamabang www.lamabang.com 1,000

>50 mnMobile

Community

by Apr 2015 Online retaill ing

Babytree www.babytree.com 1,000 N/A

Mobile

Community Matrix Partner, SIG,

China Broadband

Capital, XRS.N

B USD10m

China

Remaissance,

Partner Angel,

Matrix

Partner,MorningSid

Baby & Mom

product

purchasers

Parents

June 12, 2015

Company report

Figure 66: Rmb/Euro Figure 67: Historical ratio comparison

Sources: Wind, GF Securities (HK)

Figure 68: Biostime’s market value from Jan 1, 2012, to Jun 10, 2015 (Rmb)

Figure 69: P/E comparison from Jan 1, 2012, to Jun 10, 2015


Figure 70: P/E comparison from Jan 1, 2012, to Jun 10, 2015 Figure 71: Market value comparison from Jan 1, 2012, to May 22,

2015 (Rmb)


6.0000

6.5000

7.0000

7.5000

8.0000

8.5000

9.0000

Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15

Rmb/Euro

Market value (Rmb) P/E

Max 34,342,844,836 45.3

Min 6,464,135,292 8.7

Average 16,692,544,985 23.6

Current 14,739,752,645 18.3

June 12, 2015

Company report

Figure 72: Key assumptions


Figure 73: Financial statements

2013 2014 2015E 2016E 2017E

Probiotic supplements (RmbK) 458,164 425,094 446,349 477,593 515,801

YoY change (%) 20.82% -7.22% 5.00% 7.00% 8.00%

IMF (Rmb K) 3,752,116 3,981,575 4,320,009 4,881,610 5,613,852

YoY change (%) 38.18% 6.12% 8.50% 13.00% 15.00%

Baby food and nutrition (Rmb K) 198,778 198,778 218,656 244,894 281,629

YoY change (%) 9.57% 0.00% 10.00% 12.00% 15.00%

Baby care products (Rmb K) 152,241 173,474 208,169 260,211 338,274

YoY change (%) 43.64% 13.95% 20.00% 25.00% 30.00%

Total sales (Rmb K) 4,561,299 4,778,921 5,193,182 5,864,309 6,749,555

YoY change (%) 34.87% 4.77% 8.67% 12.92% 15.10%

GPM (%) 65.23% 61.86% 66.59% 62.40% 62.40%

NPM (%) 17.99% 17.05% 17.70% 17.30% 18.12%

S&D cost/Rev (%) 33.17% 33.56% 37.07% 34.09% 32.47%

Admin cost/Rev (%) 3.89% 3.70% 4.05% 3.68% 3.68%

June 12, 2015

Company report


Year-end Dec 31 (Rmb m) 2013 2014 2015E 2016E 2017E Year-end Dec 31 (Rmb m) 2013 2014 2015E 2016E 2017E

Turnover 4,561 4,732 5,193 5,864 6,750 PPE and others 337 494 538 576 634

Cost of sales (1,586) (1,805) (1,735) (2,205) (2,538) Land lease prepaid 84 63 63 63 63

Gross profit 2,975 2,927 3,458 3,659 4,212 Intangible assets 149 180 180 180 180

Other income and gains 106 128 128 128 128 Bond & loans receivable 184 184 161 144 130

Distribution costs (1,513) (1,588) (1,925) (1,999) (2,192) Investment in an associate 0 81 81 81 81

Administrative expenses (177) (175) (210) (216) (248) Held-to-maturity investment 21 19 19 19 19

Finance costs (11) (87) (87) (87) (87) Time deposits 855 1,146 860 972 1,118

Anti-Monopoly fine (163) 0 0 0 0 Deferred tax assets 124 129 129 129 129

Other expenses (56) (88) (64) (72) (83) Non-current assets 1,754 2,295 2,031 2,163 2,354

Profit before tax 1,162 1,118 1,300 1,414 1,731 Inventories 972 797 512 1,151 763

Income tax (341) (312) (381) (400) (507) Trade and bills receivables 15 12 7 15 11

Profit for the year 821 806 919 1,014 1,223 Prepayments and others 113 137 81 166 119

FX differences (1) (6) (2) (3) (3) Restricted cash and deposits 70 0 0 0 0

Total profit 820 801 917 1,012 1,220 Loan receivable and derivatives 33 42 19 15 12

Profit for shareholders 820 801 917 1,012 1,220 Cash and cash equivalents 1,663 3,347 4,378 4,877 5,467

Current assets 2,866 4,336 4,998 6,224 6,372

Trade payables and others 1,081 1,032 1,150 1,298 1,494

Interest-bearing bank loan 751 0 423 901 1,452

Year-end Dec 31 (Rmb m) 2013 2014 2015E 2016E 2017E Tax payable 213 236 247 279 321

Profit before tax 1,162 1,118 1,300 1,414 1,731 Current liabilities 2,045 1,268 1,820 2,478 3,267

Interest income (88) (113) (179) (198) (221) Deferred tax liabilities 60 36 36 36 36

Finance costs 11 87 87 87 87 Convertible bonds 0 2,411 2,290 2,175 2,067

D&A 27 51 59 61 66 Non current Liabilities 60 2,446 2,326 2,211 2,103

Others 4 0 1 2 1 Issued capital 5 5 5 5 5

Stock option expenses 59 17 17 17 17 Reserves 2,143 2,648 2,586 3,377 2,985

Changes in working capital (167) 151 (322) (372) (427) Equity component of CB 0 67 67 67 67

Tax paid (347) (338) (362) (393) (481) Proposed dividends 367 197 224 248 299

CFO 660 972 600 618 772 Equity 2,516 2,917 2,883 3,697 3,356

Capex (416) (135) (173) (195) (225)

Others 335 (326) 24 24 24 Year-end Dec 31 (Rmb m) 2013 2014 2015E 2016E 2017E

CFI (81) (460) (149) (171) (200) ROE (%) 33 27 32 27 36

Shares purchased (64) 0 0 0 0 ROA (%) 17.7 12.1 13.0 12.1 14.0

Changes in bank loans 480 (751) 423 478 550 EBITDA margin (%) 26.3 26.5 27.8 26.6 27.9

Interest paid (9) (9) (9) (9) (9) EBIT margin (%) 25.7 25.5 26.7 25.6 26.9

Issuance of convertible bond 0 2,414 0 0 0 Interest cover (x) 640 15 (18) 19 23

Dividends paid (622) (493) (585) (645) (778) Debt/ asset ratio (%) 45.6 56.0 59.0 55.9 61.5

Net CFF (215) 1,162 (170) (176) (237) Net gearing (%) 9.6 5.5 (3.3) (2.2) (1.1)

Net increase of CF 365 1,684 281 271 335 Current ratio (x) 1.4 3.4 2.7 2.5 2.0

Beginning Cash 401 765 2,447 2,726 2,994 Quick ratio (x) 0.3 2.0 2.1 1.5 1.4

FX effect (1) (1) (2) (3) (3) Inventory turnover days 170 176 136 136 136

End Cash 765 2,447 2,726 2,994 3,326 Receivables turnover days 1.1 0.7 0.8 0.8 0.3

Payable turnover days 41.8 44.7 50.0 42.9 42.5

Cash conversion cycle days 128.9 132.5 86.5 93.7 93.6

Income Statement

Cash Flow Statement

Balance Sheet

Financial Ratios

June 12, 2015

Company report

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

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