Asia Pacific Equity Research
08 October 2007

Company visit note
Vinamilk: Leading consumer play
VNM is the leading dairy producer in Vietnam with major market shares in all categories. 1H07 net profit grew 36% Y/Y, driven partially by financial investment (26% of net profit). Net profit margin was 18.3%, a significant improvement over 1H06 due to financial income and larger shares of higher-margin products. Key takeaways from the meeting • VNM leads the local dairy market with dominant market shares in all dairy products, a well-known brand name, factories in major regions, and a nationwide distribution network. • VNM plans a US$100m expansion program for 3 new dairy factories, a milk cow farm and diversification into beer and coffee, which could enhance its leading market position. But risks have emerged as VNM is diversifying into property and financial investments. • The stock trades at a premium to the general HSTC market on a historical FY06 P/E of 44.7x. FY07/FY08 forecasts by PXP AM put the company on prospective P/Es of 31.4X and 24.2X, respectively. In absolute terms, VNM’s share price has increased 17.6% in the past month and 139.7% over the year. But on a relative basis, the stock has underperformed VNINDEX in the past 1 month and 3 months by 0.6% and 3.2%, respectively.
NOTE: THIS DOCUMENT IS INTENDED AS INFORMATION ONLY AND NOT AS A RECOMMENDATION FOR ANY STOCK. IT CONTAINS FACTUAL INFORMATION, OBTAINED BY THE ANALYST DURING MEETINGS WITH MANAGEMENT. JPMORGAN DOES NOT COVER THIS COMPANY AND HAS NO RATING ON THE STOCK.
VND in millions Sales Net income EPS (VND) DPS (VND) Net debt (cash)/equity (%) Sales growth (%) Net profit growth (%) EPS growth (%) ROE (%) P/E (x) P/B (x) Dividend yield (%)
Source: Company data.

Vietnam Sriyan Pietersz
AC

(662) 684 2670 sriyan.pietersz@jpmorgan.com

Linh Truc Nguyen

VNM VN, Not Covered

VND187,000, Oct 5, 2007
Share price chart
VND
245000 195000 145000 95000 45000 Jan-06
Source: Bloomberg

Aug-06

Mar-07

Oct-07

One-year price performance
Absolute (%) Relative (%)
Source: Bloomberg

1M 17.6 -0.6

3M 2.2 -3.2

12M 139.7 16.6

Vietnam Dairy Products (Bloomberg: VNM VN; Reuters: VNM.VN), Historical financial data
FY04A 4,226,843 517,672 3,067 1,900 Net cash 11.0 -6.9 -6.9 30.3 61.0 17.0 1.1 FY05A 5,638,784 605,484 3,812 1,900 Net cash 33.4 24.3 24.3 29.5 49.1 13.2 1.1 FY06A 6,619,102 731,585 4,183 1,900 Net cash 17.4 9.7 9.7 29.4 44.7 12.0 1.1

Company data
52–week range (VND) Mkt cap. (VNDB) Mkt cap. (US$MM) Shares O/S (MM) Free float (%) Daily liquidity (US$MM) Exchange rate (VND/US$) Index: VNI Year-end
Source: Bloomberg

212,000-76,407 32,777 2,038 175 52.4 2.24 16,084 1,081.63 December

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Linh Truc Nguyen (84-8) 823-6270 linh.t.nguyen@jpmorgan.com

Asia Pacific Equity Research 08 October 2007

Key takeaways from the meeting
Vietnam Dairy Products Joint Stock Company (VNM VN)

Background and scope of business
Established in 1976 with just 3 dairy factories, VNM is now the leading dairy producer in Vietnam with 75% market share, 8 dairy factories covering every major region and 3 more under construction, 1 beer factory and 1 coffee factory. The company has been the most successful equitization story so far when it was equitized in November 2003 and valued at just US$150m, to become the biggest listed company on the local stock market with market capitalization of nearly US$2bn currently. The State holds a 47.6% stake in Vinamilk while foreign shareholders hold 44.2%. Business lines The company is the leader in most of its product categories. All together, VNM has approximately 75% dairy market share. VNM has more than 200 dairy products categorized into 7 main groups including: • • • • • • • Sweetened condensed milk UHT milk, drinking yoghurt Powdered milk and nutrition powder Cool/preserved products: ice cream, yoghurt, cheese Soft drinks: soya milk, fruit juice, bottled water, tea Confectionery: biscuits, chocolate Coffee

Sweetened condensed milk and yoghourt are the most competitive products of VNM, capturing 75% and 80% market share respectively. VNM also gained strong market position for its fresh milk with 55% market share. Powdered milk is mainly produced for export but also accounts for one third of the midstream segment of the local powdered milk market. Furthermore, other products like ice cream, soya milk, fruit juices, bottled water, tea and coffee also achieved strong growth and contribute more share in VNM’s product portfolio, 12.8% of gross profit in FY06 vs 6.2% in FY05. In addition to its core business of dairy production, VNM recently established a joint venture with SAB Miller to diversify into beer, and 2 subsidiaries – Property Investment One-member Limited Company to build VNM’s new head office in Phu My Hung, District 7 (charter capital of VND160bn), and International Milk Cow One-Member Limited Company (charter capital of VND100bn) to develop its own milk cow farm. Production capacity VNM has a strong competitive advantage in terms of leading production capacity in the dairy sector. VNM’s current production capacity is 525,000 tons per year of dairy

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Linh Truc Nguyen (84-8) 823-6270 linh.t.nguyen@jpmorgan.com

Asia Pacific Equity Research 08 October 2007

products and the company is building 3 new dairy factories – 2 in the North and 1 in the Central region to meet sharply expanding demand. Under its planned diversification into beer and coffee, VNM contributed a 50% stake in the US$45m joint venture with SAB Miller, whilst its coffee factory, Saigon Coffee, is a 100%-owned operation next to its beer factory in My Phuoc II Industrial Park, Binh Duong. Vinamilk already launched its Zorok beer in January 2007 and opened its beer factory of 100 million-litre design capacity in March 2007. The coffee factory which is designed for 1,500 tonnes of instant coffee and 2,500 tonnes of roasted coffee has also finished construction and was put into trial production since April 2007. Distribution VNM has an extensive nationwide distribution network, which covers every corner of the country from rural to urban, from traditional markets to modern outlets, with 180 distributors and 90,000 retailers. 90% of its sales is from traditional markets and 10% comes from modern channels. Apart from a long-time presence in the local market and the nationwide distribution network, VNM applies a competitive pricing policy for its diversified products, helping it to gain strong brand awareness and a solid foothold in the local market. VNM serves mainly the domestic market, with domestic revenue accounting up to 80% of total sales. 20% of VNM’s revenue is contributed by export sales to Iraq, the US, Australia, France, Canada, Germany and ASEAN countries. Raw material costs VNM’s major raw materials include milk powder, fresh milk, sugar, butter and packaging, among which milk constituents account for half of cost of goods sold, 75% imported and just 25% coming from local fresh raw milk. The company uses futures contracts to hedge cost increases, which have doubled YTD for milk powder and 20% YTD for sugar. VNM also gradually passed on the cost increase to customers, increasing its selling price 10-15% YTD. While these factors have helped VNM partly buffer against the impact of surging material costs, operating margin of its core business in 1H07 was also reduced to 10.6% vs 13.4% in 1H06. As discussed with the company in recent company visits, VNM stopped the production for export orders and reserved materials for local orders which are stable and have higher margins of c.28% vs. 15% for exports. Surging imported milk powder and insufficient supply of local raw milk have been VNM’s top concern. VNM targets to source 40% of its raw milk materials locally by 2010 and 50% by 2020 from 25% currently. The company began to move towards increased localization of raw materials by establishing a subsidiary to develop VNM’s own farm of 1,400 milk cows. Meanwhile, VNM continues to grant farmers allowances, bonuses and technical assistance to maintain the existing milk supply contracts, which are around 80% of total local raw milk supply.

Profitability
VNM has had growth above the 15% average growth of the dairy industry. CAGR of net sales in the 2001-2006 period was 16.6%, driven by domestic sales growing 21.8% on average and export sales 4.3%. CAGR of net profit was also very solid, averaging 24% in the same period.
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Linh Truc Nguyen (84-8) 823-6270 linh.t.nguyen@jpmorgan.com

Asia Pacific Equity Research 08 October 2007

ROA increased to 20.3% in FY06 from 15.5% in FY05 as new dairy factories were put into operation and began to generate revenue. Net margin improved substantially to 18.3% in 1H07 from 11.1% in FY06 and 14.9% in 1H06 thanks to VNM’s product restructure towards high margin products and financial income. However, the bulk of the margin improvement came from securities investments, where income more than tripled in 1H07, comprising 26% of VNM’s 1H07 net profit whilst operating profit just accounted for 74% of net profit. VNM's sales rose 10% Y/Y in 1H07 supported by sustainable growth of domestic sales but export sales decreased 6% Y/Y. VNM targets US$120m export value in 2007 but this appears ambitious relative to just US$15m actual exports in 1H07. Recent discussions with VNM management indicated that the company plans to suspend production of low margin export contracts given surging hike in prices of imported milk powder materials, with a view to reserve the materials for local orders. During 1H07, the company saw domestic sales accelerate strongly, with condensed milk up 38% Y/Y vs 10% target growth, powdered milk +18% Y/Y, yoghourt +14% Y/Y, UHT milk/ drinking yoghurt +28% Y/Y and more than 20% growth in other products including juices, coffee, tea. Management expects the trend to continue in the remaining months and yield 12% sales growth and 23% earnings growth for the whole year.
Figure 3: Breakdown of VNM's 2006 sales and gross profit
30% 25% 20% 15% 10% 5% 0% Milk pow der - Domestic Ex ports Fresh milk Condensed milk 0%
Source: Company data Source: Company data

Figure 4: 2006's gross profit margin of VNM's key product lines
Yoghurt

% Sales

% Gross Profit

10%

20%

30%

40%

50%

Capital raising/balance sheet
VNM enjoys a net cash position, with most of its debts being payables to suppliers. The company has paid a 19% cash dividend YTD, and issued rights to existing shareholders with 20:1 ratio at par value in January 2007 to increase its charter capital up to VND1,753bn. To partly finance its US$100m capacity expansion program, VNM will raise 5% of its current capital in 2008. VNM plans to pay a 10% share dividend in the first quarter of 2008.

Risk – non-core business
Diversification into beer and coffee VNM's move into the high growth beer and coffee markets is in line with its core food and beverage competency, but it may take time to generate returns. The beer
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Linh Truc Nguyen (84-8) 823-6270 linh.t.nguyen@jpmorgan.com

Asia Pacific Equity Research 08 October 2007

business will only be dividend accounted as VNM just contributed 50% of the beer joint venture while current regulations require consolidation only for holdings of more than 51%. Moreover, gaining market share in both coffee and beer products may pose a challenge. Even though the two new businesses may benefit from VNM’s established distribution network and brand name, Vinamilk’s coffee and beer products have made slow progress. The local coffee market is highly fragmented and dominated by big players like Vinacafe, Trung Nguyen and Nestle whilst the local beer industry is controlled by well known brands like Heineken, Tiger, Sabeco and Habeco. Coffee products have achieved modest product awareness since their first launch late last year while Zorok beer has also maintained a low profile since introduction in early 2007. Significant contribution from financial investments Given the booming stock market, profits from financial investments in 1H07 more than tripled over 1H06, accounting for 26% of 1H07’s net profit, up from 10% in FY06 and 6% in FY05. This substantially contributed to the improved margin in 1H07, but sustainability is questionable while diverting management time away from the expanding core business. Increasing interests in property investments Attracted by the booming stock market and property industry, VNM is also diversifying into property development. • The company entered into a Business Co-operation Contract with FICO Real Estate Company and Real Estate Finance Joint Stock Company for the construction, management, marketing and operation of the Horizon Apartment Project with an estimated investment capital of VND285 billion. VNM contributed a 24.5% stake (VND70bn or US$4.5m) in this BCC which is in the early stages of construction. VNM also established a Property Investment one-member limited company of VND160bn in chartered capital to implement the project of its new head office building in Phu My Hung, District 7, HCMC; new office in Hanoi, lands in Binh Dinh and Phu Yen. The total estimated investment capital is VND300bn or US$19m.

•

VNM’s total exposure to property investments amounts to US$23.5m, which is small compared to VNM’s large equity base. However, there is a risk of increasing capital needs and deployment of internal cash into such non-core projects.

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Linh Truc Nguyen (84-8) 823-6270 linh.t.nguyen@jpmorgan.com

Asia Pacific Equity Research 08 October 2007

Vinamilk: Summary of historical financials
Profit and loss statement VNDMM, year-end Dec Revenues % change Y/Y Gross margin (%) EBITDA % change Y/Y EBITDA margin (%) EBIT % change Y/Y EBIT margin (%) Net interest Earnings before tax % change Y/Y Tax as % of EBT Net income (reported) % change Y/Y Shares outstanding (MM) EPS (reported) (VND) % change Y/Y Balance sheet VNDMM, year-end Dec Cash and cash equivalents Accounts receivable Inventories Others Current assets Long-term investments Net fixed assets Total assets Liabilities Short-term loans Payables Others Total current liabilities Long-term debt Other liabilities Total liabilities Shareholders' equity BVPS (VND)
Source: Company data.

FY04A 4,226,843 11.0 25.1 627,710 -15.6 14.9 552,406 -34.2 12.2 -8,324 544,082 -33.8 26,410 4.9 517,672 1.0 173 3,066.6 -6.9

FY05A 5,638,784 33.4 22.3 709,672 13.1 12.6 612,631 10.9 9.3 -10,031 602,600 10.8 (2,884) -0.5 605,484 17.0 175 3,812.2 24.3

FY06A 6,619,102 17.4 24.3 856,418 20.7 12.9 755,661 23.3 9.0 -21,192 734,469 21.9 2,884 0.4 731,585 20.8 175 4,182.9 9.7

Cash flow statement VNDMM, year-end Dec EBIT Depreciation & amortization Change in working capital Taxes Cash flow from operations Capex Disposal/ (purchase) Net interest Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Beginning cash Ending cash DPS (VND) Ratio analysis %, year-end Dec EBITDA margin Operating margin Net profit margin SG&A/sales Sales per share growth Sales growth Net profit growth EPS growth Interest coverage (x) Net debt to total capital Net debt to equity Sales/assets Assets/equity ROE ROCE

FY04A 552,406 75,304 74,848 26,410 667,824 -268,294 0 8,324 -211,631 -227,463 15,625 -10,372 0 692,592 515,695 1,900

FY05A 612,631 97,041 -41,530 -2,884 660,995 -245,844 0 10,031 -22,530 -210,811 -12,872 81,233 0 515,695 500,312 1,900

FY06A 755,661 100,757 -463,568 2,884 368,774 -604,683 0 21,192 -367,493 89,258 93,913 -56,099 -333,024 500,312 156,895 1,900

FY04A 807,863 178,800 778,299 4,544 1,769,506 180,972 419,251 2,554,710 3,282 384,923 190,873 579,078 20,000 103,387 702,465 1,852,245 10,972

FY05A 523,112 731,741 1,081,501 70,123 2,406,477 609,960 568,054 3,897,936 419,649 1,036,339 1,455,988 10,410 184,620 1,651,018 2,246,918 14,147

FY06A 463,625 511,623 965,826 55,317 1,996,391 422,771 1,071,980 3,609,403 17,883 502,926 138,895 659,704 86,440 128,521 874,665 2,734,737 15,636

FY04A 14.9 12.2 12.2 12.9 2.3 11.0 1.0 -6.9 66.4 Net cash Net cash 163.0 1.5 30.3 32.1

FY05A 12.6 9.3 10.7 13.0 41.8 33.4 17.0 24.3 61.1 Net cash Net cash 174.8 1.6 29.5 29.6

FY06A 12.9 9.0 11.1 15.3 6.6 17.4 20.8 9.7 35.7 Net cash Net cash 176.3 1.5 29.4 29.7

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