Faster herd expansion and own-brand milk sales to drive earnings. Herd size growth is setto accelerate as CMD resumes purchasing 10,000 heifers per year in 2014 and 2015. We raiseour milk volume estimates by 11% for CY14 and 22% for CY15 on our increased herd sizeassumptions, and we project milk volume will grow 29% and 14%, to 1m tonnes in CY15. Weexpect faster growth of own-brand milk due to rising utilization of production lines in CY14and increased production capacity in CY15 to boost the top line, with own-brand milkaccounting for 12% of total sales in CY14 and 16% in CY15 (CY13: 10%). We shift ourforecasts from June to December year-end and upgrade CY14e and CY15e core earnings by4% and 8%, mainly on higher milk volume and a larger contribution from own-brand milksales. We forecast 73% core earnings growth in CY14 and 21% in CY15, and we are 21% and11% above consensus for those years.

Raw milk ASP to remain high. The price of raw milk in China has dropped 1.2% from itspeak in February, but is still high, up 1.4% year to date and 23% y-o-y. CMD managementdoes not foresee the supply shortage being resolved in the short term and believes there isscope for the raw milk price in China to increase. However, downstream milk companiesare adjusting their product portfolios towards more non-raw milk-based products, and thiscould hurt demand for raw milk in the long run. We project that CMD’s raw milk ASP willrise 9.5% in CY14, to RMB5,000 per tonne (in line with management guidance) and 2% inCY15, to RMB5,100 per tonne. Our sensitivity analysis shows that every 1% drop in theraw milk ASP would impact our net profit forecast by 3.6%.

Valuation and risks. Our new target price of HKD4.90 (previously HKD5.20) is based on aDCF valuation reflecting higher earnings estimates offset by higher capex for CY14-16e andan increase in the global risk-free rate that we use, to 3.5% from 3.0%; and implies 18x CY14ecore earnings. With the share price down 16% year to date (HSCEI down 6% over the sameperiod), the stock looks oversold, and we think the current CY14e PE of 13x, with a CY14-16ecore net profit CAGR of 37%, is undemanding. We reiterate our OW(V) rating. Key risks toour view: (1) Outbreak of disease, (2) feed cost fluctuations affecting margins, (3) sharpdecline in raw milk prices, and (4) sell-down by founders.

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