Initiation: going for quality over China Household...

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■ Investment case We initiate coverage of the China Household & Personal Products Sector with a Positive rating. We believe the domestic brands are well recognised and regarded by consumers in tier-2 and below cities in Mainland China, and that their moves to beef up their product quality and online sales presence will spur earnings growth in 2015-16 and position them to compete more effectively with international brands. Sanitary napkins: product mix upgrade. We highlight product mix improvements as a likely earnings and revenue driver for the domestic sanitary napkin and diaper players. In the sanitary napkins segment, we expect market leaders like Hengan to gain further market share from small and regional players, which currently account for about 20% of the market, by enhancing their product lines and leveraging their national distribution networks. Diapers: low penetration, growing market. China’s baby diaper market will see a 14% revenue CAGR for 2013-18E, according to Euromonitor, on the back of rising penetration (currently 35%) and

relaxation of the one-child policy. Daiwa’s Katsuro Hirozumi has highlighted that Japan’s diaper brands have more market share and higher prices in China than domestic ones, most notably online (see his 28 August report). We believe the big domestic players can compete with the foreign brands, as they have the requisite resources to improve product quality and develop their distribution channels. Indeed, Hengan has launched mid-to-high-end diapers at competitive ASPs vis-à-vis foreign brands, and we expect this initiative to boost its operating margin and market presence. Tissue paper: capacity expansion slowing. We believe over-capacity will be an overhang for the sector until 2H15. However, we forecast operating margins in the sub-segment to stabilise at 8-10% over 2015-16E as the market leaders halt expansion plans, sell more high-value items such as wet wipes, and expand their OEM export businesses to digest the excess supply. ■ Catalysts In our view, the main catalysts for earnings growth will be product mix upgrades and efforts to expand online sales channels. Also, Renminbi appreciation would lift financial income and reduce the cost of imported raw materials. ■ Valuation Hengan (1044 HK, HKD79.6, Outperform [2]). With the shares down 13% YTD, we see a good buying opportunity ahead of our

forecast EPS growth of 7%/21%/18% YoY for 2014/2015/2016E. Hengan continues to upgrade the quality of its sanitary napkins and diapers in step with price hikes (8-9% in 1H14), which we believe will help offset pricing pressure in the tissue paper segment due to over-capacity. Our TP of HKD89.1 is set at 23.5 x 2015E PER (the stock’s average 5-year 12M forward multiple). Vinda (3331 HK, HKD12.16, Hold [3]). Vinda has ventured into the sanitary napkin and diaper markets with the help of major shareholder SCA, but we are cautious on the tissue paper segment, which accounts for 80%-plus of its revenue. Before upgrading our rating, we would need to see a successful expansion of SCA’s product portfolio in Mainland China. Our TP of HKD11.8 is based on a 20x 2015E PER, a 15% discount to our multiple for Hengan. ■ Risks The main downside risk to our sector rating is market-share losses, particularly on online channels.

11 November 2014

Initiation: going for quality over quantity

• Domestic producers are enhancing their product mixes and hence raising their ASPs to compete against international brands

• Investors’ concern over operating-margin pressure presents a buying opportunity; we forecast 2015-16 EPS growth to accelerate

• We prefer Hengan (Outperform [2]) over Vinda (Hold [3])

China Household & Personal Products

Key stock calls

Source: Daiwa forecasts.

Consumer Staples / China

Positive (initiation)

Neutral

Negative

Anson Chan, CFA(852) 2532 [email protected]

New Prev.Hengan International Group (1044 HK)Rating OutperformTarget 89.10Upside 11.9%

Vinda International (3331 HK)Rating HoldTarget 11.80Downside 3%

How do we justify our view?How do we justify our view?

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China Household & Personal Products 11 November 2014

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How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook Hengan and Vinda: EPS and revenue YoY growth (%)

Household paper producers’ profit margins have come under pressure in 2012-13 due to overcapacity in China. However, these companies’ operating margins for diapers and sanitary napkins are still expanding, backed by ASP hikes. Hence, we believe Hengan will deliver a faster earnings recovery than Vinda in 2015-16E because it is more exposed to the sanitary napkin and diaper segments. We forecast 14% and 13% revenue CAGRs over 2013-16E for Hengan and Vinda, respectively, together with 15% and 10% EPS CAGRs.

Source: Company, Daiwa forecast

Valuation Hengan and Vinda: 12-month-forward PERs

Hengan is trading at 1.2 standard deviations from its 5-year-average 12-month-forward PER. We look for the stock to be rerated in the coming months as EPS growth should resume and the operating margin should pick up in 2015 from its 2014E trough, backed by product mix upgrades and increased operating leverage. Vinda has been rerated since SCA became the company’s major shareholder in September 2013 and then announced plans to inject its China business into Vinda. However, we believe 2015E will be a transition year for Vinda as the company will need to reduce the operating costs of its new business units. A further PER rerating is unlikely on a 6-month view, in our opinion.

Source: Bloomberg

Earnings revisions Bloomberg consensus EPS changes since 1 January 2014

The Bloomberg-consensus EPS forecasts for Hengan and Vinda have been revised down since January 2014, likely due to the renminbi’s depreciation and pricing pressure in the tissue paper segment. However, we expect limited downside in the market’s EPS forecasts for Hengan, as the company is lifting the ASPs of its diapers and sanitary napkins to offset increasing selling costs and pricing pressure in the tissue paper business. For Vinda, we see a slight downside risk to the market’s EPS forecast for 2015 given a potential increase in operating losses at the company’s new diaper and sanitary napkin businesses.

Source: Bloomberg

Positive (initiation)

Neutral

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Source: Daiwa forecasts

Sector stocks: key indicators

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Hengan International Group 1044 HK 79.60 Outperform 89.10 3.147 3.792

Vinda International 3331 HK 12.16 Hold 11.80 0.545 0.591

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


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China market overview ................................................................................................................. 5

Diapers – growth in quantity and quality ................................................................................... 8

Positive short- and long-term segment growth drivers .......................................................... 8

Increasing use of e-commerce ................................................................................................ 10

Adult incontinence products: high-potential market ............................................................. 11

Sanitary napkins –price hikes and industry consolidation ....................................................... 12

Industry consolidation ............................................................................................................ 12

Tissue paper – oversupply overhang ......................................................................................... 14

Overcapacity remains an overhang ........................................................................................ 14

Valuation and recommendations ............................................................................................... 17

Valuation methodology ........................................................................................................... 17

Hengan .................................................................................................................................... 17

Vinda ....................................................................................................................................... 18

Investment risks ......................................................................................................................... 19

Company Section

Hengan International Group ................................................................................................. 20

Vinda International ................................................................................................................ 34


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China market overview

We believe ASP hikes and rising penetration are potential earnings drivers for the household product players. We expect the domestic leaders to leverage their national sales networks and launch new products in order to expand market share in 2015E. Market size According to the China National Household Paper Industry Association (CNHPIA), the domestic market for disposable household and personal care products was worth some CNY122bn in 2013. On our estimates, the market – which comprises diapers (both infant and adult), sanitary napkins, and household papers – expanded by 8% YoY in 2013. We forecast the market to be worth CNY180bn by 2020, which calls for a revenue CAGR of 6% between 2013 and 2020. As we see it, the market’s growth will be driven by:

1. Volume growth from a base of low per-capita consumption. For example, penetration of baby diapers in China was only around 35% in 2013, compared with 90%-plus for developed countries, while per capita consumption of tissue paper in China is only 20-50% that of developed countries,

2. Vinda and Hengan raised the ASPs of their products by 2-5% YoY over 2012-13, and we expect price hikes for household products to continue in the coming 3 to 5 years, in step with improvements to product quality.

China: size of market (ex-factory prices) for disposable household & personal products

Source: CNHPIA, Daiwa forecasts

High-margin business Compared with other staples, such as food and beverage items, disposable household products tend to carry relatively high gross margins. We believe the higher margins reflects: 1) the greater brand loyalty commanded by disposable household products, 2) the difference in consumption profiles, with sanitary napkins mainly consumed by adults, and 3) ongoing product developments and mix upgrades for disposable household products. As shown in the chart below, the gross margins of personal products in China typically range from 30% to 70%, compared with 10% to 45% for food and beverage items. Moreover, with the exception of tissue paper, we expect the gross margins of most household products to be less volatile than for other staples over our forecast horizon, as we expect their input costs to be steadier and producers to focus on upgrading quality rather than competing solely on price. Gross margins: comparison of staple items (2013)

Source: Companies (1. Hengan’s data, 2. Mengniu’s data 3. Tingyi’s data, 4, WH Group)

After seeing a marked expansion in its operating margin in 2012, driven by lower raw material costs, Hengan has faced sustained pressure on its operating margins due to: 1) price competition in the tissue paper segment, 2) increasing selling expenses attributable to

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brand building and the promotion of tissue paper sales, and 3) a slowdown in baby diaper sales. Collectively, these factors have led to operating deleverage. Hengan: operating margin by segment (2010-16E)

Source: Company, Daiwa forecasts

In the baby diaper segment, Hengan experienced a sharp YoY loss of market share in China in 2013, as it took the company time to upgrade its product mix by introducing new production lines and undertaking related marketing. Moreover, prior to 2012, Hengan had zero presence on online sales channels, which in recent years have been the fastest-growing sales channel for baby diapers (even now Hengan is not among the top-10 brands in the online baby diaper market in China, while foreign brands collectively have a 70% share). Along with Hengan’s market-share loss, this combination of factors has led to it facing significant pressure on its operating margins in the segment. Diaper market in China: market share of major players (2010-13)

Source: CNHPIA, Daiwa

Operating margins set to rebound We believe personal care players can enhance their operating margins by upgrading their product mixes and/or being more stringent in controlling costs, particularly in the tissue paper segment. Going forward, we expect these companies to focus on developing high-end sanitary napkins and diapers

carrying gross margins of over 60%, compared with just 30-35% for tissue paper. We expect both pricing and cost trends be favourable for Hengan and Vinda in 2015. Price hikes. Product mix enhancements can be key drivers of prices for sanitary napkins and diapers. For example, Hengan recently added new functionality to its diaper products and launched new packaging (eg, products specifically targeting infant boys or girls, and different age groups), while also raising its prices. Daiwa’s Staples analyst in Japan, Katsuro Hirozumi, highlighted in his recent report that some customers in Mainland China are willing to buy diapers imported directly from Japan, which are more expensive than their domestic rivals. Separately, we believe tissue paper prices will likely remain under pressure in 2015 due to continued oversupply. Cost trends. Pulp (wood or fluff) and petrochemicals (mainly water superabsorbent) are the key raw materials used in the production of disposable personal hygiene products. On abundant global supply of both raw materials, we expect personal care players’ raw material costs to hold steady or decline slightly YoY in 2015. International brands are market-share leaders for now… Reflecting a widespread perception among customers that they lead in product quality, international brands collectively account for a larger proportion of the Mainland China markets for baby diapers and sanitary napkins than the domestic players. As shown in the chart below, Hengan is the leading domestic player within the sector, but is only ranked 4th in diapers and has a slim lead over international brands in the sanitary napkin market. By comparison, the domestic brands have a bigger presence in the household paper segment, to which entry barriers and profit margins are low, according to our market research. Market share by retail value, 2013 (domestic players highlighted) Rank Sanitary napkins % Diapers % Tissue paper % 1 Hengan 10.7 P&G 36.2 Hengan 11.4 2 P&G 7.9 Unicharm 11.7 APP 8.4 3 Unicharm 6.7 Kimberly Clark 10.2 Vinda 7.9 4 Arbonne Baby Care n.a. Hengan 9.3 C&S Paper n.a. 5 Kimberly Clark 2.5

Source: Euromonitor

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According to a Bain & Company report (Chinese shoppers: Evolving behaviors in a challenging environment), published in early 2014, international brands accounted for about 90% of the Mainland China market for baby diapers and over 50% of the markets in other personal care categories, such as toothpaste, skincare products, and body wash. Of particular note, international brands have fared well on online channels, which are the fast-growing sales channel for personal care products. According to a Bain & Company study, online sales of baby diapers in Mainland China were up 39% YoY in 2013, putting the segment among the top eight fast-moving consumer goods categories in China. However, despite growing by 20x from 2011 to 2013, on our estimates, Hengan’s sales via online channels accounted for less than 2% of its revenue in 2013 …but domestic leaders are catching up However, we believe domestic players are well placed to capture market share in tier-3 cities and below in the coming years. Importantly, shoppers in these cities are growing in “consumption power”, and hence should continue to drive revenue growth in the broader sector. We believe the domestic market leaders have the most potential to tap this growing base of demand by virtue of their national production and distribution networks. For example, Hengan’s 3,000 distributors cover around 1m points of sale in China, including many low-tier cities. Vinda, for its part, has more than 1,300 distributors and 8 production plants in Mainland China, which gives it far more reach than international players such as Kao and Unicharm. Central to the success or failure of the domestic leaders’ push to regain market share will be coming up with the right product mix, in our opinion.

However, there are signs that international brands are losing ground already. For 2013, Bain & Company reports that international brands’ combined share of the Mainland China market for diapers declined by around 2pp, while they lost 5pp of market share in the market for skincare products. We believe the domestic players are starting to claw back some market share through their strategy of improving product quality and penetrating lower-tier cities, where they are better placed in terms of product pricing and distribution. In the following sections of this report, we examine the potential growth drivers for the sector as a whole, as well as the potential for the major players to upgrade their product ranges in each sub-segment.


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Diapers – growth in quantity and quality

Industry forecasts call for China’s baby diaper sales volume to see an 8% CAGR over 2013-20E. We expect the domestic and foreign market players in the country to benefit from the relaxation of the one-child policy and raise prices on product quality upgrades. Our industry research indicates that baby diapers should see among the fastest sales-volume growth of China’s major personal hygiene product segments over the coming years. According to the China National Household Paper Industry Association (CNHPIA), the China baby diapers market saw sales volume rise by 11.3% YoY to 22.7bn pieces in 2013. The CNHPIA forecasts sales volume of baby diapers to reach 29.75bn pieces in China in 2020, representing an 8% CAGR over 2013-20E. The CNHPIA assumes that the country’s penetration rate of diapers will reach 60% by then, up from 35% in 2013. Euromonitor forecasts retail sales by value of China’s diaper market to rise at a 14% CAGR over 2013-18E (its forecasts run out to 2018). China baby diaper market: annual sales by volume and retail value

Source: CNHPIA, Euromonitor

Positive short- and long-term segment growth drivers

China’s relaxation of its one-child policy We expect China’s gradual relaxation of its one-child policy in place since 1H14 to lead to an increase in the country’s birth rate over the coming years. As highlighted in our report of 2 May 2014 on the China Dairy Sector, The cream is upstream, regional governments in the majority of China’s provinces in 1H14 announced the implementation of an application process for couples seeking the right to have a second child. As of 31 May, about 271,600 of the 11m couples qualifying for this had submitted an application, representing about 2.5% of all eligible households. Officials from the National Health and Family Planning Commission of the PRC estimate that this policy relaxation will lead to an additional 2m births in 3-5 years’ time. This implies a 12% increase from the number of births in 2013. China: annual number of births (LHS) and birth rate (RHS)

Source: Bureau of Statistics of China, CEIC

Note: breakdown unavailable for 2013

Product price hikes and quality upgrades Both domestic and international baby diaper brands in China have been increasing their ASPs since 2012, mainly through product mix upgrades, and we think more is to come on this front. In this context, Daiwa’s Japan Consumer Staples Sector analyst, Katsuro Hirozumi, published a report on 28 August 2014 on the disposable diaper market in China from the perspective of Japanese brands’ development in China (Premium Japan-made disposable diapers to continue to sell well; could ride e-commerce wave], in which he has highlighted the following, which we extrapolate for the China diaper market: 1.”High-end disposable diapers made in Japan should continue to sell, but those made in China look set to struggle”. We believe this shows

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that Chinese consumers’ brand perceptions of domestic players’ diaper products are currently inferior to those of Japanese players. An increasing availability of Japanese brands (as Japanese and other foreign players are expanding their production capacities and online sales channels) should further enhance Japanese diaper brands’ awareness among Chinese consumers in the coming years. But, we also note that domestic diaper players are taking steps to enhance their brand awareness, as we go on to discuss. 2. “Japanese diaper companies should focus on hiking product prices rather than increasing sales volume”. Mr Hirozumi has also conducted a retail price survey in Shanghai, where he found that the retail prices of Japanese and other foreign diaper brands ranged between CNY1.3/piece and CNY2.81/piece (medium-sized, tape type). This is below the low-end retail prices of Chinese products (<CNY1/piece) based on our research. According to China’s second-largest diaper player by 2013 revenue, the Japan company Unicharm, its diaper retail ASP in China has trended up gradually over mid-2012 to mid-2014. We estimate it has increased from approximately CNY1.37/piece (June 2012) to CNY1.5/piece (June 2014), which we believe has been driven mainly by the company’s product mix upgrades and launches of more high-priced items with more functions and value-added designs, such as pull-up pants. Unicharm: diaper retail ASP in China (CNY / piece)

Source: Unicharm

Domestic players are catching up with foreign players in quality and branding Our research shows that prior to 2013, only foreign diaper players have been able to capture Chinese consumers’ growing preference for higher-quality diapers. Since 2013, however, domestic players are also increasing their presence in the mid-range and high-end diaper categories, as follows:

1) Domestic players have been upgrading their product mixes. For example, in 2013 and 1H14 Hengan launched new products with high ASPs (CNY1.5-1.8/piece for babies aged below 6 months, compared with CNY1.2/piece for its low-end products), made using production facilities imported into China. Hence, its revenue from mid-range and high-end diaper products increased by 17% YoY in 2013 and 16% YoY in 1H14, while its low-end diaper products saw revenue decline by 11% YoY and 12% YoY in the respective periods. As such, the contribution to its total diaper revenue from mid-range and high-end products increased from 71% in 1H13 to 77% in 1H14.

2) Other domestic players like C&S Paper and Vinda have started distributing foreign brands’ diapers (mostly in the mid-range and high-end segments) in China since 2013. As they are only distributing these products, their profit margins on these products are lower than those of the vertically integrated players, on our estimates, though through this approach they save time and resources by not having to build their own brands and develop the products in-house. Thus, we believe they are better positioned than pure domestic brands. Also, in 3Q14, Vinda has obtained the right to use and produce the baby and adult diaper products of SCA (its parent company since 4Q13) in China, which we believe illustrates well how the company can use its domestic distribution network to market high-quality foreign products.

Baby diapers: low penetration rate, good potential to expand According to the CNHPIA and Euromonitor, penetration of baby diapers was below 35% in 2013 in China. The penetration rate was above 90% in coastal areas and tier-1 cities such as Beijing and Shanghai but was much lower in rural areas. By comparison, the 2013 penetration rate of baby diapers was 95% in both the US and Japan according to Beijing S&P Information Consult (a consumer business consultant firm that has been operating for more than 15 years in China), as the next chart shows. We expect the penetration rate of baby diapers in China to catch up with that in developed countries over the medium to long term, driven by: 1) an increasing number of educated and young parents, who generally prefer disposable diapers to cloth nappies for reasons of convenience and hygiene, and 2) increasing availability as more foreign and domestic brands are expanding their production capacities in China, launching more high-quality diaper products, and thus raising their sales penetration in China. For example,

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Unicharm (8113 JP, JPY2,511, Hold [3]) targets to increase its sales coverage from about 800 cities in 2012 to 1,200 cities by the end of 2014, according to its 2013 annual report. Moreover, an increasing use of online sales channels also makes it easier for diaper players to penetrate into lower tier-cities at a lower distribution cost. Penetration rates of baby diapers in 2013 (%)

Source: Euromonitor, Beijing S&P Information, CNHPIA

Increasing use of e-commerce

In China, diapers are distributed through the following 5 channels, with the first 3 of these accounting for the majority of sales, based on our estimates: Modern channels (retail organisations). These comprise supermarket and hypermarket chains. While they are still an important sales channel, diaper sales at these outlets declined by 4% YoY in 2013, according to AC Nielsen. We expect diaper sales through these channels to continue to weaken in the years ahead, given declining customer traffic and greater competition from other channels. Specialty baby stores. These are standalone stores and chains that sell maternity and baby goods. They have been a fast-growing sales channel in China in terms of revenue and store count over the past few years. Biostime (1112 HK, Not rated) estimates that there are over 70,000 such baby specialty stores in China at present, up from 50,000 stores 3 years ago. E-commerce. This includes direct sales through online platforms (eg, T-mall, the diaper company’s member website, etc.) and sales to online shopping outlets that resell the products on to consumers (eg, jd.com). Also, some diaper brands (eg, Biostime) leverage baby specialty stores to deliver customers’ orders placed online.

Traditional distributors. These distributors distribute the diaper players’ products to retail stores in low-tier cities, mom-and-pop shops and some of the specialty baby stores. Pharmaceutical and medical channels. These include hospitals, pharmacy chains etc. In some industry research statistics they are also classified as modern channels or as outlets serviced by distributors. China baby products market: sales breakdown by channel (12 months ended May 2014) Infant formula Diapers

As % of sales Sales growth YoY As % of sales Sales growth YoYRetail organisations 34 -8 47 -4Specialty baby stores 42 8 28 9E-commerce 24 38 35 46Total 100 7 110 9

Source: AC Nielsen, Biostime

Online shopping has become increasingly important as a way of selling babycare products overall in China. According to the consultancy Bain & Company, online sales of diapers and infant formula accounted for 28% and 21%, respectively, of the total sales by value of these products in China in 2013, up from respective shares of 20% and 15% in 2012. We believe the increasing prominence of online sales channels is favourable for leading domestic and foreign diaper and infant formula brands and can help them to penetrate into new geographical regions as their products become available to consumers online. In particular, for baby diapers, in the 12-month period ended 31 May 2014, retail sales through e-commerce channels were up by 46% YoY and accounted for about 35% of total retail sales of baby diapers in China, according to AC Nielsen and Biostime. By contrast, diaper sales through baby specialty stores and retail chains were up only 9% YoY and down 4% YoY, respectively, for the same period. Above all, online sales platforms provide a quick way for parents to share and compare their experiences of using different baby diaper brands. This is particularly attractive for new and young parents who want to give their infants the best products but lack product knowledge, and can find out about them fast through online sources. Online sales penetration rates in China for baby products (diapers, infant formula) are the highest of personal care and consumer staple items, according to 2013 data from Kantar Worldpanel and Bain & Company.

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China: selective consumer products – online sales as % of total sales in 2013

Source: Kanta Worldpanel, Bain & Company

According to iResearchChina Consulting Group, an Internet industry research company, the top-3 diaper players present in China accounted for about 65% of online sales of baby diapers in the country in 1Q14. Online sales include domestic brands such as Daddy baby and Qingboo, but the domestic baby diaper player and Hong Kong-listed player, Hengan, is not among the top-10 brands for online sales of baby diapers (as the next chart shows). We believe specialty baby stores will remain an important sales channel for baby diapers in China in the coming years, as they provide deliveries and other supporting services for online shoppers, and some shoppers still prefer to visit physical stores, where they can receive personalised services and view the products before buying them. Online sales market shares of baby diapers in China (1Q14)

Source: iResearchChina

Adult incontinence products: high-potential market

The market for adult incontinence products comprises mainly adult diapers, diaper pads and under-pads. Over the past 10 years, China’s domestic consumption of these products has contributed more to the market’s than exports have. In 2013, domestic sales volume of these products was up by 41% YoY, and accounted for about 76% of the 2.57bn pieces produced in China, according to the CNHPIA. In terms of the market’s value, its size based on the 2013 data is only about 10% of that of the baby diaper market in China; however, we note that many baby diaper brands are also developing or expanding into the adult diaper business. We believe China’s adult diaper market offers strong business growth potential, for 2 key reasons. 1) The country’s ageing population. According to the Chinese Academy of Social Sciences (CASS), the country’s elderly population (aged 60 years and over) should increase by 10m people per year to reach 400m people by 2033 and account for about 30% of the country’s total population then, up from 15% in 2013. 2) Increasing GDP levels per capita. The CNHPIA believes that, once per capita GDP in China reaches USD8,000-10,000 per year (which compares to its 2013 level of USD6,7000, the elderly will be able afford personal care products like adult diapers.

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5

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20

25

30

35

40

45

Babydiapers

Infantformula

Skincare Colourcosmetics

Biscuits Chocolate Shampoo Milk

Pampers26.9%

Huggies22.3%KAO

15.4%

Mampoko11.8%

Coon4.8%

Chiaus3.6%

Mignon Baby3.2%

Moony2.2%

Qingboo1.4%

Daddy baby1.0%

Others7.4%


- 12 -

Sanitary napkins –price hikes and industry consolidation

We believe the players in China’s domestic sanitary napkin market will expand their businesses via: 1) ASP hikes, and 2) further market-share gains through industry consolidation. According to the CNHPIA, the sanitary napkin retail market in China had a size of CNY32.4bn in 2013, representing an increase of 13% YoY. Sales volume in 2013 was 96.6bn pieces, implying a penetration rate of 91.1%. The CNHPIA forecasts sales volume to reach 117.5bn pieces in 2020, implying a CAGR of 2.8% over 2013-20. China sanitary napkin market: sales volume and penetration rate

Source: CNHPIA

Industry consolidation

China’s sanitary napkin market is concentrated, with the top-10 brands in aggregate accounting for 81% of total sales volume in 2013. That said, we still see room for the market to grow further through industry consolidation. According to the CNHPIA, there were 654 enterprises producing sanitary napkins in China in 2013 but most of them were not national players. We believe many of these companies produce mid-range and low-end products for low-tier cities and low-income households. With increasing brand awareness

among consumers and availability of large brands’ products through e-commerce, we believe national sanitary napkin players can still grow their business by substituting the small and low-end regional brands. Domestic brands are generally more competitive than foreign brands if they have both domestic production facilities and mid-to-low priced products for price-sensitive consumers. Moreover, major players’ replacements of counterfeit products in rural areas have also has driven their sales volumes over the past few years. Sanitary napkin market shares by sales volume in China, 2013

Source: CNHPIA

Price hikes should help underpin growth Introduction of value-added products. Launches of new products are generally a good pretext for putting through price hikes. Our discussions with Hengan, and based on the data from Japanese players present in the market such as Unicharm and Kao, the upgrading of product mixes has been the key ASP driver for the sector in the past 5 years. The development of new materials (with better absorbent power and lower weights) and special designs/features (ultra-thin, body hugging, etc.) has enabled companies to continuously launch new products with higher ASPs. This, coupled with more marketing on new products, has allowed producers to continue to replace old products with more high-value new products. For example, the retail ASP on sanitary napkins has been on an upward trend over the past 3 years, according to Unicharm.

82.3 86.8 91.3 91.1100

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140

2009 2010 2011 2012 2013 2020E

bn pieces (LHS) Penetration rate (RHS)

(%)(bn pieces)

Hengan22.4%

Unicharm16.9%

P&G12.0%

Arbonne Baby Care

11.7%

C-BONS GROUP

7.6%

Kimberly Clark3.9%

Johnson & Johnson

3.2%

Kao1.7%

Others20.6%


- 13 -

Retail ASP of Unicharm’s sanitary napkin products

Source: Unicharm

Brand building. We believe sanitary napkins have high consumer loyalty compared with other personal care products due to frequent usage of the products, and the risk to health if the products are contaminated. The high gross margin on this product (40-70%) also allows producers to spend more on advertising to establish a good brand image. In China, foreign brands usually hire domestic celebrities to endorse their products, particularly to target fashion-savvy women in first and second-tier cities. A strong brand and customer loyalty means better pricing power and relative ease of introducing new products with higher-profit margins to existing customers. Raw-material cost trends – diapers and sanitary napkins Petrochemicals (40-55% of the segment’s COGS). The petrochemicals used in the production of sanitary napkins and diapers are mainly superabsorbent polymer, which allow liquids to be easily absorbed into the products. There are numerous types of superabsorbent materials, but the most popular is sodium polyacrylate, which is produced from acrylic acid and sodium hydroxide. The cost of acrylic acid has declined slightly since 1H14, and given the abundant global supply, we believe the cost of this material will remain largely stable over 2014-16.

Spot price of acrylic acid in the US (USD/tonne)

Source: Bloomberg

Fluff pulp (15-25% of the segment’s COGS). Fluff pulp is a type of chemical pulp made from long fibre softwoods. Important parameters for fluff pulp are bulk and water absorbency. Prices of fluff pulp have remained steady in China so far in 2014. According to RISI, a forest product information provider, prices of fluff pulp will be under pressure from now until 2019 as global capacity expansion exceeds demand. Fluff pulp price in China (CNY/tonne)

Source: Wind

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- 14 -

Tissue paper – oversupply overhang

We believe overcapacity will remain an overhang for the sector until 2H15. We like players with rational expansion plans and strong brand recognition and product mixes.

Overcapacity remains an overhang

The Chinese tissue paper producers’ operating margins have declined significantly due to price competition driven by overcapacity. Between 2009 and 2013, tissue paper capacity increased by more than 53%, according to CNHPIA, and at the same time, the 4 largest players expanded their capacities by 80-136%. As such, the industry’s average utilisation rate dropped from 86% to 80% over the same period. We believe overcapacity will intensify further in 2H14 and 1H15 as capacity expansion of some industry leaders cannot be stopped due to machine contract commitments. CNHPIA estimates tissue paper capacity in China to increase from 10.96m tpa in 2014 to 13.4m tpa in 2015 (29%/22% YoY increases for 2014/15E, respectively). Tissue paper capacity and output in China

Source: CNHPIA, Daiwa

That said, we believe the excess capacity will ultimately be digested by: 1) Increasing domestic consumption. Chinese consumption of tissue paper was up 5% YoY to 4.4kg in 2013, albeit still representing just 20-50% of that for developed countries. Urbanisation and increasing availability of hygiene and products with special functions (eg, wet wipes, kitchen towels) are key growth drivers, in our view. 2) China entering the export market. China exported 0.635m tonnes of tissue paper in 2013, up 20% YoY, which accounted for about 9% of the country’s output. Tissue paper accounted for about 55% of the export volume. Market leader Hengan has targeted to expand its export business to maintain its utilisation rate despite the capacity additions in the industry by Hengan. Tissue paper per capita consumption comparison (kg)

Source: CNHPIA

Price war to linger Operating margins have declined since 2012 The top-4 Chinese household paper players’ operating margins have dropped significantly after the marked rise seen in 2012 (which was driven by lower wood pulp costs). We believe the decline has been driven by both lower ASPs and increasing selling and promotion expenses to enhance sales volumes. As discussed above, we believe overcapacity in the industry will last until 2015, hence price wars will remain a common way for most players to boost sales volume. However, we believe price wars would not be a good strategy in the long run as: 1) they may hurt the profitability of the distributors (and hence their long-term relationships with the paper producers) by forcing them to share promotional expenses with the producers or accept lower retail prices, and 2) they would make it difficult for the distributors to raise ASPs in the future if their products were perceived as being low-end after ASPs were reduced.

5.55 5.97 6.547.71

8.51

10.96

13.40

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16

2009 2010 2011 2012 2013 2014E 2015E

Capacity Output Domestic consumption

(m mt)

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25

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- 15 -

In our opinion, product mix upgrades and brand development are better ways for producers to tap into the tissue market in China. Product-mix upgrades and diversification to drive ASPs and volumes. CNHPIA estimates that toilet rolls accounted for around 60% of tissue paper consumption in China in 2013, followed by box tissues (23%) and handkerchiefs (8%). However, we believe the growth in demand for non-toilet roll products will be faster than that for toilet rolls over the next 3 years due to the current low consumption and increasing demand for products that serve a special purpose (eg, wet wipes, paper kitchen towels, etc). As such, we think increasing sales of non-toilet roll products could also lead to higher ASPs for tissue paper products. As shown in Vinda’s financials in 2013, the ASPs of non-toilet roll products were 12-80% above that for toilet rolls. Vinda’s sales of non-toilet roll products in China were up 21% YoY for 2013, versus 8% for toilet roll products. China: tissue paper market share breakdown by product type

Source: CNHPIA

Ex-factory ASP of different tissue paper products (2013)

Source: Vinda, Daiwa estimates

Raw-material cost trends Paper pulp. We estimate that paper pulp accounts for 50-60% of the COGS for tissue paper production, and about 2/3 of the pulp used is hardwood pulp (BHKP, which has a short fibre) and 1/3 is softwood pulp (NBSK, which has long fibres). According to Empresas CMPC (CMPC.CI , Not rated), a global pulp supplier of wood pulp, and Hawkins Wright (HW), a global research firm on forest, pulp and paper industry, the global supply and demand outlook are as follows: Softwood. Global capacity growth is more or less in-line with demand, and utilisation rates will remain at a healthy level of about 91% over 2014-18E. HW forecasts softwood pulp demand to grow at 0.127m tonne/year over 2014-18E, versus 0.19m in capacity. Hardwood. Global capacity growth is slightly faster than demand, and utilisation rates have remained weak at below 90% over the past 2 years. HW forecasts softwood pulp demand to grow at 0.98m tonne/year over 2014-18E, versus 1.33m in capacity. Hence, we believe the raw-material cost outlook for the tissue paper producers will remain favourable in 2015-16E. Based on Bloomberg data, BHKP and NBSK pulp averaged USD749/tonne and USD923/tonne for 9M14, down 8% and up 9% YoY, respectively. We estimate the normal wood pulp inventory for the tissue producers is currently at about 6 months (including raw materials being shipped to China), hence wood pulp costs in 2H14 and 1Q15E are highly visible at a lower (YoY) level and in terms of inventory in hand they have enough wood pulp for production in 1H15E. We assume flat wood pulp costs in 2015-16E. In the case of wood pulp prices declining, we estimate this would be more favourable for Vinda than Hengan, due to Vinda’s higher exposure to the tissue paper business (almost 100% of its revenue, versus about 50% for Hengan). Our sensitivity analyses show that a 1% decline in unit pulp costs would lead to a 7% rise in Vinda’s EPS for 2015E, and a 1% increase for Hengan.

Toilet rolls60.6%

Box tissues23.0%

Handkerchiefs7.7%

Paper napkins3.2%

Kitchen rolls0.7%

Paper towels3.0%

Others1.7%

12,596

18,976

22,692

14,10616,121

0

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10,000

15,000

20,000

25,000

Toliet Roll Handkerchief(including wet

wipes)

Box tissue Paper napkins Softpack

(HKD/tonne)


- 16 -

Sensitivity analysis: Hengan Gross-profit margin (%) EPS (HKD)

2014E 2015E 2014E 2015E Base case 46.3% 46.5% 3.15 3.791% increase in Change in pp Change (%)Wood pulp cost -0.2 -0.2 -1 -1Petrochemicals -0.2 -0.2 -0.8 -0.8Packaging cost -0.1 -0.1 -0.3 -0.3ASP Sanitary napkins 0.2 0.2 1.1 1.1Diapers 0.1 0.1 0.5 0.4Tissue paper 0.3 0.3 1.9 1.9

Source: Daiwa

Sensitivity analysis: Vinda Gross-profit margin (%) EPS (HKD) 2014E 2015E 2014E 2015E Base case 30.0 30.4 0.55 0.59 1% increase in Change in pp Change (%)Wood pulp cost -0.3 -0.5 -4.5 -7.0Packaging cost -0.1 -0.1 -1.1 -1.4ASP 0.6 0.8 1.1 1.1Interest rate 0.0 0.0 -0.5 -0.6

Source: Daiwa


- 17 -

Valuation and recommendations

We prefer Hengan to Vinda over the next 6 months given its better prospects for near-term earnings growth and more diversified revenue mix.

Valuation methodology

We believe PER methodology is suitable when valuing personal hygiene product companies given their earnings-growth visibility and steady profit margins. To derive our target prices, we first consider the past-5-year average PER of the individual companies and apply a premium or discount to the trading average to derive our PER. We believe that any premium or discount is justified by changes in the operating margin or earnings growth rate, or product mix improvement, while any discount is usually a result of potential market-share losses or profit-margin pressure due to commodity-price volatility. We then compare the company’s current trading PER with those of its peers in China to see whether or not the valuation appears attractive or demanding. In general, we believe a premium for large-cap companies is justified by their leading market positions in their respective segments. China Packaged F&B Sector: past 5-year average PER trading range

Past-5-year 12M forward PER Standard PER (x)

Company High-end Low-end Average deviation 2014E 2015EHengan 31.0 19.7 24.2 2.24 25.3 21.0Vinda 24.2 10.3 15.6 2.57 22.3 20.6Source: Bloomberg, 2014-16 EPS numbers are Daiwa’s forecasts

Hengan

We initiate coverage of Hengan with an Outperform (2) rating and 6-month target price of HKD89.1. Our target price is based on a target PER of 23.5x (which is equivalent to the average of the stock’s 12-month forward PERs over the past 5 years) on our 2015 EPS forecast of HKD3.79. Our target PER is at a 15% premium to the China Staple Sector’s average. We believe the premium is supported by Hengan’s higher ROE, operating margin and strong cash flow. Hengan’s share price has fallen by 13% YTD due to concerns in the market about the oversupply of tissue paper capacity in China and increasing selling expenses. We view the current share-price weakness as a good opportunity to accumulate the stock. As shown in the following chart, Hengan is trading at below the middle of its past-5-year PER trading range of 20-31x. We expect the stock to be rerated over the next 6 months: 1) as we expect earnings growth to re-accelerate in 2015-16E on an absence of forex losses and the surge in selling costs coming to an end, and 2) given the success of new product launches. Hengan: 12-month forward PER bands

Source: Bloomberg

35

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1044 HK 19x 22x

25x 28x 32x

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- 18 -

Vinda

We initiate coverage of Vinda with a Hold (3) rating and 6-month target price target of HKD11.8. Our target price is based on a target PER of 20x, which is at a 15% discount to our target PER for Hengan. We believe Vinda deserves to be rerated from its historical average after SCA became its major shareholder in September 2013. As one of the world’s largest feminine hygiene and tissue paper companies, SCA should help enrich Vinda’s product mix and brand portfolio in China, as well as reduce its financial and raw material costs by Vinda being able to leverage on SCA’s scale. The stock is trading currently at close to the high-end of its past-5-year PER trading range of 10-24x. We believe the current valuation has priced in the positives related to SCA. We expect earnings growth in 2H14-15E to be challenged by an initial surge in selling costs

to develop the new businesses (diapers and sanitary napkins) and increasing financial costs. For the stock to rerate further we would need to see the new businesses reaching a profitable scale, and the overcapacity situation in the tissue paper industry in China improving. Vinda: 12-month forward PER bands

Source: Bloomberg

China staples sector: valuation comparison

Bloomberg Mkt.Cap. Price Stock Δ %

PER (x)

EPS Growth

EV/EBITDA (x)

Revenue YoY %

EBIT margin ROE%

Name code Rating USDm 10 Nov 2014 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E

Personal care products Hengan* 1044 HK Outperform HKD 12,620 79.6 -4 3 26.9 25.3 21.0 17.8 0 7 20 18 15.8 13.4 14 15 15 24.0 22.1 22.8 22.5Vinda* 3331 HK Hold HKD 1,570 12.16 -4 5 23.1 22.3 20.6 17.4 -4 4 8 19 14.6 13.0 13 11 15 10.5 9.7 9.5 11.3Average 25 23.7 20.8 17.6 -2 6 14 18 15.1 13.2 14 13 15 17.2 15.9 16.1 16.9Major China Food and beverage players Want Want China* 151 HK Buy HKD 17,256 10.2 -6 4 25.4 23.5 18.9 16.2 25 8 24 17 15.6 12.2 14 7 14 23.1 23 25.6 35.7Tingyi* 322 HK Outperform HKD 13,233 18.42 -18 -9 33.7 25.2 20.6 18 7 34 22 15 10.2 8.6 19 3 8 6.7 8.9 9.9 17.3WH Group* 288 HK Buy HKD 9,634 5.13 n.a. -18 14.6 9.8 9.6 8.3 38 50 2 16 6.3 5.8 80 101 8 9.3 8.7 8.5 23Tsingtao* 168 HK Underperform HKD 8,906 53.85 -11 -5 32.7 27.5 24.8 22.7 3 19 11 9 6.2 5.2 10 13 10 7.4 7 7.3 14.2Mengniu Dairy* 2319 HK Hold HKD 7,758 30.9 -18 -7 27.2 24.9 18.7 15 17 9 33 25 12.5 9.6 20 19 12 4.3 4.6 5.6 10.2CRE* 291 HK Hold HKD 5,254 16.98 -27 -10 25.1 44.8 34.1 27.7 7 -44 32 23 7.6 7.1 16 15 12 3.5 2 2.2 2.1UPCH* 220 HK Hold HKD 3,876 7 10 -3 44.8 37 26.8 21.9 -47 21 38 22 13.4 10.5 9 3 6 2 3 4.3 6.1Biostime 1112 HK NR HKD 1,269 16.34 -56 -35 9.5 11.5 10.5 9.1 10 -18 10 15 7.8 7 35 3 10 23.5 22 22.5 26.6China Foods 506 HK NR HKD 1,065 2.97 1 -5 n.a. n.a. 36.2 22 n.a. -78 n.a. 65 16.3 10.3 -15 5 11 -1.6 0.7 1.9 -1.7Yashili Int. 1230 HK NR HKD 1,123 2.46 -13 -12 15.9 23.7 16.7 13.8 -8 -15 13 21 11.6 9.2 6 -13 13 9.6 13.5 15.3 11.1Huiyuan 1886 HK NR HKD 881 3.15 -16 -3 18.6 n.a. 20.9 13 n.a. n.a. n.a. 61 17.5 10.3 13 12 35 -1.8 8.2 13.3 1.3Tenwow 1219 HK NR HKD 718 2.7 -8 -9 10.1 9.7 8 6.3 n.a. 4 22 28 8.6 7 11 10 16 9.6 9.9 10.3 14.8Average 23.4 23.7 20.5 16.2 6 -1 21 26 11.1 8.6 18 15 13 8 9.3 10.6 13.4

Source: Bloomberg, *Daiwa forecasts

Global personal care product companies: valuations Bloomberg Mkt.Cap. Price Stock Δ % PER (x) EPS Growth EV/EBITDA (x) Revenue YoY % EBIT margin ROE(%)Name code Rating CRY USDm 10 Nov 14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E

PROCTER & GAMBLE PG US NR USD 240,840 89.13 10 5 21.3 20.4 18.9 17.5 4 4 8 8 13.5 12.7 1 0 3 18.4 19.7 20.5 18.4 KIMBERLY-CLARK KMB US NR USD 42,177 113.24 10 9 20.3 18.8 18.4 17.1 25 8 2 7 11.1 11.1 0 (0) (2) 15.2 16.4 16.8 48.2 Svenska Cellulosa AB SCAB SS NR SEK 16,129 168.60 2 4 21.3 15.8 14.5 13.6 25 35 9 7 9.4 8.7 4 16 4 10.9 11.1 11.7 11.3 KAO CORP 4452 JP Outperform JPY 19,520 4,313 6 4 34.2 26.9 23.2 21.5 25 27 16 8 10.0 9.4 8 6 4 9.5 9.6 10.3 12.1 UNICHARM CORP 8113 JP Neutral JPY 13,673 2,511 19 1 39.2 43.3 32.3 27.7 (18) (10) 34 17 18.4 13.7 21 (10) 40 11.2 10.6 11.8 8.6 27.3 25.0 21.4 19.5 12 13 14 9 12.5 11.1 7 2 8 13.0 13.5 14.2 19.7

Source: Bloomberg

02468

101214161820

Sep 09 Sep 10 Sep 11 Sep 12 Sep 13 Sep 14

3331 HK 7x 11x15x 19x 24x


- 19 -

Investment risks

Competition from international brands, product safety hazards, commodity price volatility are key investment risks for the sector. Competition from foreign brands – a key risk Foreign brands are perceived by Chinese consumers as being of a higher quality and safer than local brands. Most foreign-branded diaper products have gradually gained market share in China over the past few years. While we believe local personal care product brands are better positioned in low-tier cities and regional markets due to their low prices and strong distribution networks there, increasing consumer awareness and accessibility to foreign brands could offset such advantages in the long run. Product-mix upgrades and co-operation with renowned international players are key ways for domestic players to enhance their competitiveness. Increasing A&P expenses Personal care products usually have high brand stickiness due to the risk consumers perceive of switching to a new brand (in particular for baby products). We believe domestic players have started to invest more in advertising and promotion to enhance their brand awareness in an effort for their products to become a parent’s first chosen diaper or a girl’s first used sanitary napkin.

Commodity prices Major raw materials for personal hygiene products include wood pulp and petrochemicals. Currently, supply of most materials is in abundance in China and raw-material costs have remained largely stable so far in 2014. Companies would not be able to pass on any cost pressure fully if raw-material costs increased rapidly in a short period of time. Overcapacity – tissue paper According to CNHPIA, tissue paper production capacity in China will increase by 57% between 2013 and 2015 and reach 13.4m tpa by the end of 2015. This number looks aggressive compared with: 1) the consumption volume growth of 9% in the past 3 years, and 2) our 17% and 12% sales volume CAGR (2013-16E) forecasts for Hengan and Vinda, respectively. Although we believe much of these new capacities will target the export market or expansion will be delayed, some regional competitors may choose to further lower their ASPs to boost sales volumes, putting further pricing pressure on Vinda and Hengan.


■ Investment case We initiate coverage of Hengan International, the largest sanitary napkin and tissue paper brand in China, with an Outperform (2) rating and 6-month target price of HKD89.10. We expect the company’s product-mix upgrades and progress with its online-to-offline (O2O) channel to lead to a revival in its operating margin and EPS growth in 2015, and hence see scope for a rerating over the next 6 months. Product-mix upgrades should offset rising selling costs. We forecast Hengan’s operating margin to trough at 22.1% in 2014 and rebound to 22.8-23.6% in 2015-16, as it further upgrades its product mix to meet rising demand from consumers and to gain market share from small/regional competitors. We forecast its mid- and high-end products to account for 80-85% of sanitary napkin and diaper sales for 2015-16, from 70-80% in 1H14.

Sales channel investment stands to pay off. Hengan has in the past been weaker than foreign brands in terms of online sales, which is a fast-growing sales channel for diapers. However, it is in the midst of developing an O2O channel, whereby its wide physical store network, which covers 1m retailers in China, will serve as pick-up or delivery points for this new e-commerce channel. Hengan also streamlined its product portfolio online and built a distribution centre in 2013-1H14 to strengthen its service platform and lower administration costs. We expect these initiatives to pave the way for new product launches in 2H14, and drive a revenue CAGR of 14% over 2013-16E, up from 9% YoY in 2012. ■ Catalysts We see the main share-price catalyst as a rebound in the operating margin in 2015E on continuous product-mix upgrades for diapers and sanitary napkins. A buyback of shares by the company at below HKD80/share would also cushion the share price, in our view. ■ Valuation Our 6-month target price of HKD89.10 is based on a PER of 23.5x for 2015E, in line with the stock’s past-5-year-average 12-month forward PER. We expect the

stock to rerate ahead of the earnings growth acceleration in 2015E. ■ Risks We see the main risks as: 1) competition from foreign brands, 2) failure to expand its O2O business, and 3) raw-material cost volatility.

Consumer Staples / Hong Kong1044 HK

11 November 2014

Hengan International Group

Initiation: a local leader catching up

• Operating margin and EPS growth look set to rebound in 2015, which could drive a rerating of the stock

• Efforts on product-mix upgrades and online sales network should start to pay off in 2015 as economies of scale build

• Coverage initiated with an Outperform (2) rating and target price of HKD89.1, on a 2013-16E EPS CAGR of 15%

Source: FactSet, Daiwa forecasts

Consumer Staples / Hong Kong

Hengan International Group1044 HK

Target (HKD): 89.10Upside: 11.9%10 Nov price (HKD): 79.60

BuyOutperform (initiation)

HoldUnderperformSell

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Nov-13 Feb-14 May-14 Aug-14

Share price performance

Hengan (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 76.35-98.55Market cap (USDbn) 12.623m avg daily turnover (USDm) 18.54Shares outstanding (m) 1,229Major shareholder Sze Man Bok (18.6%)

Financial summary (HKD)Year to 31 Dec 14E 15E 16ERevenue (m) 24,440 28,085 31,746Operating profit (m) 5,399 6,403 7,486Net profit (m) 3,870 4,661 5,490Core EPS (fully-diluted) 3.147 3.792 4.467EPS change (%) 6.8 20.5 17.8Daiwa vs Cons. EPS (%) 1.3 1.3 1.0PER (x) 25.3 21.0 17.8Dividend yield (%) 2.3 2.9 3.4DPS 1.850 2.275 2.680PBR (x) 5.5 5.0 4.5EV/EBITDA (x) 15.8 13.4 11.4ROE (%) 22.5 24.8 26.4




- 21 -

Growth outlook Hengan: recurring net profit and YoY growth

We forecast Hengan’s recurring net profit growth to re-accelerate to 20% YoY for 2015 and 18% YoY for 2016, up from 7% YoY for 2014 and 3% YoY for 2013, driven mainly by operating margin expansion on continuous product mix upgrades in its sanitary napkin and diaper segments. A driver of this net profit growth should also be Hengan’s strong balance sheet, which should generate net financial income of about HKD300m (included under other income) each year for 2014-16, on our forecasts.


Valuation Hengan: 12M forward PER bands

The Hengan stock has been derated since 4Q13 due to investors’ concerns about profit margin pressure at the company’s tissue paper business as a result of over-capacity in China, as well as forex losses due to CNY depreciation. We expect the stock to rerate again over the next 6 months, as we project a recovery in the company’s operating margin in 2015 on the back of its product mix upgrades (in particular for the sanitary napkin segment) and continuous growth in online sales and sales at its high-end diaper segment.

Source: Bloomberg

Earnings revisions Hengan: consensus EPS forecast revisions (2014-15E)

The Bloomberg consensus 2014 and 2015 EPS forecasts for Hengan have trended down slowly since mid-2013 on concerns about the company’s tissue paper business. We see limited downside to the consensus forecasts now, as Hengan’s diaper and sanitary napkin sales have picked up and should support operating margin expansion in 2015 and 2016. Our 2014-16E EPS are slightly (1-1.3%) above those of the consensus.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

0%

5%

10%

15%

20%

25%

30%

35%

40%

(1,000)

0

1,000

2,000

3,000

4,000

5,000

6,000

2011 2012 2013 2014E 2015E 2016E

Net profit (LHS) Forex gain / loss (LHS) YoY % (RHS)

(HKDm)

35

55

75

95

115

Sep

09

Dec

09

Mar

10

Jun

10

Sep

10

Dec

10

Mar

11

Jun

11

Sep

11

Dec

11

Mar

12

Jun

12

Sep

12

Dec

12

Mar

13

Jun

13

Sep

13

Dec

13

Mar

14

Jun

14

Sep

141044 HK 19x 22x

25x 28x 32x

(HKD)

0.0

1.0

2.0

3.0

4.0

5.0

Jun-

13

Jul-1

3

Aug-

13

Sep-

13

Oct

-13

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

2014E 2015E

(HKD)

BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5


- 22 -

Key assumptions

Profit and loss (HKDm)

Cash flow (HKDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESanitary napkin volume YoY 10 10 64 16 12 17 15 10Diapers volume YoY 26 13 10 (4) 3 1 5 5Tissue paper volume YoY 16 33 26 25 12 22 17 13Sanitary napkin ASP YoY 1.5 0.0 1.5 3.1 7.1 8.0 5.0 5.0Diapers ASP YoY (8.7) 0.0 1.5 3.1 5.8 7.0 6.0 5.0Tissue paper ASP change YoY (0.9) 3.2 4.1 (8.7) (0.0) (5.0) (3.0) 0.0

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESanitary napkins 2,546 3,170 4,114 4,915 5,898 7,452 8,999 10,393Diposable diapers 2,160 2,447 2,723 2,685 2,938 3,175 3,534 3,896Other Revenue 6,127 7,815 10,213 10,923 12,350 13,812 15,552 17,456Total Revenue 10,834 13,432 17,051 18,524 21,186 24,440 28,085 31,746Other income 107 249 456 565 776 847 873 889COGS (5,853) (7,487) (10,250) (10,209) (11,627) (13,132) (15,016) (16,856)SG&A (2,487) (3,194) (3,963) (4,139) (5,248) (6,756) (7,539) (8,293)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 2,601 3,000 3,294 4,741 5,088 5,399 6,403 7,486Net-interest inc./(exp.) (18) 39 (38) (202) (72) (347) (205) (197)Assoc/forex/extraord./others 0 0 0 0 185 (140) 0 0Pre-tax profit 2,583 3,038 3,255 4,539 5,201 4,912 6,198 7,289Tax (416) (552) (570) (1,001) (1,245) (1,213) (1,488) (1,749)Min. int./pref. div./others (50) (48) (37) (19) (50) (50) (50) (50)Net profit (reported) 2,118 2,438 2,649 3,519 3,906 3,650 4,661 5,490Net profit (adjusted) 2,125 2,370 2,605 3,531 3,627 3,870 4,661 5,490EPS (reported)(HKD) 1.841 2.000 2.156 2.861 3.174 2.969 3.792 4.467EPS (adjusted)(HKD) 1.848 1.944 2.120 2.871 2.947 3.147 3.792 4.467EPS (adjusted fully-diluted)(HKD) 1.848 1.944 2.120 2.871 2.947 3.147 3.792 4.467DPS (HKD) 1.100 1.305 1.350 1.700 1.850 1.850 2.275 2.680EBIT 2,601 3,000 3,294 4,741 5,088 5,399 6,403 7,486EBITDA 2,943 3,384 3,727 5,291 5,791 6,197 7,304 8,501

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 2,583 3,038 3,255 4,539 5,201 4,912 6,198 7,289Depreciation and amortisation 342 385 433 550 703 797 902 1,015Tax paid (416) (552) (570) (1,001) (1,245) (1,213) (1,488) (1,749)Change in working capital 315 (1,099) 221 (984) (812) (583) (693) (679)Other operational CF items 18 (39) 38 202 72 347 205 197Cash flow from operations 2,842 1,733 3,378 3,306 3,919 4,261 5,124 6,073Capex (948) (1,117) (2,428) (2,469) (1,407) (1,429) (1,700) (1,700)Net (acquisitions)/disposals 0 0 0 0 13 0 0 0Other investing CF items 0 0 0 0 0 0 0 0Cash flow from investing (948) (1,117) (2,428) (2,469) (1,395) (1,429) (1,700) (1,700)Change in debt 922 2,582 1,906 4,009 8,192 0 0 0Net share issues/(repurchases) 0 123 120 0 103 (200) 0 0Dividends paid (1,096) (1,466) (1,594) (1,844) (2,216) (2,278) (2,346) (2,996)Other financing CF items (63) (72) (148) (240) (364) (469) (469) (469)Cash flow from financing (236) 1,167 284 1,926 5,714 (2,947) (2,815) (3,464)Forex effect/others 8 (68) (44) 12 (279) 220 0 0Change in cash 1,665 1,716 1,190 2,776 7,960 105 610 908Free cash flow 1,893 617 950 837 2,512 2,832 3,424 4,373


- 23 -

Balance sheet (HKDm)

Key ratios (%)


Company profile

Hengan International Group (Hengan) is the largest supplier of sanitary napkins and household tissue paper in China in terms of sales, with market shares of around 10.9% and 11.4%, respectively, in 2013 according to Euromonitor. Hengan also produces diapers (for babies and adults) and snack products.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 4,461 6,048 8,327 9,607 19,624 19,659 19,994 20,787Inventory 2,175 2,760 2,934 3,831 4,386 4,954 5,664 6,358Accounts receivable 883 1,396 1,893 1,870 2,184 2,520 2,896 3,273Other current assets 285 546 590 883 1,127 1,183 1,243 1,305Total current assets 7,803 10,750 13,744 16,191 27,321 28,316 29,796 31,724Fixed assets 4,344 5,184 7,257 9,117 9,832 10,451 11,187 11,810Goodwill & intangibles 616 607 601 591 581 610 610 610Other non-current assets 1,384 2,036 1,717 3,306 2,456 2,506 2,606 2,706Total assets 14,148 18,577 23,319 29,205 40,190 41,883 44,200 46,850Short-term debt 2,175 3,815 6,815 7,441 13,233 13,233 13,233 13,233Accounts payable 1,273 1,319 1,881 1,803 2,097 2,368 2,708 3,040Other current liabilities 727 943 1,316 1,578 1,585 1,690 1,803 1,926Total current liabilities 4,175 6,077 10,012 10,821 16,915 17,291 17,745 18,199Long-term debt 555 1,497 404 3,787 6,187 6,187 6,187 6,187Other non-current liabilities 121 178 185 188 170 170 170 170Total liabilities 4,851 7,752 10,600 14,797 23,272 23,648 24,101 24,556Share capital 122 122 123 123 123 123 123 123Reserves/R.E./others 8,895 10,381 12,219 13,955 16,410 17,727 19,591 21,787Shareholders' equity 9,017 10,503 12,341 14,078 16,534 17,850 19,714 21,910Minority interests 280 322 377 330 385 385 385 385Total equity & liabilities 14,148 18,577 23,319 29,205 40,190 41,883 44,201 46,851EV 96,387 97,424 97,106 99,788 98,018 97,983 97,649 96,855Net debt/(cash) (1,731) (736) (1,108) 1,621 (204) (239) (574) (1,368)BVPS (HKD) 7.395 8.614 10.042 11.455 13.427 14.522 16.039 17.826

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) 35.4 24.0 26.9 8.6 14.4 15.4 14.9 13.0EBITDA (YoY) 62.0 15.0 10.1 42.0 9.4 7.0 17.9 16.4Operating profit (YoY) 69.9 15.3 9.8 43.9 7.3 6.1 18.6 16.9Net profit (YoY) 65.1 11.5 9.9 35.6 2.7 6.7 20.4 17.8Core EPS (fully-diluted) (YoY) 63.9 5.2 9.1 35.4 2.7 6.8 20.5 17.8Gross-profit margin 46.0 44.3 39.9 44.9 45.1 46.3 46.5 46.9EBITDA margin 27.2 25.2 21.9 28.6 27.3 25.4 26.0 26.8Operating-profit margin 24.0 22.3 19.3 25.6 24.0 22.1 22.8 23.6Net profit margin 19.6 17.6 15.3 19.1 17.1 15.8 16.6 17.3ROAE 27.4 24.3 22.8 26.7 23.7 22.5 24.8 26.4ROAA 17.6 14.5 12.4 13.4 10.5 9.4 10.8 12.1ROCE 25.3 21.3 18.3 20.8 16.4 14.6 16.6 18.4ROIC 30.2 27.8 25.0 26.7 23.6 23.4 25.9 28.1Net debt to equity n.a. n.a. n.a. 11.5 n.a. n.a. n.a. n.a.Effective tax rate 16.1 18.2 17.5 22.1 23.9 24.7 24.0 24.0Accounts receivable (days) 28.0 31.0 35.2 37.1 34.9 35.1 35.2 35.5Current ratio (x) 1.9 1.8 1.4 1.5 1.6 1.6 1.7 1.7Net interest cover (x) 145.9 n.a. 85.8 23.5 70.3 15.6 31.3 38.0Net dividend payout 59.7 65.3 62.6 59.4 58.3 62.3 60.0 60.0Free cash flow yield 1.9 0.6 1.0 0.9 2.6 2.9 3.5 4.5


- 24 -

Profit margin rebound in 2015E

We expect Hengan’s operating margin to trough at 22.1% in 2014 due to pricing pressure on tissue paper, but believe ASP hikes and product mix upgrades in other segments will result in an operating margin rebound in 2015-16E. Hengan: operating margin and gross margin trends


Continuous upgrades to its sanitary napkin and diapers mix

Sanitary napkins – more to come For Hengan’s sanitary napkins segment, product mix upgrades have been a major contributor to the segment’s gross margin expansion over the past 4 years. Mid-range to high-end products (including 7-space, Princess series, etc.), accounted for 80% of this segment’s sales in 1H14, up from 68% in 2011. We still see room for further gross margin expansion through further product-mix upgrades and potential for Hengan’s brands to replace other domestic brands’ products.

Hengan’s sanitary napkins segment: revenue breakdown by mid-range to high-end tiers, gross margin trend


Hengan’s sanitary napkins segment: ASP increases and revenue growth (YoY %)


While the top-10 sanitary napkin brands, which include Hengan, in aggregate accounted for about 80% of the market in China in 2013, we see room for the top players to capture even more market share from the small players. As highlighted in our sector piece that accompanies this report, there are still over 600 sanitary napkin brands in China, and most of them do not have a national presence. Compared with international brands, Hengan looks best positioned to take market share from those players, due to its more extensive distribution network nationwide, and more diversified product portfolio with prices ranging from the low-to high-end, which can serve consumers with different levels of consumption power. We discuss Hengan’s distribution strengths in the next section.

19.3%

25.6% 24.0% 22.1% 22.8% 23.6%

39.9%44.9% 45.1% 46.3% 46.5% 46.9%

0%

10%

20%

30%

40%

50%

2011 2012 2013 2014E 2015E 2016E

Operating margin Gross margin

60.4

65.8 66.368.0

69.070.0

54565860626466687072

0

2,000

4,000

6,000

8,000

10,000

12,000

2011 2012 2013 2014E 2015E 2016E

Mid-and high-end products (LHS) Others (LHS)

Segment's GPM (RHS)

(HKDm) (%)

0

5

10

15

20

25

30

2013 2014E 2015E 2016E

ASP hike Revenue growth


- 25 -

Diapers – slow sales-volume growth should be offset by product mix upgrades The sales outlook for diapers has been sluggish over the past 3 years on slow sales-volume growth due to: 1) fierce competition from foreign brands, which generally enjoy higher brand recognition among young consumers, and 2) Hengan’s weak presence in online sales channels. However, we expect the segment’s ASP to start to pick up in 1H15 (by 8% YoY, based on our forecasts), which should be positive for the segment’s gross margin in the long run. We estimate that the gross margin on the company’s high-end products exceeds 70% at present, versus 40% for low-end products. As such, these product mix upgrades should lift the segment’s operating margin gradually over 2014-16E. Hengan’s diaper segment: revenue breakdown by mid-range/high-end tiers (HKDm), and proportion of segmental sales (%)


Hengan’s diaper segment: ASP increases and revenue growth (YoY %), operating margin %


Tissue paper segment: price competition likely to linger

As highlighted in our sector piece that is part of this report, we believe oversupply in China’s tissue paper industry will linger for at least another year on the back of capacity expansion by many peers. Based on Hengan’s current capacity expansion plans, we look for its capacity to expand by 13% YoY for 2014 and 24% for 2015, and then flatten out in 2016. We forecast Hengan’s tissue paper sales volume for 2014, 2015 and 2016 to reach 1.03m tonnes, 1.2m tonnes and 1.36m tonnes, respectively, up by 13%, 17% and 13% YoY, respectively. Such growth should be supported by: 1) more discounts and promotions, and 2) the OEM/export business. Hengan’s tissue paper export sales by value reached HKD600m in 1H14 (11% of the segment’s revenue), and Hengan plans to set up a joint venture to enhance its overseas sales of tissue paper in 4Q14. Hengan’s tissue paper segment: capacity vs. sales volume, utilisation rate


Although there was a strong pick-up in export household paper prices in 2013, which supported volume growth and utilisation rates in the segment, we believe Hengan’s plan to increase its tissue paper exports will only provide mild support for its operating margin, as the export price increase was due mainly to the CNY’s appreciation against the USD. We estimate that the operating margin for the company’s tissue paper export business is similar to that for its domestic business, at 9-10%.

0

20

40

60

80

100

0

1,000

2,000

3,000

4,000

5,000

2011 2012 2013 2014E 2015E 2016E

Total (LHS) High-end diapers (LHS)

High-end diapers as % of total (RHS)

13.2

22.520.6 19.6

22.725.5

(5)

0

5

10

15

20

25

30

2011 2012 2013 2014E 2015E 2016E

ASP Hike YoY Revenue YoY Operating margin

0.88

0.90

0.92

0.94

0.96

0.98

1.00

1.02

0

200

400

600

800

1,000

1,200

1,400

1,600

2011 2012 2013 2014E 2015E 2016E

Capacity (LHS) Sales volume (LHS) utilisation rate (RHS)

(000 tonnes/year) (x)


- 26 -

China: exports of tissue paper (tonnes, LHS) and ASP (USD/tonne, RHS)

Source: Wind

Also, we believe a decline in the tissue paper segment’s production-capacity utilisation rate, which we estimate to decline from 100% in 2014E to below 90% in 2015-16E, coupled with ASP pressure, will weigh on the segment’s gross margin in 2015 and 2016. Hengan’s tissue paper segment: ASP and gross margin


Operating leverage should kick in starting in 2015

ASP increases should offset higher advertising and promotion costs Hengan’s selling/cost ratio increased from 17.5% in 2012 to 18.3% in 2013, and further to 21.3% in 1H14. We believe it was driven by increasing brand building expenses for diapers and promotion activity for tissue paper. That said, we expect a pick-up in revenue to lead to increased operating leverage from 2015E onward. Hengan’s ratio of A&P expenditure to revenue rose substantially over 2012-1H14, from 8.4% in 2012 to 8.8% in 2013 and 11.1% in 1H14. This came about primarily from marketing and promotion activities, and thus expenses for its tissue paper business, as well as for its new baby diaper products, increased. Given the company targets to: 1) increase sales of its new products, and 2) boost sales volumes to satisfy the new tissue paper capacity, we forecast the A&P/revenue ratio to remain elevated at 9-11.1% over 2014-16. However, we expect the impact of such sustained high A&P spending on brand building to be offset partially by ASP increases across all of its segments, as discussed above. Our forecast increases in segmental ASPs translate into blended ASP rises for the company of 5-8% YoY over 2014-16E for baby diapers and sanitary napkins, respectively. Hengan: A&P expenses and selling costs as % of revenue (%)


0

500

1,000

1,500

2,000

2,500

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2009 2010 2011 2012 2013

Tonnes (LHS) ASP (RHS)

31.435.4 34.1

30.5 28.7 27.9

0

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15

20

25

30

35

40

10,000

10,500

11,000

11,500

12,000

12,500

13,000

13,500

2011 2012 2013 2014E 2015E 2016E

ASP (LHS) Gross margin (RHS)

(HKD/tonne) (%)

10.08.4 8.8

11.110.0 9.0

18.817.5 18.3

21.3 20.7 20.1

0

5

10

15

20

25

2011 2012 2013 2014E 2015E 2016E

A&P cost ratio Selling cost ratio


- 27 -

Well-placed to build its online presence

Hengan’s nationwide production and distribution network leaves it better placed vs. foreign brands to capture market share from domestic small players, and well-prepared to expand its online presence following product mix upgrades under way

We believe Hengan’s strong production and distribution network throughout China has been one of the key drivers of its strong revenue growth over recent years – its revenue increased at a 22% CAGR over 2008-13. Specifically, having an extensive national distribution network gives the company a robust platform through which to launch its new products (such as tissue paper in 2004 and snacks in 2009) and tap into growing demand for its products in China’s rural regions. Hengan: segmental revenue and YoY growth


Strong national network

Production. Hengan’s national network of production plants puts it in a better position than major international competitors, in our view. This is because the company has production plants in western, central and northern China, which help it to contain its logistics costs and penetrate into the country’s inland coastal regions . Among the international players in the household and personal products industry that are

present in China, we note that only Procter & Gamble (P&G) has a number of production plants that comes close to Hengan’s and a network that spread over the country, as the next table shows. (Domestic peer Vinda has a comparable production network to Hengan’s in terms of size and national reach.) Household and personal players in China: locations of production plants (2013) Product segment Hengan Kaos Unicharm P&G

Kimberly Clark Vinda

Sanitary napkins

Shandong, Tianjin, Fujian, Hefei, Shaanxi,

Sichuan, Chongqing,

Guangxi, Jiangxi, Jilin etc.

Shanghai

Shanghai, Tianjin

Beijing, Shanghai,

Tianjin, Chengdu,

Guangdong, Fujian

Beijing Shanghai Nanjing

Guangdong,

Sichuan, Liaoning,

Hubei, Zhejiang, Shandong, Beijing

Diapers Hefei Tissue paper n.a. n.a. n.a. Other products Shanghai n.a. n.a. Total no. of plants in China 13 2 2 7+ 4 8+

Source: Companies, Daiwa

By virtue of having a large and extensive production network, Hengan has been able to keep its ratio of logistics costs to revenue at below 5% per annum since 2006 (as the next chart shows) despite its rapid expansion of the tissue paper business, where bulkier and low-priced products compared with its other segments entail higher logistics costs than for its other segments.

Hengan: logistics costs vs. tissue paper sales as % of total revenue (%)


Distribution. In 2013, about 33% of Hengan’s sales were conducted directly to supermarket chains, while most of the remaining 67% of its sales went to more than 3,000 distributors (and more than 30,000 sub-distributors), which in turn supply small retailers. Hengan’s management believes that out of 1.02m retail stores in China that are serviced by the company’s team of more than 15,000 sales people, it has a “controllable” position in 1m of these stores. “Controllable” means that Hengan’s products have access to good shelf-space positions in the stores.

41 35

24 27

9 14 15 15 13

0

10

20

30

40

50

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

Sanitary napkins Diposable diapers Tissue paper

Snacks Others YoY (RHS)

(HKDm) (%)

4.5

4.2

4.7

4.4

4.24.0

4.2 4.2 4.2

0

10

20

30

40

50

60

3.6

3.8

4.0

4.2

4.4

4.6

4.8

5.0

2006 2007 2008 2009 2010 2011 2012 2013 2014E

Logistics cost % of revenue (LHS)

Tissue paper sales as % of total revenue (RHS)


- 28 -

By comparison, Unicharm, which has the second-largest domestic market share in diapers (13.6% in terms of 2013 sales) and sanitary napkins (15.9%), also has a substantial distribution network covering 1,000 cities in China (according to Unicharm’s 2013 disclosures). Its network represents about 40% of the number of counties and cities in China, based on data from the China Bureau of Statistics. However, we believe Unicharm’s network is only stronger than Hengan’s in coastal areas, where it is more convenient for sales of Unicharm's products imported from Japan. Despite Hengan’s smaller market share than Unicharm (ranked 4th in diapers, according to Euromonitor), we believe Hengan is better positioned to capture market share in China’s lower-tier cities and rural areas, where consumer spending power is on the rise.

Strong foundation to develop business online

Online sales started from a modest base … Hengan entered into the online sales arena in 2011, and over 2012-13 opened online stores and started distributing its products on online platforms such as T-mall, jd.com and yihaodian. The company’s revenue derived from online platforms has grown rapidly from just CNY5m in 2011 to over CNY100m in 2013, but we estimate that it still accounts for less than 2% of Hengan’s total revenue, and thus lacks the scale required to make a meaningful contribution to the company’s bottom line. We note that foreign players that compete with Hengan in China have a much larger presence with online platforms currently. In particular, in the diaper segment Hengan is not among the top-10 baby diaper brands in China’s online sales market, despite its No. 4 position in this segment in the overall China market. As a result, Hengan lost out in 2013, when total sales of baby diapers carried out online in China rose by 46% YoY, compared with a 4% YoY decline in baby diaper sales in supermarkets and a 9% YoY sales increase in specialty baby stores. Based on our industry research, we believe foreign household and personal product brands have taken the first-mover advantage in engaging with frequent online shoppers (usually young consumers) in China. It has taken Hengan a long time to build up brand recognition among this new group of consumers.

… now poised to take off Notwithstanding this slow start, we expect Hengan’s sales through online platforms to start taking off in 1Q15, as the company has worked on improving its logistics support facilities and product mix over the past few years in order to expand its sales online. Optimisation of SKUs. We estimate that Hengan has more than 500 SKUs available to be sold online. However, management reduced the number of SKUs it made available online to around 300 in 2013 in order to facilitate inventory control and the logistics involved. Going forward, Hengan plans to focus its online sales on 3 sub-brands – Heartexx, Anerle and 7-space series. For diapers in particular, Hengan will focus on promoting its ultra-thin series (launched in April 2014). According to the management, this product has a retail ASP of about CNY1.5-1.7 per piece for the small-sized category, slightly lower than international brands, but have a comparable or similar quality. These products have a gross margin exceeding 70%, so increasing their sales would help to offset increases we expect in the company’s selling and other fixed costs due to its investment in online channels. Logistics development. In 2013, Hengan built 3 logistics centres – in Beijing, Shanghai and Guangzhou – to support deliveries nationwide of its orders taken online. In July this year, Hengan started to engage some distributors in Fujian to deliver its products purchased online. According to the local newspaper Jinjiang Economy News, Hengan has engaged 200 retailers (mainly convenience stores) in Jinjiang, the province in which the company was founded, to deliver products ordered online to customers there.


- 29 -

Financial analysis

We forecast Hengan to deliver recurrent net profit growth of 7%, 20% and 18% YoY for 2014, 2015 and 2016, respectively, driven by steady sales volume growth for its sanitary napkins and diapers, and supported by mild ASP increases. We forecast Hengan’s revenue to increase by 15% YoY for both 2014 and 2015, and by 13% YoY for 2016. We expect sales volume growth to be the key top-line driver for its tissue paper and sanitary napkins segments. For 2015 and 2016 we envisage moderate ASP rises for its sanitary napkins and diapers segments on the back of product mix upgrades, but continuous pricing pressure at the tissue paper segment. We assume stable raw-material costs for 2014-16, and thus forecast slight operating margin improvements for its sanitary napkins and diapers segments, but margin declines each year for its tissue paper and snacks businesses. Hengan: reported and recurring net profit and recurring net profit growth


Hengan: segmental revenue breakdown (2014E)


Hengan: key P&L assumptions and profit margins (%) 2012 2013 2014E 2015E 2016E

Sales volume YoY Sanitary napkins 16 12 17 15 10Diapers -4 3 1 5 5Tissue paper 25 12 22 17 13 ASP YoY Sanitary napkins 3 7 8 5 5Diapers 3 6 7 6 5Tissue paper -9 0 -5 -3 0 Revenue YoY Sanitary napkins 19 20 26 21 16Diapers -1 9 8 11 10Tissue paper 14 12 16 13 13Snacks -10 16 -10 10 10 Gross margins Sanitary napkins 65.8 66.3 68.0 69.0 70.0Diapers 42.9 44.5 46.6 48.7 50.5Tissue paper 35.4 34.1 30.5 28.7 27.9Snacks 38.2 42.3 43.0 41.0 41.0Group 44.9 45.1 46.3 46.5 46.9Operating margins Sanitary napkins 43.3 43.0 43.0 44.0 45.0Diapers 22.5 20.6 19.6 22.7 25.5Tissue paper 15.4 11.2 8.0 6.7 6.9Snacks 3.7 7.3 8.0 6.0 6.0Group 25.6 24.0 22.1 22.8 23.6

Source: Company, Daiwa estimates

Operating and gross margin trends We believe Hengan’s operating margin outlook by segment is mixed for 2014-6E:

1) Sanitary napkins: we expect this segment’s operating margin to improve slightly over 2014-16E on product mix upgrades. High-end products such as 7-space and the Princess sub-series, accounted for about 83% of the segment’s revenue for 1H14.

2) Diapers: in 1H14, revenue from mid-range and high-end products increased by 16% YoY, while revenue from OEM and low-end products declined by 12% YoY. We believe Hengan will continue to upgrade its product mix and launch new products with higher ASPs and new functions so as to lift the segment’s

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(HKDm) (%)

Sanitary napkins30.5%

Diapers13.0%

Tissue paper48.4%

Snacks5.9%

Others2.2%


- 30 -

operating margin. For example, the super-absorbent series, which was launched in 3Q12, had a gross margin of above 70% and contributed about 20% to segmental revenue in 2013 (+53% YoY).

3) Tissue paper: we expect this segment’s operating margin to remain under pressure over 2014-16 on continuous price discounting. That said, we forecast its operating margin to trough at about 7% in 2015-16E as we expect the tissue paper oversupply in China to ease gradually.

4) Snacks: we expect low raw-material costs (eg, palm oil, sugar) to help sustain a segmental operating margin of 8% for 2014E. However, we believe fierce competition and operating deleverage will put pressure on operating margin over 2015-16E and reduce it to 6% for both years.

Selling and administrative costs As discussed before, we look for selling costs as a ratio of revenue to increase to 27.6% in 2014E from 24.8% in 2013 due to stepped-up promotional activity for tissue paper. However, the ratio should remain largely stable over 2014-16E as Hengan will digest its new paper capacity by expanding its overseas/OEM business which incurs low selling expenses. We also expect administration costs to remain steady over our forecast horizon. Hengan: SG&A cost and as a ratio of revenue


Forex gains/losses: As a result of CNY depreciation against the USD/HKD, Hengan reported a forex loss of HKD178m in 1H14 (2013: financial gain of HKD279m), due to the difference between its functional currency (CNY) and reporting currency (HKD). We have not assumed any forex gain or loss in our forecasts for 2015-16. Financial income and expenses: With Hengan’s strong cash position, we estimate that 12-14% of its net profit will be attributable to interest income (HKD500-600m per year) over 2014-16E.

Tax. We forecast Hengan’s effective tax rate to remain high at 23-24% in 2014. Its tax rate is below the standard tax rate of 25% in China due to its exposure to Hong Kong (10-15% of its profit before tax) and as a result of tax benefits attributable to subsidiaries operating in western China, which enjoys tax benefits. Dividend. We expect Hengan to maintain a 60% payout ratio (of recurring net profit) over 2014-16, similar to its 2013 level. Strong operating cash flow and balance sheet to support share buyback We forecast Hengan’s operating cash flow to exceed HKD4bn over 2014-16, hence allowing it to maintain a strong balance sheet and have cash at its disposal to spend on capacity expansion. At the same time, cash interest expenses are low in terms of cash outflow, since the company issued a zero-coupon convertible bond with a face value of HKD5.4bn in June 2013. The effective interest cost is about 2.7% only, and the initial conversion price is HKD120 per share. The strong cash flow has also supported share buybacks. Hengan has bought back around 2.3m shares since announcing its interim results in August, at prices of between HKD74/share and HKD80/share. Hengan: net cash and cash flow


23.2 22.324.8

27.6 26.8 26.1

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01,0002,0003,0004,0005,0006,0007,000

2011 2012 2013 2014E 2015E 2016E

Operating cashflow Net cash

(HKDm)


- 31 -

Valuation

At a 21x 2015E PER, we believe the current share price has yet to price any re-acceleration in earnings growth in 2015-16E. Our target price of HKD89.10 implies 12% upside potential.

Valuation methodology

We believe PER is a suitable methodology to value Hengan given its profile as a personal hygiene producer, with what we regard as good earnings visibility and stability. To value Hengan, we use our 2015 EPS forecast and assign a target PER of 23.5x, which is in line with the stock’s past-5-year average 12-month forward trading PER. Our target PER corresponds to a 15% premium to the major China staple companies’ average 2015E PER at current share prices, of 20.5x (based on our and the Bloomberg consensus EPS forecasts). In our view, this premium is justified by Hengan’s: 1) quality earnings growth record of consistent double-digit YoY EPS growth since its IPO that we expect it to maintain over 2015-16, 2) higher-than-peers ROE and operating margin for 2014E, and 3) a consistently high payout ratio (past-5-year average of 61%) which we expect it to maintain over 2014-16. Hengan is also trading at a discount to its past-5-year PER average (1SD below), due to: 1) investor concerns about overcapacity and increasing promotions and discounts for its tissue paper business, and 2) the

company lagging its foreign competitors in the diaper and online businesses. We believe such concerns have been overplayed, as the stock is now trading at 1.2SD below its past-5-year average. Looking forward, we believe product-mix upgrades in other segments will help offset the sluggish tissue paper business. Hengan has also already launched diaper products in its online channels and mid-and high-end segment in 1H14. We expect the stock to rerate over the next 6 months, as net profit growth starts to reaccelerate from 7% in 2014 to 20%/18% YoY in 2015-16E. Hengan: 2012-16E revenue and earnings and Daiwa forecasts vs. Bloomberg consensus

2012 2013 2014E 2015E 2016ERevenue (HKDm) 18,524 21,186 24,440 28,085 31,746 YoY growth (%) 9% 14% 15% 15% 13% vs. consensus (%) n.a. n.a. 0.3% 0.3% -1.9%Net profit (HKDm) 3,531 3,627 3,870 4,661 5,490 YoY growth (%) 36% 3% 7% 20% 18% vs. consensus (%) n.a. n.a. -0.1% 0.2% -0.9%EPS (HKD) 2.8707 2.9473 3.1475 3.7922 4.4668 YoY growth (%) 35% 3% 7% 20% 18% vs. consensus (%) n.a. n.a. 1.3% 1.3% 1.0%

Source: Company, Bloomberg, Daiwa forecasts

Hengan: 12-month forward PER bands

Source: Bloomberg

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PER (x)

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Investment risks

Competition from foreign brands – key risk Foreign brands (in particular Japanese) are aggressively promoting their personal care and baby diaper products in China. Hengan might lose market share to them if it does not manage to differentiate its products from foreign competitors in terms of both quality and value. Failure to expand its online sales. The online sales channel grew faster than other distribution channels for baby and personal care products in China in 2013. Hengan has been working on optimising its online product offering to improve its presence there since 2013. However, it is still not one of the top-10 players in online baby diaper sales in China, and as such, its revenue growth for 2014-16E may come below our forecast if it continues to lag its peers in online sales. Raw-material cost volatility. Wood pulp and petrochemicals are Hengan’s major raw materials, whose costs are largely stable or have only increased

slightly in the year-to-date. If raw-material costs increased rapidly, Hengan would likely not be able to pass on the cost pressure immediately through a price hike.

Company background

Established in 1985, Hengan is engaged in the production and distribution of personal hygiene products as well as snacks. It was among the first of a few domestic players to launch sanitary napkin products in the 1980s, and it then launched diaper products in 1996 and tissue paper products in 1997. Its famous brands include Hearttex, Anerle, Anle, and 7-space. Through acquisitions, Hengan entered the snacks business in 2009 under the brand QinQin. It was listed on the Hong Kong Stock Exchange in 1998. Hengan is founded by Mr. Sze Man Bok (chairman) and Mr. Hui Lin Chit (CEO), who now own 18.6% and 18.3% stakes, respectively. Other management, employees and relatives own 10.7% of Hengan.

Hengan: product portfolio

Source: Company


■ Investment case We initiate coverage of Vinda International, the 3rd-largest household paper brand in China, with a Hold (3) rating. Svenska Cellulosa Aktiebolaget (SCA), one of the world’s largest personal hygiene product players, became Vinda’s major shareholder in 2013. We believe Vinda’s recent acquisition of SCA’s operation in Hong Kong and sales contract in China will provide a significant engine for growth from 2016 onward. Different strategic approach. Rather than undertaking aggressive promotions and discounts, as most of its peers do, Vinda has sought to safeguard its peer-leading ASPs and margins by increasing its sales of high-value items such as wet wipes, and developing an online sales platform. Following the company’s acquisition of the Tempo sales contract in China, we expect Vinda’s market share, particularly in the handkerchief category, to catch up

with those of its peers. By leveraging its existing sales network to sell these new products, we expect Vinda to cap its selling expenses at 15% of revenue in 2015-16. New businesses to be a near-term drag. We believe the personal care businesses acquired from SCA (and V-care JV stake) will weigh on Vinda’s profit margin in 2015 given the company’s lack of scale. In our view, 2015 will be a year of transition for Vinda and earnings visibility will be relatively low. ■ Catalysts Given Vinda’s reliance on tissue paper (over 85% of 2015E earnings), its earnings are more sensitive than major competitor Hengan’s to any softening in wood pulp prices, gradual easing of oversupply of tissue paper in China, on our analysis. If its sales of SCA’s high-margin products exceed our expectations, there would be upside to our EPS forecasts. ■ Valuation Our target price of HKD11.80 is set at a 20x 2015E PER, a 15% discount to our target 12-month forward PER for Hengan. We believe the rerating in Vinda shares since 3Q13 already prices in the benefits of SCA’s involvement (product mix enhancement/financial support).

■ Risks The main downside risks to our rating are a rise in pulp costs and higher fixed costs due to the acquired business of V-care. Upside risks include a rise in ASPs and any accretive asset injections.

Consumer Staples / Hong Kong3331 HK

11 November 2014

Vinda International

Initiation: SCA’s acquisition premium priced in

• Leveraging parent’s Tempo brand and product portfolio in an effort to enhance its revenue mix and operating margin

• Our below-consensus EPS forecasts reflect concern over an increase in start-up costs for new personal hygiene products

• Initiating at Hold (3), with target price of HKD11.80 based on 20x 2015E PER


Consumer Staples / Hong Kong

Vinda International3331 HK

Target (HKD): 11.80Downside: 3.0%10 Nov price (HKD): 12.16

BuyOutperformHold (initiation)

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Share price performance

Vinda Intl (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 10.48-13.92Market cap (USDbn) 1.573m avg daily turnover (USDm) 0.48Shares outstanding (m) 998Major shareholder SCA (51.0%)

Financial summary (HKD)Year to 31 Dec 14E 15E 16ERevenue (m) 7,561 8,676 9,881Operating profit (m) 737 821 947Net profit (m) 545 590 699Core EPS (fully-diluted) 0.545 0.591 0.700EPS change (%) 3.9 8.3 18.5Daiwa vs Cons. EPS (%) 12.2 (3.0) 0.5PER (x) 22.3 20.6 17.4Dividend yield (%) 0.8 1.0 1.2DPS 0.101 0.118 0.140PBR (x) 2.4 2.2 2.0EV/EBITDA (x) 14.6 13.0 11.5ROE (%) 11.3 11.4 12.3




- 35 -

Growth outlook Vinda: recurring profit and YoY growth

We forecast Vinda’s recurring profit growth to accelerate to 8% in 2015 and 19% in 2016, from a trough of -2% in 2013 and 4% in 2014. Our forecasts are premised on: 1) a gradual reduction in losses at the V-care businesses (sanitary napkins and diapers), 2) business upside from the acquisition of SCA’s business in China, and 3) upgrades to the product mix of the tissue paper businesses. Our forecasts call for revenue to expand by 11%, 15% and 14% YoY for 2014-16, respectively.

Source: Company, Daiwa

Valuation Vinda: 12m forward PER band

Vinda shares have undergone a rerating since 3Q13, when SCA become the major shareholder by acquiring a circa 28% stake for HKD11 per share. With the stock now trading at a 20.6x 2015E PER, or 1.3SD above its 5-year average 12-month forward PER of 15.6x, we believe the benefits of SCA’s involvement are largely priced in. We would suggest investors revisit the stock if there are signs the company is succeeding in the sanitary napkin and diaper businesses (either V-care or SCA’s brands) or if there is an easing of oversupply in the tissue paper industry.

Source: Bloomberg

Earnings revisions Vinda: Bloomberg consensus EPS changes

The Bloomberg-consensus EPS forecasts for 2014 and 2015 have steadily declined since mid-2013, likely to due to the ongoing oversupply situation in the tissue paper market and forex losses due to CNY depreciation. However, our 2014-16E EPS are slightly below those of the market, as we are concerned about the near-term cost impact of integrating the V-care businesses.

Source: Bloomberg


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Key assumptions

Profit and loss (HKDm)

Cash flow (HKDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EVolume YoY % 17 26 19 27 14 10 13 13ASP YoY % (1.7) 2.2 10.9 (0.2) (0.7) 1.1 1.5 0.8Selling cost ratio % 10.1 12.4 12.1 12.8 13.9 15.0 15.5 16.0Wood pulp cost change YoY % (21) 34 (2) (12) 11 1 0 0

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EToliet roll 1,732 2,201 2,926 3,669 3,970 4,169 4,377 4,596Other tissue papers 1,408 1,877 2,602 3,379 3,664 3,807 3,741 3,640Other Revenue (364) (476) (762) (1,024) (836) (414) 559 1,645Total Revenue 2,776 3,602 4,765 6,024 6,798 7,561 8,676 9,881Other income 9 28 23 58 58 48 35 35COGS (1,825) (2,540) (3,469) (4,169) (4,826) (5,295) (6,036) (6,809)SG&A (437) (626) (814) (1,138) (1,317) (1,578) (1,854) (2,160)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 523 463 506 775 712 737 821 947Net-interest inc./(exp.) (28) (3) 19 (41) (57) (78) (102) (94)Assoc/forex/extraord./others 0 0 (2) (16) 17 (30) 0 0Pre-tax profit 495 460 522 719 672 629 719 852Tax (97) (91) (116) (182) (130) (120) (129) (153)Min. int./pref. div./others 0 0 0 0 0 0 0 0Net profit (reported) 398 369 406 537 543 510 590 699Net profit (adjusted) 396 363 401 533 525 545 590 699EPS (reported)(HKD) 0.440 0.394 0.432 0.537 0.543 0.510 0.591 0.700EPS (adjusted)(HKD) 0.438 0.388 0.428 0.534 0.525 0.545 0.591 0.700EPS (adjusted fully-diluted)(HKD) 0.438 0.388 0.428 0.534 0.525 0.545 0.591 0.700DPS (HKD) 0.132 0.118 0.120 0.156 0.156 0.101 0.118 0.140EBIT 523 463 506 775 712 737 821 947EBITDA 645 594 669 975 986 1,088 1,203 1,340

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 495 460 522 719 672 629 719 852Depreciation and amortisation 122 130 163 200 274 351 382 394Tax paid (93) (101) (140) (217) (205) 85 (129) (153)Change in working capital (290) (339) (150) (15) (1) (241) (281) (326)Other operational CF items 21 (3) (21) 53 81 84 101 94Cash flow from operations 255 147 373 740 821 908 792 861Capex (160) (473) (833) (1,264) (1,386) (1,000) (300) (300)Net (acquisitions)/disposals 1 1 7 36 (21) (1,439) 0 0Other investing CF items (7) (6) (5) (4) (3) (2) (1) 0Cash flow from investing (166) (478) (831) (1,232) (1,410) (2,441) (301) (300)Change in debt 119 224 882 114 653 1,563 (300) (500)Net share issues/(repurchases) 0 33 5 531 (9) (9) (9) (9)Dividends paid (69) (112) (112) (130) (161) (161) (161) (161)Other financing CF items (13) 206 (82) (21) 31 (139) (114) (104)Cash flow from financing 37 351 692 494 514 1,253 (584) (773)Forex effect/others 0 0 0 (0) (44) 22 0 0Change in cash 127 21 235 1 (119) (258) (93) (213)Free cash flow 95 (326) (460) (525) (565) (92) 492 561


- 37 -

Balance sheet (HKDm)

Key ratios (%)


Company profile

Vinda is the 3rd-largest tissue paper brand in China, with a market share of approximately 12% in 2013, according to AC Nielsen. Its major products include toilet rolls, box tissues, handkerchiefs, and soft-pack tissues.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 348 390 716 760 693 458 371 160Inventory 912 1,322 1,372 1,447 1,643 1,802 2,055 2,318Accounts receivable 409 647 939 1,116 1,286 1,502 1,810 2,164Other current assets 5 1 43 42 41 90 90 90Total current assets 1,675 2,359 3,071 3,365 3,663 3,853 4,326 4,732Fixed assets 1,839 2,273 3,022 3,987 5,102 7,198 7,124 7,039Goodwill & intangibles 7 11 10 13 21 21 21 21Other non-current assets 218 248 360 458 586 382 382 382Total assets 3,738 4,891 6,464 7,823 9,373 11,454 11,854 12,174Short-term debt 513 557 801 1,219 1,032 1,800 1,500 1,500Accounts payable 680 980 1,210 1,423 1,820 1,997 2,276 2,568Other current liabilities 60 64 69 91 58 65 65 65Total current liabilities 1,253 1,601 2,080 2,733 2,911 3,862 3,842 4,133Long-term debt 350 530 1,169 865 1,705 2,500 2,500 2,000Other non-current liabilities 65 72 76 105 110 110 110 110Total liabilities 1,668 2,203 3,325 3,704 4,726 6,472 6,452 6,243Share capital 90 94 94 100 100 100 100 100Reserves/R.E./others 1,979 2,594 3,045 4,019 4,547 4,882 5,302 5,831Shareholders' equity 2,070 2,688 3,139 4,119 4,647 4,982 5,402 5,931Minority interests 0 0 0 0 0 0 0 0Total equity & liabilities 3,738 4,891 6,464 7,823 9,373 11,454 11,854 12,174EV 12,656 12,838 13,334 13,368 14,093 15,890 15,677 15,389Net debt/(cash) 516 698 1,254 1,325 2,044 3,842 3,629 3,340BVPS (HKD) 2.290 2.870 3.345 4.121 4.654 4.990 5.411 5.941

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) 14.5 29.8 32.3 26.4 12.8 11.2 14.8 13.9EBITDA (YoY) 100.4 (8.0) 12.6 45.9 1.1 10.3 10.6 11.4Operating profit (YoY) 137.6 (11.3) 9.1 53.3 (8.1) 3.4 11.5 15.2Net profit (YoY) 138.9 (8.3) 10.5 32.9 (1.7) 3.8 8.3 18.5Core EPS (fully-diluted) (YoY) 138.9 (11.6) 10.3 24.7 (1.6) 3.9 8.3 18.5Gross-profit margin 34.2 29.5 27.2 30.8 29.0 30.0 30.4 31.1EBITDA margin 23.2 16.5 14.0 16.2 14.5 14.4 13.9 13.6Operating-profit margin 18.8 12.9 10.6 12.9 10.5 9.7 9.5 9.6Net profit margin 14.3 10.1 8.4 8.9 7.7 7.2 6.8 7.1ROAE 21.0 15.3 13.8 14.7 12.0 11.3 11.4 12.3ROAA 11.9 8.4 7.1 7.5 6.1 5.2 5.1 5.8ROCE 19.4 13.8 11.4 13.7 10.5 8.8 8.8 10.1ROIC 17.3 12.4 10.1 11.8 9.5 7.7 7.5 8.5Net debt to equity 24.9 26.0 40.0 32.2 44.0 77.1 67.2 56.3Effective tax rate 19.7 19.8 22.3 25.3 19.3 19.0 18.0 18.0Accounts receivable (days) 44.0 53.5 60.8 62.3 64.5 67.3 69.7 73.4Current ratio (x) 1.3 1.5 1.5 1.2 1.3 1.0 1.1 1.1Net interest cover (x) 19.0 140.9 n.a. 19.0 12.5 9.5 8.0 10.1Net dividend payout 30.0 30.0 27.7 29.0 28.7 19.8 20.0 20.0Free cash flow yield 0.8 n.a. n.a. n.a. n.a. n.a. 4.1 4.6


- 38 -

Earnings growth set to reaccelerate

Following an expected contraction in 2014, we forecast Vinda’s net profit to grow by 8% YoY in 2015 and 19% YoY in 2016, on an enhanced product mix that lifts volume growth and gross margins, alongside steady raw-material costs.

Pricing power

Vinda has demonstrated its strong pricing power in recent months. While most of its competitors reduced their ASPs in 2013 and 1H14 in a bid to boost their sales volumes, Vinda opted not to lower its ASPs. Indeed, we see a 2% YoY increase in Vinda’s blended ASP for 1H14, driven mainly by upgrades to its product mix. In 1H14, Vinda’s revenue from higher-value items such as wet wipes and soft packs were up 63% YoY and 37% YoY, respectively, compared with an 11% rise in the company’s total revenue. Non-toilet roll products contributed 45.2% of Vinda’s revenue in 1H14, up from 39-42% in 2012-13. Vinda: revenue and contribution from non-toilet roll products


Note: non-toilet roll products include handkerchiefs, wet wipes, box tissues, etc

We believe that discounting remains an effective way of promoting toilet roll products, as consumers of such necessities and other home-use products tend to be particularly price-sensitive. However, in our view, Vinda does not need to follow this discounting trend because its capacity expansion plans are less aggressive than those of its peers. Vinda: annual capacity expansion and production volume


Instead, Vinda has pursued a market-oriented approach, whereby it has sought to distinguish its brand image and reputation from those of its competitors. For example, it conducted a marketing campaign – the “Ultra Strong National Bus Tour” – in 2013 and 1H14 where it promoted its Ultra Strong product line in major cities across China. We see the promotion as an effective way for Vinda to exchange views with retailers and consumers on product issues while enhancing brand equity and customer loyalty. It has also sponsored Fashion Kids (《潮童天下》), a popular variety show produced by Dragon TV and featuring actress and mother Ye Yiqian, and put on the Vinda Tissue-made Wedding Gown Show for Families, which attracted widespread coverage in the media. We believe both initiatives have helped to raise awareness of the Vinda brand among consumers in Mainland China. Vinda: Vinda Tissue-made Wedding Gown Show for Families

Source: Company

61.4 60.9 58.4 55.150.4 46.5

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- 39 -

Besides, the Vinda brand has had a long association with popular cartoon characters. In 2009, Vinda launched its “Vinda Pleasant Goat Series” household paper and wet tissues, which featured the Pleasant Goat and Big Big Wolf (喜羊羊與灰太狼) characters to attract younger consumers. And, in 2013, Vinda launched a new product line featuring the internationally known SpongeBob SquarePants character.

Strong distribution network

As of June 2014, Vinda had 216 sales offices and 1,231 distributors in China. These distributors are the major revenue contributors (49%), followed by key accounts (hypermarkets and supermarket chains, 33.3%), corporate clients (12.6%), and the e-commerce channel (5.1%). In terms of sales coverage, we estimate that Vinda’s distributors covered some 0.3m points of sales in Mainland China in 1H14, compared with 1m for Hengan. We attribute Hengan’s broader reach to its longer operating track record and broader product line. Vinda: e-commerce revenue and contribution to total revenue

Source: Company, Daiwa estimates

While traditional distributors remain an important channel for sales of tissue products, we believe other channels are growing in prominence in China. Chief among these, in our view, is the e-commerce channel. Vinda’s revenues via e-commerce were up 253% YoY in 1H14, and sales via this channel accounted for 5.1% of the company’s total revenue in 1H14, up from 1.6% in 1H13. According to management, Vinda is already profit-making in its e-commerce channel, which we believe is in contrast to most of its peers. We attribute Vinda’s relatively strong sales growth and profitability in e-commerce to its focus on selected stock-keeping units (SKUs). Based on our checks of third-party online sales platform jd.com, Vinda has only 29 tissue paper SKUs (ex-Tempo) as of September 2014, compared with 199 for Hengan (only for its Hearttex-brand products, which are mainly tissue paper). We believe Vinda’s much smaller number of SKUs should translate to lower fixed costs for the company and make the shopping experience more straightforward, particularly as tissue paper is effectively a commodity offering. Without specifying a timeline, management is targeting for e-commerce to contribute more than 10% of the company’s total revenue.

0

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50

100

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1H13 2H13 1H14

E-commerce revenue (LHS) % of total (RHS)

(HKDm) (%)


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Tapping synergies with SCA

Through SCA, Vinda has access to a range of well-known brands (including Tempo) that should allow it to broaden its revenue stream.

Increased involvement of SCA

SCA became a shareholder in Vinda in 2007 when it invested CNY366m for a 15% stake in the company after its IPO. It gradually increased its holding on the open market in subsequent years before acquiring a stake of approximately 31% from Vinda’s founding shareholder and current chairman Li Chao Wang and public shareholders for HKD11 per share. After becoming Vinda’s majority shareholder in October 2013, SCA transferred to Vinda several of its businesses in China and Hong Kong in September 2014. We believe SCA’s increased involvement with Vinda is positive in several respects.

Brand equity SCA has licensed to Vinda certain rights regarding its tissue and personal hygiene care product brands: 1) the exclusive rights, granted free of charge, to use the Tempo brand for tissue paper products in Hong Kong, Mainland China and Macau, 2) the exclusive right to use the feminine care brand Libresse, elderly care brand Tena, and babycare brand Libero, for free in the first 3 years of cooperation, and 3) the exclusive rights, granted free of charge, to use the Dr. P (elderly care products) and Sealer (babycare products) trademarks. In our opinion, having access to the Tempo brand will help Vinda to build upon its position in the China tissue paper market. We believe the Tempo name is well regarded by consumers in Mainland China and Hong Kong, who are willing to pay a premium for what they see as a quality brand. According to our checks in supermarkets and convenience stores in Hong Kong, the ASPs of Tempo box tissue products are 3-50% above those of Vinda products of the same weight and similar packaging. Although we estimate that Tempo’s market share in Mainland China is insignificant at present, due to its low penetration in Inner China and relatively high ASP, we believe Vinda will be better able to address the high-end segment using the Tempo brand.

SCA: ranking by market share

Source: SCA


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By leveraging SCA’s brands and experience in a wide range of personal care products, Vinda can diversify its revenue base and enter new segments without having to invest heavily in brand building and product development. This approach should also enhance Vinda’s product portfolio, putting it in a better position to compete for distributors. Vinda: new brand and product portfolio from SCA

Brands Products Tenure Regions covered Licensing fee

Tempo Tissue paper Perpetual

Hong Kong/ Mainland China, Macau

Free Dr.P (包大人) Elderly care Trademark

rights n.a.

Sealer (噓噓樂) Baby diapers Trademark rights

n.a.

Tena, Tork, Libero, Libresse

Feminine care products and diapers

Exclusive Waived for first 3 years

Source: Company

Product portfolio, geographical expansion Acquisition of SCA’s China businesses. In September 2014, Vinda completed the acquisition of the following businesses of SCA for a total consideration of HKD1.144bn:

1. SCA Tissue, which sells tissue products and adult diapers in Hong Kong. This business generated revenue and net profit of HKD310m and HKD23m, respectively in 2013.

2. China sales contracts relating to the sale and distribution of consumer tissues and personal care and hygiene products in Mainland China. Only the sales and distribution agreement and customer contracts were acquired; the employment contracts and agreements relating to borrowing were not. In 2013, this business generates sales of HKD405.2m. As part of the deal Vinda also acquired raw materials and products amounting to HKD85.4m as of 30 June 2014.

3. EB Fujian, which owns the land-use rights for a site covering 96,226sq m in Xiamen (Fujian Province) and worth CNY16.2m. According to Vinda, the site is intended to be developed into a manufacturing plant for paper and paper products.

4. SCA Healthcare, which is based in Shanghai and is intended to provide home-based healthcare and health management consultancy services (no timetable has yet been given).

We believe that in the near term the acquired businesses will be a drag on Vinda’s operating margin in Mainland China, where the business just acquired has yet to become profitable due to its limited scale. Vinda has sought to contain its exposure to these losses by acquiring only the sales and distribution agreement and customer contracts, but not SCA’s sales personnel and offices. By using Vinda’s logistics network, sales personnel, distributors, and selected distributors newly acquired through the PRC sales contracts, Vinda should not face a significant increase in selling costs when it starts selling SCA’s products, in our view, and we look for operating leverage to kick in during 2016E once the business has been scaled up. Increased transparency, enhanced management Vinda started announcing quarterly results in 2014, bringing it into line with the practice of its parent company. SCA recently appointed a new CFO for Vinda, Mr. Toby James Lawton, who was formerly the CFO for SCA’s Asia Pacific business. At the same time, most of Vinda’s senior management and board of directors remained with Vinda after SCA took majority control, and SCA has only appointed non-executive directors to the board. We believe Vinda’s original management team is still responsible for the day-to-day operations of the company, while SCA is helping in developing high-end tissue paper and other personal care products. Loan support With the agreement to acquire SCA’s China business, SCA agreed to provide a term loan facility at a maximum of HKD1.2bn with a maturity of 3 years. The interest rate was not disclosed but management said it was more favourable than loans offered by independent third parties. As of 1H14, the annual interest rates of Vinda’s bank loans ranged from 1.14% to 6.90%, and we estimate the company’s effective interest rate at 2.6% for 2014E.


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Vinda’s contribution to SCA

Since 2007, SCA has spent some HKD5.5bn acquiring Vinda shares (implied cost of HKD9.09/share). Hence, we believe SCA views Vinda as an important part of its long-term future in several respects. SCA: Vinda stake acquisitions Date of acquisition No. of shares purchased (m) Price (HKD) Amount (HKD m)

Sep-13 393.8 11 4,331.5Arp 2012 46.9 15 703.5Feb-08 42.0 3.5 147.02007 127.5 2.84 362.2Total 610.2 9.09 5,544.1

Source: HKEX, Daiwa

Seeking growth in emerging markets. SCA has been active in making acquisitions outside Europe, particularly in emerging markets. As shown in the chart below, SCA has acquired or increased its investment in 5 personal hygiene product companies in Asia and South America over the past 3 years. Indeed, for PISA and Fine Sancella, SCA raised its holdings from 50% to 100% through acquisitions. We believe SCA remains eager to increase its exposure to emerging and other fast-growing markets, and hence we would not rule out the possibility of SCA further lifting its stake in Vinda in the long term. SCA’s acquisitions in emerging market aside from Vinda Company Name Amount Location Time Business

Stake acquired

Stake owned

Fine Sancella USD 25m

Middle East

June 2014 Feminine care products 50% 100%

Everbeauty USD 290m Taiwan 2012

Baby diapers and Incontinence care products 100% 100%

PISA SEK

520m Chile 2012 Tissue paper, incontinence

care products 50% 100%San Saglik SEK 95m Turkey 2011 Incontinence care products 95% 95%

Pro Descart Sek

450m Brazil 2011 Incontinence care products 100% 100%

Source: SCA

Earnings accretive, cost saving. In 1H14, SCA’s revenue and pre-tax profit were up 8% and 24% YoY, respectively, of which we estimate Vinda contributed about 7% and 5% of the totals, respectively. Financial indicators: Vinda and SCA (1H14)

SCA Vinda SEK m YoY(%) HKD m YoY(%) Vinda's contribution (%)

Revenue 50,063 8 3,680 11 6.9GP 12,727 12 1,086 13 8.0GPM 25.4 +0.9pp 29.5 +0.6pp n.a.EBIT 5,564 21 346 -10 5.8EBIT margin 11.1 +1.2pp 9.4 -2.2pp n.a.Profit before tax 5,081 24 277 -24 5.1

Source: SCA, Company

According to SCA, its hygiene business in China recorded net sales of only SEK600m (around USD95m) in 2013 (0.7% of its overall revenue). We believe the business has high fixed costs compared with Vinda, given Vinda only acquired the sales contracts and inventory of the operation, but not the business unit itself. With the transfer of the business to Vinda, we believe Vinda will leverage its existing distribution network and China management experience to bring down the cost of distributing SCA-branded products and improve its profit margin. Leverage overcapacity in China tissue paper industry. China looks set to see further oversupply in tissue paper production, given the rapid capacity expansion plans of various players. However, we believe Vinda could make use of its idle capacity or engage other OEM partners to produce SCA’s products at low cost for export.


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Financials

Excluding forex losses, we forecast Vinda’s net profit to increase YoY by 4% in 2014, 8% in 2015 and 19% in 2016. We expect the new sanitary napkins and diaper businesses to be a profit drag in the beginning. We forecast YoY revenue growth of 11% in 2014, 15% in 2015 and 14% in 2016, driven primarily by: 1) a 12% production-volume CAGR over 2013-16, and 2) the acquisition of SCA’s Hong Kong businesses, its sales contracts in China and consolidation of the VS-care JV business after the acquisition. Low-margin toilet rolls will likely remain the main revenue contributor, although we expect the sales contribution from this segment to come down gradually from 61% in 2012 to 55% in 2014. Vinda: reported and recurring net profit and recurring profit growth


Vinda: revenue breakdown (2014E)


Gross margin trend We look for selling prices of different product categories to remain largely steady over 2014-16. However, we look for the ASP on Vinda’s tissue paper as a whole to increase slightly on a product mix shift towards higher-margin items, such as pocket tissues and softpacks of tissues. We estimate that wood pulp is a major COGS component (50-60%) for Vinda’s tissue paper production. Assuming a slight decline in wood pulp prices over 2014-16, we forecast Vinda’s gross margin to remain largely stable at 30-31% over 2014-16, up from 29% in 2013, due to product-mix upgrades in its paper segment. Toilet rolls, being the lowest-value category among different tissue paper categories, are most sensitive to wood pulp cost changes. If wood pulp prices increase significantly, the margin pressure on toilet rolls is the most severe among all categories, but we believe Vinda could partially offset such an impact by reducing its discount and promotion offers. Vinda: gross margin assumptions for different products

2010 2011 2012E 2013E 2014E 2015E 2016EToilet Roll 14.3 26.5 29.8 27.0 27.0 26.0 26.0Handkerchief (including wet wipes) 29.3 32.1 33.3 33.0 33.0 34.0 34.0Box tissue 30.1 30.2 32.9 32.0 32.0 32.0 32.0Paper napkins 17.7 24.3 28.6 27.0 27.0 27.0 27.0Softpack n.a. 29.0 32.5 32.5 32.5 32.0 32.0Others 17.8 23.3 31.8 30.0 45.0 50.0 50.0Company's average 29.5 27.2 30.8 29.0 30.0 30.4 31.1

Source: Company, Daiwa estimates after 2012

(5%)

0%

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25%

30%

35%

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200

300

400

500

600

700

800

2011 2012 2013 2014E 2015E 2016E

Recurring profit (LHS) YoY (RHS)

(HKDm)

Toliet Roll55.1%

Handkerchief (including wet

wipes)11.5%

Box tissue3.7%

Paper napkins2.5%

Softpack22.4%

Others4.8%


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Vinda: volume and ASP YoY change for tissue paper (%)

Source: Company, Daiwa

Selling costs We look for selling costs to increase to 15-16% as a ratio of revenue (from 14% in 2013) due to rising promotional costs for new products and brand building. They include TV advertising, marketing campaigns and sales activities in hypermarkets. We see upside risks to our selling cost estimates if Vinda has to increase its investment in brand building for its new product portfolios, such as sanitary napkins and diapers. Vinda: SG&A cost and as a ratio of revenue


Forex gains/losses: As a result of CNY depreciation against the USD/HKD, Vinda reported a forex loss of HKD22m for 1H14 (2013: financial gain of HKD44m), due to the difference between its functional currency (CNY) and reporting currency (HKD). We have not included any forex gains or losses in our 2015-16 forecasts. Financial income and expenses: We forecast interest expenses to increase to about HKD100m per year over 2014-16 after the acquisition of SCA’s business and the V-care JV, which we expect to incur an expense of HKD1.4bn in 2014.

Dividend: On increasing capex and financial costs, Vinda’s dividend payout ratio looks set to decline from about 30% in 2011-13 to 20% over 2014-16E. Net gearing could peak in 2014E We forecast capex at about HKD300m per year over 2015-16, down from HKD1bn in 2014E as tissue paper capacity expansion is finished. The company also spent HKD1.1bn to acquire SCA’s China and Hong Kong businesses, and HKD295m for the remaining 59% stake in V-care. These transactions were mainly financed via bank loans and a shareholder term loan of HKD1.2bn from SCA. We also forecast Vinda to generate HKD 790-900m of operating cash flow every year over 2014-16 to gradually pay off the debt. Vinda: net gearing ratio and investing cash flow


18.9

26.6

13.610.0

13.0 13.010.9

-0.2 -0.7

1.1 1.5 0.8

(5)

0

5

10

15

20

25

30

2011 2012 2013 2014E 2015E 2016E

Volume ASP

12.1 12.813.9

15.0 15.5 16.0

5.1 5.6 6.1 6.5 6.5 6.5

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4

6

8

10

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14

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18

2011 2012 2013 2014E 2015E 2016E

Selling expenses (as % of revenue) Adverstising and promotion

40%32%

44%

77%67%

56%

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500

1,000

1,500

2,000

2,500

3,000

2011 2012 2013 2014E 2015E 2016E

Capex (LHS) Acquisition (LHS) Net gearing (RHS)

(HKDm)


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Valuation

At a 20.6x 2015E PER, the current share price seems to price in the growth potential of the non-tissue paper business. Our target price of HKD11.80 implies 3% downside potential.

Methodology

We believe PER is a suitable methodology to value Vinda given its profile as a personal hygiene producer, with what we regard as good earnings visibility and stability. We use our 2015 EPS forecast and assign a target PER of 20x, which is at a 15% discount to our target PER assigned to Hengan. Over the past 5 years, Vinda has been trading at a 35% discount to Hengan’s PER on average, but this has significantly narrowed to 15% on average since SCA announced its stake increase in Vinda to 51% in September 2013. We believe the narrowing is justified as SCA will help diversify Vinda’s product portfolio and provide strong financial and technology support. Vinda: 12M forward PER discount to Hengan

Source: Bloomberg

Vinda’s past-5-year average 12-month forward trading PER was 15.6x. Our target PER, which represents a 1.3SD premium to such an historical average, reflects Vinda’s diversification into the hygiene business and its support of its parent company, an internationally renowned player in the industry. Vinda: 12-month forward PER bands

Source: Bloomberg

In the long term, we expect Vinda stock to be rerated, if it can: 1) continue its accelerated earnings growth (at 8% YoY in 2015E and 19% YoY in 2016E), and 2) successfully diversify its revenue mix away from just tissue paper to other personal hygiene products. Vinda: 2012-16E revenue and earnings and Daiwa vs. Bloomberg consensus

2012 2013 2014E 2015E 2016ERevenue (HKDm) 6,024 6,798 7,561 8,676 9,881 YoY growth (%) 26% 13% 11% 15% 14% vs. consensus (%) -0.4% -1.0% 0.3%Net profit (HKDm) 533 525 545 590 699 YoY growth (%) 33% -2% 4% 8% 19% vs. consensus (%) 12.2% -1.1% 1.1%EPS (HKD) 0.5337 0.5250 0.5455 0.5906 0.7002 YoY growth (%) 25% -2% 4% 8% 19% vs. consensus (%) 12.5% -1.7% 0.2%Source: Company, Bloomberg, Daiwa forecasts

-70%-60%-50%-40%-30%-20%-10%

0%10%20%

Sep-

09

Dec

-09

Mar

-10

Jun-

10

Sep-

10

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Vinda's valuation vs Hengan

02468

101214161820


3331 HK 7x 11x15x 19x 24x


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PER (x)

EPS Growth

EV/EBITDA (x)

Revenue YoY %

EBIT margin ROE%






Source: Bloomberg


- 47 -

Key investment risks

Downside risks Overcapacity – key risk: According to the China National Household Paper Industry Association (CNHPIA), tissue paper production capacity in China will increase by 57% between 2013 and 2015 and reach 13.4m tpa. This forecast looks aggressive when compared with: 1) consumption volume CAGR of 9% over the past 3 years, and 2) our 17% and 12% sales volume CAGR (2013-16E) assumptions for Hengan and Vinda, respectively. Although we believe much of these new capacities will target the export markets or may be delayed, some regional competitors may choose to further lower their ASPs to boost their sales volumes, putting further pricing pressure on Vinda and Hengan. Commodity prices: The major raw materials for personal hygiene products include wood pulp and petrochemicals. Currently, the supply of most materials is in abundance in China, and raw-material costs have remained largely stable so far in 2014. Compared with Hengan, Vinda’s earnings are more sensitive to wood pulp price changes, as its gross margin is lower and its revenue exposure to tissue paper is higher. High gearing: Vinda’s net gearing and interest costs increased substantially in 2H14 to finance its acquisition of SCA’s sales contracts for its China and Hong Kong operations.

Upside risks Upward ASP adjustments: Vinda has strong brand recognition in China, and has been able to keep its ASP steady through its product mix upgrades in 1H14. It tends to drive sales volume through marketing and brand building rather than offering excessive discounts. We believe Vinda can raise its ASP ahead of peers on its strong brand once overcapacity issue in the industry eases after 2016, on our estimates. More support from SCA: As a strong global personal care product manufacturer, SCA can provide further support to Vinda’s operation in terms of product development, asset injections or business opportunities outside China in the future that would likely be earnings-accretive.

Company background

Established in 1985, Vinda focuses on the production and distribution of household paper products in China. In 1990, it registered the Vinda trademark and started its own brand products. It was listed on the Hong Kong Stock Exchange in 2007. It also formed a JV in 2010, V-care, to diversify into the personal care segment, and later, in 2014, acquired all of the JV’s stake. Vinda is founded by Mr. Li Chao Wang, who is now the chairman and owns about a 22% stake in the company.

Vinda: product and brand portfolio post acquisition of SCA’s Chinese operations

Source: Company


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Daiwa’s Asia Pacific Research Directory

HONG KONG

Hiroaki KATO (852) 2532 4121 [email protected] Regional Research Head

Kosuke MIZUNO (852) 2848 4949 / (852) 2773 8273

[email protected]

Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected] Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional)

Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Regional)

Junjie TANG (852) 2773 8736 [email protected] Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong, China); Broker (China); Insurance (China)

Anson CHAN (852) 2532 4350 [email protected] Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected] Gaming and Leisure (Hong Kong/China)

Lynn CHENG (852) 2773 8822 [email protected] IT/Electronics (Semiconductor) (Greater China)

Dennis IP (852) 2848 4068 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap

Joey CHEN (852) 2848 4483 [email protected] Steel (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional)

Brian LAM (852) 2532 4341 [email protected] Transportation – Aviation (Hong Kong/China); Railway; Construction and Engineering (China)

Carrie YEUNG (852) 2773 8243 [email protected] Transportation – Transportation Infrastructure (Hong Kong/China)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES

Bianca SOLEMA (63) 2 737 3023 [email protected] Utilities and Energy

SOUTH KOREA

Sung Yop CHUNG (82) 2 787 9157 [email protected] Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Mike OH (82) 2 787 9179 [email protected] Capital Goods (Construction and Machinery)

Jun Yong BANG (82) 2 787 9168 [email protected] Oil; Chemicals; Tyres

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game

TAIWAN

Rick HSU (886) 2 8758 6261 [email protected] Head of Regional IT/Electronics; Semiconductor/IC Design (Regional)

Steven TSENG (886) 2 8758 6252 [email protected] IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected] IT/Technology Hardware (Handsets and Components)

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Head of India Research; Strategy; Banking/Finance

Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities

SINGAPORE

Ramakrishna MARUVADA (65) 6499 6543 [email protected] Telecommunications (China/ASEAN/India)

Royston TAN (65) 6321 3086 [email protected] Oil and Gas (ASEAN/China); Capital Goods (Singapore)

David LUM (65) 6329 2102 [email protected] Property and REITs

Evon TAN (65) 6499 6546 [email protected] Property and REITs

Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)


- 49 -

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Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Capital Markets Co. Ltd., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship

Within the preceding 12 months, The subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); China Everbright Bank Company Limited (6818 HK); econtext Asia Ltd (1390 HK); Lotte Shopping Co (023530 KS); Rexlot Holdings Ltd (555 HK); Neo Solar Power Corp (3576_TT); Accordia Golf Trust (AGT SP); Hua Hong Semiconductor Ltd (1347 HK).

*Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd. Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage. DHK market making DHK may from time to time make a market in securities covered by this research.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research. Australia This research is distributed in Australia by Daiwa Capital Markets Stockbroking Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. India This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to, or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited. Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research. Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE Link at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively. Thailand

This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”).

This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. While the information is from sources believed to be reliable, neither the information nor the forecasts shall be taken as a representation or warranty for which Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees incur any responsibility. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any


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direct or consequential loss arising from any use of this research or its contents.

The information and opinions contained herein have been compiled or arrived at from sources believed reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user.

Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research. United Kingdom This research report is produced by Daiwa Capital Markets Europe Limited and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory . Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany. Bahrain

This research material is distributed by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000). Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions. Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in

the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.


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• For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.

• There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.

• There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants.

*The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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