Investment Summary

– Interim income as of the end of June this year increased by 28.8% y.o.y to RMB 4.573 billion, and the adjusted EBITDA increased by 16.2% to RMB 1.249 billion. As the top-
line growth in 1H exceeded expectations, the management team has raised the ANC(adult nutrition and care) and BNC(baby nutrition and care) business revenue growth guidelines. ANC`s revenue growth guideline has been increased from 20% to over 30%, and EBITDA has remained at around 30%, milk powder in the BNC business has been increased from 15 to 20% to slightly above 20%, and the probiotics has been increased from 20 to 30% to about 30%, which is lower than the actual growth of 64% in 1H, mainly due to the one-off capture of the shortage of goods at the end of last year, as well as the base factor. BNC`s EBITDA is expected to remain around 20%.

– The management team said that recent operational data was in line with expectations, and has not yet seen the impact of the trade war between China and USA on China`s retailing market. We believe that the one-off factors of restocking by distributors during the launch of new registered infant formula, and the backorders placed in the fourth quarter of 2017, will not occur in 2H. We also take into account of the large base effect, and expect that the revenue growth of BNC business will slow down from 1H. However, the growth trend of ANC business is expected to continue, as considering the company will launch a number of new SKUs. The management revealed that around 8 to 9 new SKUs will be launched in 2H of the year, including oral-intake hyaluronic acid and collagen jelly which will be launched during the upcoming Nov. 11.

-The cross-border e-commerce(CBEC) positive list may be launched by the end of this year in China, that will imply that Swisse non-vitamin SKUs of ANC business cannot be sold through this channel. However, we question about whether it can be launched on time, as the details of the policy remain to be clarified. In fact, the market is currently brewing noises about launching a negative list. At the same time, E-commerce Law will be implemented from next year. It requires anyone who engages in purchasing abroad, must obtain licenses and fulfill its tax obligation, purchasing in person or micro shops will be under regulated. We believe that the market of purchasing from abroad is too big to be fully regulated. For H&H, it already has large e-commerce partners including Tmall, JD.com, VIP.come and NetEase Kaola.com. It also has physical stores. We believe the negative impacts of the new law on the company is limited in medium to long term.

The company intends to further expand its offline business. It plans to increase the number of stores from the current 7,000 to more than 9,000 by the end of the year. 50% of the newly added stores will be maternal stores, and there will be synergies with the BNC business. Due to the uncertainty of the policy in the online business, and the increase in the penetration rate of 3rd to 4th-tier cities, the management team expects the share of the offline business to increase in the future.

-We expect that the price increase of ANC business in 1H will help GPM to expand y.o.y., while OPM will decline, as this year was positioned as investment year. We expect it will continue to increase spending on marketing activities, including online and offline platforms for its new infant formula. It will also improve the high debt situation caused by the acquisition of Swiss, we expect financial expenses to fall year by year, which will help to improve the net profit margin. We give Buy Rating, forecast P/E ratio 23.9 times, the corresponding target price HKD49.55. (current price as of October 25, 2018)