Earnings in line

Royal Group announced 1H16 results: revenue was Rmb1.1bn, up 64.2% YoY; net profit attributable to shareholderswas Rmb100mn, up 78.3% YoY, or Rmb0.12 per share.

Trends to watch

Earnings in line; movie/TV & media business saw revenue growth of 180%. The movie/TV & media linerecorded core business revenue of Rmb268mn, up 180.5% YoY, while the dairy business’s share of revenue declined26.3ppt to 48.4%. Normal temperature yogurt and fermented milk products saw rapid growth, especially the former.Cultural business rose 15.8ppt to 30% of revenue, and industry chain deployment is done. The main TV dramasbringing earnings were “The Nanny Man” and “Promised Happiness”. “The Red Guards” is in late-stage production andrevenue is expected to be recognized in 2H. Comprehensive gross margin increased 2.42ppt to 37.8%.

The company has an extensive movie/TV project pipeline and is transforming toward high quality projects, which maybecome a main earnings driver. Invest in 2H is planned in the following TV dramas: “Memory is Always There”, “BanriXianyao” and “Dadong’s Friends Circle”, involving topics of youth, ethics, modern fantasy and classical fantasy. Thecompany is trying to make high quality and major projects. We expect earnings upside and better word-of-mouth.

Movie/TV and preschool education resources to generate synergy. The company will build China’s largestcommunications platform for parent-child preschool education, comics/animation and children’s derivatives using theXindongman channel and Easyvlink’s live broadcast platform as communication media. Representative products wouldinclude children’s milk, children’s derivatives, and children’s finances and insurance, and promotional channels wouldinclude Zhenpin Yuedong’s mother-child cross-border e-commerce platform, Baby Let’s Go, offline schools andkindergartens. This will help the company to realize synergy between preschool education and movie/TV business.

Earnings forecast

We maintain our earnings forecast for 2016 & 2017.

Valuation and recommendation

The stock is trading at 42x 2016e P/E. We maintain our BUY rating and Rmb20.8 target price, implying 9.47% upside room from the current price.

Risks

Dairy competition; earnings of acquired targets; business integration risk after capital operation.