Industry growth and market consolidation to drive revenue。

Yuanshengtai (YST) should benefit from secular growth in dairydemand in China and the consolidation in cow farming being drivenby the government. YST plans to double capacity to 108,000 cows by2017. We expect this to support a 23% revenue CAGR in 2013-17.

FCF improvement and strong earnings growth are key positives。

Investors are concerned about cow farming’s long pay-back periodand negative free cash flows (FCF). However, we believe YST hassufficient cash to support capex to construct ranches and buy cowsuntil 2017 with no additional funding. Also, due to its successful IPOin 2013, we expect YST’s financial expenses to drop sharply in 2014,helping it achieve 138% net profit growth in 2014.

Strong quality and efficiency to support margin improvement。

YST’s superior product and relative independence means it enjoys ahigher raw milk ASP than peers. Its strong operations managementprovides it with higher per-cow output. As a result, we forecast goodmargins for FY14E (41.7% net margin) but there is a risk thesedeteriorate in the long term as supply of high-quality raw milk rises.

Initiate at BUY: HKD2.83 TP set at 17x FY14E PE (114% upside)。

We set our HKD2.83 TP conservatively at 17x FY14 PE – theaverage PE of two lowest-valued Hong Kong-listed dairy companies.

China Modern Dairy (1117 HK) is the closest peer, and is trading at19x FY14 PE. With YST’s shorter track record and smaller scale, webelieve a 10% PE discount to China Modern Dairy is appropriate.

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