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Be selective − watch out, the tide’s going out
We suggest investors remain selective in investing in China staple stocks after the share price rally since 2H last year. Trading up remains the main theme, and companies involved in the consumer trade uptrend should fare better, but mass-market players may still not be able to generate sufficient demand to fill their capacity, despite a temporary, probably unsustainable recovery. We have replaced Wuliangye with CRB in our top-buy list, after Wuliangye’s 25% share price rally YTD. We recommend investors Buy China Mengniu, CRB and Dali Foods, and Sell Tingyi and Want Want.
Downside pressure on CPI emerges
Starting from 2H 2016, the expectation of an acceleration in inflation in 2017 has led to better sentiment on consumer stocks. Staple stocks under our coverage outperformed the HSI by 500bps in 2H16. The outperformance YTD has slowed to 90bps vs. the HIS, which we believe reflects some concerns on downside risk of inflation. Despite consumer products shifting from the low end to the high end, we have yet to see a meaningful recovery in volume growth − hence we view any risks for further upward pressure on inflation as muted. This is in line with our house view. In February, our China economists lowered their expectations for CPI in 2017 from 2.5% to 2.2%. A strong PPI of 7-8% in 1Q may not necessarily lead to a high CPI later this year, in our opinion. We see downside risks to the current valuations of staple companies.
Focus on premiumisation
The improved sentiment in the Chinese consumer market since 2H 2016 is largely a result of a high-end recovery, such as a rebound in premium baijiu, beer companies’ focus on the high-end segment, soft beverage companies’ product innovation and Biostime’s increasing exposure to nutritional products. All such companies are guiding for a margin improvement in the long term, even though revenue may not grow at such a fast pace as before. We believe this is the future direction of the Chinese staples market, and those who adopt this profit-focus change early are likely to ride on the secular consumer trade uptrend and outperform the market.
Downgraded China Modern Dairy, changed EPS forecasts for Tingyi and UPC
After the 2016 results announcements, we downgraded China Modern Dairy to Hold from Buy on a weaker raw milk price outlook. We changed our FY17 EPS forecasts for Tingyi (up 7%) and UPC (down 29%), due to the short-term impact of UPC’s strategy change. We use DCF, PE and EV/EBITDA to value China consumer staple companies. The main downside risk this year is raw material prices, which could rise again and hurt margins. The main upside risk is a consumer demand recovery stronger than we expect.
20170407-Deutsche Bank-China Consumer Staple：Treasure Hunt.pdf
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