In June, YILI announced the acquisition of Sanny Dairy in Guizhou Province. We think this acquisition of Sanny is the kick-off of expansion and restructuring of the Company. More outward growth is expected in the future and it may guide the Company to enter a new era of growth. Moreover, current milk consumption per capita in Guizhou ranks very low among various provinces in China, and thus the room for development is huge. It is possible for the Company to continue to expand the production capacity in Guizhou after acquiring the production plant there. Meanwhile, with respect to product mix, Sanny Dairy also produces pasteurized milk; and this would help to enhance the product mix of YILI.

The Company persistently made effort on enhancing her product mix in the recent few years. YILI strengthened the introduction of high-end products which optimized the product mix. The proportion of high-end products increased to 37% in 2014, from 32% in 2012. In an overall sense, Satine, QQ Star and Ambrosial are the main momentum bringing growth of high-end products. In addition, the first cross-segment product, Walnut milk, also enabled YILI to achieve the largest order quantity ever in her history, making a three times yoy growth of order quantity. The Company has started massive production of Walnut milk, but the supply is not adequate to the demand.

The profitability will improve. First, raw materials` price lowers. The cost of raw milk produced by large-scale pastures only started decline in 2014Q4 due to their annual accounting settlement. Secondly, the Company's product mix has been enhanced, with contribution from high-end products increase rapidly. Moreover, the profitability of high-end products is stronger. Thirdly, expense control also helps to enhance profitability.

Moving towards a global leader of healthy diet products

YILI has further consolidated her rank-one status in the dairy product industry in China. With her outstanding advantages on cost control, product mix, market promotion and brand management, YILI further outstripped competitors in the market. Currently, the Company not only enhances categorization of her products, but also starts putting effort on expansion through acquisition. Such actions are of global sense, guiding the Company to move towards a global leader of healthy diet products. We grant a valuation corresponding to 30x of earning per share in 2015, with target price set as CNY26.4, keeping the rating of “Buy”. (Closing price as at 17 July 2015)

Outward expansion brings new era of development

In June, YILI announced the acquisition of Sanny Dairy in Guizhou Province, which is the largest dairy company in Guizhou. Sanny Dairy currently owns more than 20,000 in-cowshed milk cows in Guiyang. Sanny also operates regionally recognized brands of “Moutain Flowers” and “Huadow Ranch” etc, with daily average sale volume amounted to 600,000 packs of fresh milk. Sanny's product lines cover various categories of room-temperature or low-temperature liquid milk; and her logistics system is becoming more mature, with 5,000 points of sale network in the region.

We consider this acquisition of Sanny is the kick-off of expansion and restructuring of the Company. More outward growth is expected in the future and it may guide the Company to enter a new era of growth. In the annual report of 2014, Yili mentioned for the first time her strategical target of bidding the top five ranks of the global dairy producers, and becoming a high-end healthy food group by 2020. Being the leading dairy giant in China, YILI expands through acquisition and restructuring, which comply with both the norms of development of dairy industry as well as the state policies. According to the plan of restructuring of dairy industry released in June 2014, consolidation of milk powder producers would be achieved by December 2015 and approximately 87 producers would be kept. Moreover, the market share of the top ten domestic brands would be raised to 65%. By the end of 2018, enterprises with domestic dairy brands would be limited to approximately 50, with the market share of the top ten domestic brands raised to 80%.

It is worth to note that the current milk consumption per capita in Guizhou ranks very low among various provinces in China, and thus the room for development is huge. It is possible for the Company to continue to expand the production capacity in Guizhou after acquiring the production plant there. Meanwhile, with respect to product mix, Sanny Dairy also produces pasteurized milk; and this would help to enhance the product mix of YILI.

Continuous enhancement of product mix

The Company persistently made effort on enhancing her product mix in the recent few years. Yili strengthened the introduction of high-end products which optimized the product mix. The proportion of high-end products increased to 37% in 2014, from 32% in 2012. In an overall sense, Satine, QQ Star and Ambrosial are the main momentum bringing growth of high-end products. Satine and QQ Star recorded robust growth in sale volume in 2014. According to the statistics by AC Nelson, the annual growth in sale of Satine amounted to nearly 60%, while QQ Star also had more than 25%. These two brands contributed half of the total growth of sale of liquid milk of the Company. Ambrosial, a new brand being put under spotlight, has successfully become a recognized high-end brand of the Company. In April 2015, the sales contribution from Ambrosial already surpassed Mengniu Just Yogurt which was launched half a year before.

It is worth to note that the first cross-segment product, Walnut milk, also enabled YILI to achieve the largest order quantity ever in her history, making a three times yoy growth of order quantity. The Company has started massive production of Walnut milk, but the supply is not adequate to the demand.

Apparent improvement on profitability

Since the end of financial crisis, profitability of the Company has consistently improved. Benefitted from the decline of the cost of raw milk in 2014, such improvement was more apparent. We believe such trend would continue in 2015.

Firstly, the price of raw material is going downward. In the beginning of 2014, the price of raw milk was about RMB4.3 per kg. After a downward adjustment of nearly a year, it hovers about RMB3.4 per kg in the recent months, representing a drop of 20%. It is worth to note that even though the clearing price of raw milk produced by family-run ranches (which contributes 60% to the raw milk of YILI) significantly dropped in 2014, the cost of raw milk produced by large-scale pastures (which contributes 30% to the raw milk of YILI) only started decline in 2014Q4 due to their annual accounting settlement.

Secondly, the Company's product mix has been enhanced, with contribution from high-end products increase rapidly. Moreover, the profitability of high-end products is stronger. The current gross profit margin of room temperature liquid milk is only around 20% to 25%, but the gross profit margins of new high-end products such as Satine and Walnut milk etc was recorded as 35% or even higher than 40%.

In addition, expense control also helps to enhance profitability. With the completion of channel sinking by YILI, economies of scale would gradually emerge and the marketing expense ratio will continuously decrease, which brings comparative advantages than competitors. In addition, benefiting from the layout of factories in the neighborhood and the full-load transportation of single goods, the efficiency of logistics supply chain will increase, and the expenses for loading, unloading and transportation will decline.

Catalyst

More-than-expected sales volume of high-end products;

Faster-than-expected progress of outward expansion;

Faster-than-expected implementation of internationalization strategy.

Risk

Intensified competition among dairy product producers;

Worse-than-expected sale and promotion of new products;

Risk of food safety.

FINANCIALS

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