Zhitong Financial APP learned that CICC issued a research report that China Food (00506) has now completed its asset restructuring, retaining only its beverage business and selling all its business except beverages, receiving nearly HK $6 billion in cash, of which HK $2.88 billion is intended to be used to pay a special dividend and will be submitted to the special shareholders' meeting for approval on November 22nd. In the future, after China Food turns its focus to the beverage business, it will release the company's development potential for a long time through endogenous and epitaxial development, and achieve the goal of building a leading beverage company with a revenue of more than 50 billion yuan put forward by the parent company Cofco Group.

We expect that the company's future growth may come from the following five areas:

Based on our expectations for revenue from beverage sales (about HK $16 billion) and profits (HK $401 million) this year, we believe that future growth will come from:

1. The integration of the acquired Coca-Cola Company bottling plant has led to an increase in profit margins.At present, the net profit rate of these bottling plants is only 1/3 of that of Cofco's existing bottling plants. We expect the seven newly acquired bottling plants to contribute about HK $5.6 billion in sales (consolidated from the second quarter of this year) and about HK $60 million in net profit. Cofco's existing bottling plants have a net interest rate of 3.3 per cent, while the newly acquired bottling plants have a net interest rate of only 1.1 per cent.

We believe that the difference in the net interest rate this year lies in the low capacity utilization and increased operating costs of the newly acquired bottling plants (including some of the integration costs incurred after the merger). As the business continues to integrate, the gap in net interest rates will gradually narrow, and we expect the net interest rates of newly acquired bottling plants to exceed 50bbp in each of the next three years.

The sales revenue and profit contribution of new products such as 2.Monster energy drinks increased.We find that the company does not have a large-scale operation for this new product this year, probably because the company will carry out a hybrid reform next year, allowing management to own shares, and we expect the company to increase investment in this new product in the future. Chinese food is expected to start the reform of the mixed system soon.

We make assumptions about the revenue and profit contribution of Monster energy drinks in two scenarios: optimistic and pessimistic, although Chinese food is expected to introduce more Coca-Cola Company family products in the future. The pessimistic assumption is that Coca-Cola Company and Monster expect the product's market share in China to increase by 5 percentage points a year after the product launch, while the optimistic assumption is that Monster tested the waters in some cities in the fourth quarter of 2016, and the results show that Monster's market share growth is much higher than the target of 5%.

So we assume that the market share in the first year is 20%, and optimistically increase by 10 percentage points a year, then Monster's market share in China will reach the level of Red Bull after about four years of large-scale launch. Under the framework of OEM (authorized production and distribution) cooperation with Coca-Cola Company and Monster, Monster's profit margin will be slightly higher than that of existing carbonated drinks and will be more stable.

In the benchmark case between optimism and pessimism, we expect the penetration rate to be 12% in the first year, and then increase by 70.8% a year, then Monster's market share will reach Red Bull's level in 6-7 years after launch. The current market size of energy drinks (factory caliber) is about HK $31 billion, and we assume that the demand for CAGR in the next few years is about 10%.

3. Coca-Cola Company is likely to reduce his stake in the joint venture (currently 35 per cent) and become a shareholder in China Foods through hybrid reforms.We believe that Coca-Cola Company does not want to miss the opportunity to become a shareholder of Chinese food through hybrid reform. As a result, Coca-Cola Company may consider reducing his stake in the joint venture, thereby limiting the total number of holdings to the range required by Cofco. Coca-Cola Company currently holds a 35 per cent stake in the bottling joint venture with Cofco and 12.5 per cent in the same bottling joint venture with Swire.

4. We do not rule out the possibility that China Food will consider integrating Coca-Cola Company's bottling business in China in the near future.Like PepsiCo Inc, who is the only bottler in China, Coca-Cola Company will probably have only one bottler in China in the future. We believe that the integration of Coca-Cola Company's bottling business in China may be the first step for China Food to become a beverage kingdom with annual revenue of 50 billion yuan. At present, Cofco bottling business can cover more than 80% of the regional market share, which also shows that the company has the possibility of eventual integration.

5. Cofco proposed to build a specialized beverage platform with annual revenue of 50 billion yuan to create a leader in China's soft drinks market.Therefore, we think that in addition to integrating Coca-Cola Company's bottling business in China, China Food may also negotiate with Coca-Cola Company to dabble in more beverage subsectors through mergers and acquisitions.

Cofco Packaging's recent acquisition of a stake in Jiadobao, a herbal tea maker, has raised market expectations that Chinese food and Cofco packaging will eventually be incorporated into the beverage platform, as Cofco Packaging supplies metal packaging for Chinese food. the segment of Jiadobao's layout, Coca-Cola Company, lacks relevant experience, so it may consider enriching the range of local products through mergers and acquisitions. Coca-Cola Company hopes to develop into the non-carbonated beverage market to differentiate risks and create better growth prospects, so mergers and acquisitions are also possible in other product areas.

Hybrid reform may be the next important move to unleash the potential for future growth.

As one of the important tasks in the reform of state-owned enterprises of Cofco, the mixed system reform is expected to be officially launched next year.The hybrid reform is expected to involve well-prepared business units, including the beverage business.

For the beverage business, we think the company may consider including management, Coca-Cola Company and other strategic investors who can bring benefits to China Food into the company's shareholder structure. Cofco's stake may fall from about 75 per cent to less than 50 per cent, as the beverage industry is a fully competitive, market-oriented industry, so it does not need to exceed 50 per cent.

Although the specific methods of the mixed system reform may be different, the mixed system reform will be able to release the company's future development potential. Among the five growth points we put forward, the mixed system reform will affect the 3rd, 4th and 5th points, which will help us to improve the model and make better predictions.

The existing model can not fully reflect the potential of the company, so we use DCF and EV/EBITDA valuation method to get the target price at the end of 2018.Because the growth point 3-5 points are more related to expansion, and different paths lead to different results. Therefore, in the latest financial forecast, we only reflect the first two growth points which are greatly affected by the company's endogenous growth rate.

The FY17 projections of business units that have been disposed of no longer have a significant impact. We restate FY17~ 's 19-year financial forecast, reflecting only the beverage business. We believe that the accounting data for the beverage business will not change before and after the recent asset restructuring, while the only change since the beverage business has become the only food business in China is that it will incur additional management costs of about HK $10 million a year.

Due to the limited information available at present, we have simulated the financial data of FY17. In the financial forecast of FY18~19 year, we reflect the first ~ second growth point, but because of the uncertainty of the path, the third ~ fifth growth point is not involved in the financial forecast of FY18~ in 19 years. We use the DCF model to get the target price at the end of 2018, and use the EV/EBITDA method commonly used in the bottling industry to check and confirm.

We will switch the target price of DCF to the end of 2018 and the target price of HK $6.21 by the end of 2018, corresponding to 11.9 times the expected EV/EBITDA in 2018, which is in line with the average of international comparable companies. The new target price also corresponds to 34.2 times 2018 earnings per share. There is a wide gap between earnings and EBITDA (HK $507 million vs. HK $1.57 billion), mainly due to the low profit margin of EBIT (5.4 per cent) and the 35 per cent minority equity. We believe that EBIT profit margins will gradually improve and minority shareholders' rights and interests are expected to decline after the company's mixed system reform.

(editor: Wang Mengyan)