What’s new? Want Want’s 1H17 net profit declined 15% yoy to RMB1,501m and theresults were 6% below our and consensus forecasts. Higher-than-expected input costpressure (eg sugar, tinplate, PET and paper) was the key reason for the earningsmiss as the group’s gross margin was down 3.3ppt yoy to 44.5%. For gross marginby segment, dairy beverage was down 3.1ppt to 47.3%, rice cracker dropped 3.2pptto 38.5% and snack food down 4.2ppt to 44.0%. Management believes the costpressure should start to ease in 2H17 but does not expect a meaningful recoverygiven a high comparison base last year. Total revenue was down 4% yoy, mainly dueto a decline in rice cracker sales given the early Chinese New Year this year. For2H17, rice cracker sales could still be lacklustre as the late Chinese New Year in2018 should also lead to a shorter sales period. Want Want declared an interim DPSof USD0.48 cents, representing a pay-out of 27% (1H16: 27%) and maintained ahealthy balance with net cash of RMB3.1bn, about 5% of its market cap.
Dairy beverage sales recovery is key: One of our key concerns on Want Want isthe continued decline in its Hot-kid milk sales. We see flavoured milk as a matureproduct and the structural change in consumer habits towards UHT/pasteurized milkis a key challenge for Want Want. During 1H17, dairy beverage sales were down 3%yoy, compared to -8% in 2H16 and -18% in 1H16. On a quarterly basis, managementindicated it believed the decline in Hot-kid milk sales is likely to have bottomed in1Q17 as it had achieved mid-single digit growth in 2Q17, including a low single-digitincrease for tetra-pack and double-digit growth for tin-pack. Management believesthe recovery was driven by restocking and increased penetration in lower tier-citiesand this trend should continue to improve in 2H17.
Valuation and risks: Want Want shares currently trade at 17x 2018e PE, which webelieve is excessive given uncertainty on its sales outlook in the medium term. Wecut our 2017-19 earnings estimates by 3-4%, mainly to reflect our lower gross marginassumptions. We cut our DCF-based target price to HKD4.30 from HKD4.50 toreflect our reduced earnings estimates and reiterate our Reduce rating. Key upsiderisks include stronger-than-expected flavoured milk demand, raw material pricemovements, successful new products, share buyback and M&A.
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