To issue new shares to SOE controlled by Inner Mongolia government Yili announced that it was planning to issues shares to Inner Mongolia Communications Investment Co. LTD (“IMCI”), an SOE wholly owned by Inner Mongolia Development and Reform Commission. Yili extended the shares suspension to 5 trading days after October 10th. The placement should strengthen stability of the board We expect the share placement, if completed, will strengthen the stability of the board. To recap, current largest shareholder Hohhot Investment (SOE controlled by local government) and four core managements have a total 16.75% equity interest in Yili, followed by the second largest shareholder Sunshine Insurance, who announced to increase its shares to 5% on Sep 18. A-share’s key regulation on share placement What’s the potential price for share placement? The issue price should NOT be lower than weighted average price in the 20 days before the valuation base day. Who could approve share placement? The share placement should be approved by 2/3 of shareholders on the shareholder’s general meetings. How long could a company suspend trading for private placement? 15 days + 3 months. Typically, the suspension should be no longer than 10 days, but with granting periods 1) incremental 5 days by the company’s application; 2) incremental 20 days with approval of board meeting; and 3) incremental 2 months with approval of shareholder’s general meetings. How to nominate a new board member in listed company? Shareholders who have over 3% of equity interest could submit a proposal during shareholder’s general meetings. The proposal of nominating a board member should be both approved by 50% of shareholders and 50% of small/medium size shareholders on the general meeting.

Sunshine Insurance Group has become second-largest shareholder Yili announced that Sunshine Property Insurance Company and Sunshine LifeInsurance Company, which are acting in concert (together referred to“Sunshine insurance Group”, SIG), have increased their equity interest in Yilifrom 4.9% before Sep 14to 5.0% after Sep 14. With 5% equity interest, SIGhas become the second-largest individual shareholder of Yili. (The largestshareholder is Hohhot Investment Limited with 8.79% interest, and the thirdlargestshareholder is chairman Mr. Pang Gang with 3.89% interest). SIGindicated in the filing that it currently has no plan to increase its equity interestin the next 12months. We believe the announcement was made in accordance with Securities Law ofChina According to chapter 4of the Securities Law, when an investor increases itsequity interest in a listed company to 5%, the investors shall submit a writtenreport to the regulator, the stock exchange, and the listed company withinthree days. Furthermore, whenever the investor’s equity interest increases ordecreases by 5% going forward, the investors shall make a similarannouncement. Maintaining Buy In the near-term, we do not expect Yili’s operations to be affected by theshareholder changes, given that the board members are not likely to changeimmediately. We maintain Buy on the company, as we expect the mix upgradeand margin expansion to continue to drive earnings growth, and we forecastmore stabilization in industry price discounts in 2017.

2Q16recurring earnings miss Yili reported 1H16results with 0.2% sales increase, 21% net profit increaseand 2.9% recurring net profit increase. On quarterly basis, 2Q16sales/EBITdeclined 2.6% and 5.6% respectively, which is below DB’s forecast at a5.0%/9.7% increase and market consensus at 4%/9%. Liquid milk growth slowed down, likely due to channel destocking and weakgrowth on low end products We forecast its liquid milk growth slowed down from c.10% in 1Q16to c.0% in2Q16. We expect its low end products, i.e. pure milk, milk beverage, and kids’milk likely recorded a higher magnitude of decline, considering its retails salesof other high-end products report 10-131% growth. Meanwhile, sales sloweddown, likely due to channel de-stocking following its high growth previousquarters. Rising A&P has driven the market share, but not ex-factory sales Gross margin expanded 320bps yoy in 2Q16on lower raw milk cost and mixupgrade, as market expected. Yet gross margin savings were mostlyreinvested into A&P and selling expense/sales increased 300bps yoy in 2Q16.Rising A&P has driven its market share of room temperature products increaseto expand 130bps yoy to 31.0% in 2Q16, and that of chilled products toexpand 80bps yoy to 16.5%. 3Q16Outlook: we expect improving growth with clearer channel, earlier midautumnfestival and easier comparing base After destocking in 1H16, we expect Yili’s to have less channel de-stockingpressures in 3Q16. Secondly, an earlier and longer mid-autumn festival (3daysin Sep 15) compared to 2015(2days from Sep 26) should help a longer peakseasonsales. Thirdly, it should have an easier comparison base in 3Q16, due tohigh selling expenses in 3Q15. Management still expects positive sales growthfor the full year. Maintaining Buy.

Margin to expand on mix upgrade and declining raw milk cost. We expect Yili to enter a bottoming-up cycle in 2016-17. Key profit drivers willbe fast growth of UHT yoghurt and high-end milk, and margin expansion fromlower raw milk cost. We expect industry price competition to continue tostabilize in 2H16 with more balanced raw milk supply. We forecast 13.8% netprofit CAGR for 2016-18. We continue to see re-rating potential on improvingoutlook. Reiterating Buy. 1H16 preview: 8.1% EBIT growth on expanding margin. We believe Yili’s heavy spending on branding and scaling up of productioncapacity for UHT yoghurt began to bear fruit in 1H16. We expect UHT yoghurtsales to double in 1H16. Meanwhile, its gross margin should continue toexpand, helped by a mix upgrade, stabilized competition, and the trendingdown raw milk price. We forecast 3.6% sales growth and 8.1% EBIT growthfor 1H16. 2H16 outlook: EBIT growth to accelerate with lower base. We expect earnings growth to speed up in 2H16, helped by an easiercomparing base, and we forecast 9.7% EBIT yoy growth. We expect morebalanced raw milk supply in 2017, and therefore a less-intensive price discountat the retail end. We forecast 13.8% net profit CAGR in 2016-18. Reiterating Yili as our top buy in dairy sector. We revise up our earnings forecasts on an improving outlook and expect13.8% net profit CAGR in 2016-18. We use DCF and raise our target price fromRmb18.4 to Rmb20.4. Our TP implies 21.0x 2017E P/E. We retain Yili as ourtop pick in the dairy sector for its solid earnings growths. Key catalyst will bethe 1H16 earnings results on August 23. Risks: raw milk over-supply worsensin 2017, price competition intensifies in 2H16, and any food safety issues.

Sales up 2% and net profit up 19%. Yili reported 1Q16 result with sales increase 2% yoy to Rmb15,326mn and netprofit increase 19% yoy to Rmb1,554mn. Sales growth was a bit disappointed,but net profit growth was higher than our 2016 full year forecast at 9% andconsensus growth at 12%, which was helped by gross margin expansion andhigher non-operating income. Weak industry demand and intensive competition continued in 1Q16. Yili’s market share in UHT/chilled products expanded 240bps/140bps yoy to30.8%/19.3% in 1Q16, but its sales only increase 2% yoy, indicating thatindustry sales growth remained sluggish. Yili maintain intensive marketingspending and its selling expense/sales ratio increase 409bps yoy to 25.3% in1Q16. We believe the intensive marketing spending is necessary for long-termgrowth and expect this to generate more growth when the industry recovers. Margin expansion on lower in-put cost and improving product mix. Yili’s gross margin expanded 440bps yoy to 42.1%. We believe this is mainlyhelped by trending down industry raw milk cost and lower-priced inventory. Meanwhile, this is also helped by product mix upgrade. To recap, Yili’s salespercentage in key high-end products (including Satine, Ambrosial, Pro-Kido,Chang Qing and Mei Yi Tian) improved 500bps in 2015. Good visibilities on earnings growth; buy. We expect Yili’s market share continue to increase on its intensive marketingspending and its effective control in distribution channel. Meanwhile, weexpect its gross margin expansion to be earnings driver in near-term. Weforecast 9% yoy net profit growth. Yili remained as our top pick in dairy sector. We reiterate Buy. Key downside risks include 1) food safety issues, 2) lowerthan-expected sales growth in high-end products, 3) greater-than-expectedintensive competition.

2016: targets of 7.4% yoy recurring sales growth and 8.6% yoy PBT growth…We held a post-results conference call for Yili last Friday. Yili guides Rmb63bnrevenue and Rmb6.0bn profit before tax in 2016. Excluding the impact of thediscontinued farming subsidiary, the guidance implied 7.4% yoy sales growthand 8.6% yoy PBT growth. …mainly driven by high-end and new products。 Management expects sales to be driven by high-end and new products. Torecap, Yili’s sales percentage in key high-end products (including Satine,Ambrosial, Pro-Kido, Chang Qing and Mei Yi Tian) improved 500bps, and itsnew products accounted for 16% of sales in 2015. The profit margin shouldexpand due mainly to the mix upgrade and lower raw milk price. Yili to keep intensive A&P and will go to lower-tier regions。 Yili will maintain a similar level of advertisement and promotion/sales as in2015 (12.1% in 2015). Management indicated that it will avoid pricecompetition and focus on mix upgrade. Meanwhile, the company plans toimprove its penetration in county and rural regions by increasing salespeopleand distributors. Capex will remain at the 2015 level (Rmb3.7bn in 2015). Industry outlook: raw milk price to remain stable。 Management expects the raw milk price to be stable in 2016. It also expectsintensive competition to continue in the near-term but was still confident in thelong-term demand for the dairy sector. Management does not expect importedliquid milk to be a big threat to the domestic market given the longer logisticstime and higher channel expense. Reiterating Buy。 We trim our earnings forecasts by 1-2% in 2016-17 and forecast 8.9% yoy netprofit growth in 2016. We lower our price target by 1% to Rmb18.4 based onthe DCF method, which employs a WACC of 9.5% and terminal value growthrate of 2.0%. Yili is our top pick in China dairy sector, as we expect it to continue to gainmarket share in the near-term and to benefit from the trend of consumerstrading up in China. We reiterate Buy. Key downside risks include 1) foodsafety issues, 2) lower-than-expected sales growth in high-end products, 3)greater-than-expected intensive competition.

4Q15 net profit beat, but EBIT in line Yili reported 2015 results with sales of Rmb59,863m and Rmb4,632m,representing 10.9%/11.8% yoy growth, respectively. By segment, in 2015, itsliquid milk/milk powder increased 11%/7.2% yoy, while ice cream declined4.3% yoy. 4Q15 net profit was 56% higher than our forecast mainly due tolower impairment costs, lower financial costs and higher non-operatingincome. EBIT was 3% lower than our forecast. What we like in the results Our key positives include the following: 1) a speeding up of sales growth in4Q15, at 17.7% yoy, compared to 8% yoy in 3Q15, helped by its increasingA&P (this indicates that it is gaining market share among the tough industryenvironment); 2) the product mix continues to move up – the sales portion ofhigh-end products (i.e. UHT yoghurt, high-end milk) has increased 5ppts; and3) inventory days have declined by six days yoy to 44 days. What we do not like in the results – increasing operating expense ratio in 4Q15 The selling expense/sales ratio increased 4.9ppts yoy to 24.8% in 4Q15, mainlydue to the 17% yoy increase in the A&P expense during the tough macroenvironment. Meanwhile, the G&A/sale ratio increased 1.0ppts to 8.8% in4Q15, mainly due to increasing deprecation in the period. 2016 outlook – target of 8.6% pre-tax profit growth The company guided total revenue of Rmb63bn and pre-tax profit ofRmb6.0bn, representing 4.3% and 8.6% yoy growth, respectively. Thecompany targets to achieve this through new product growth, a strengtheningof branding and improving channel penetrations. Reiterating Buy Yili is our top pick within the China Dairy sector. The results indicate that itcontinues to gain market share in 4Q15 through its intensive marketinginvestment. We expect the company to continue to drive its growth throughmarket share gains and mix upgrades; reiterating Buy.