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  • Margin pressure lingers, yet this could ease for most sub-segments by mid-2022
  • Based on our sensitivity analysis, noodles and dairies should see manageable impact from material cost fluctuations 
  • Buy those with ability to pass on costs to consumers; Top pick China Mengniu & Yili; Upgrade Tingyi to BUY

Commodity cost pressure to lessen starting mid-2022. We believe the rise in agricultural commodity prices should begin to moderate by mid-2022, after seeing double-digit growth in 2021F driven by demand-based inflation.  The rate of inflation in G20 countries should subside as supply constraints should gradually fade, while wage increases should moderate. Our DBS house view is that inflation should stay benign at 2.5% p.a. in FY21-22F. We expect raw milk prices to grow at slower pace in FY22F, live hog prices to recover on a m-o-m basis and palm oil price pressure could fade in 2H22. Concerns remain on adverse weather changes and additional COVID-19 outbreaks. 

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Our sensitivity analysis shows that Yili and Mengniu earnings are more resilient under cost pressure. Despite cost hike concerns, we found that prices of dairies, instant noodles and condiments have been adjusted in the face of increases in raw material prices YTD and managed to pass on the cost to customers with dairy makers still expanding their operating margins. We have conducted a sensitivity analysis to assess the potential impact of costs of key commodity items of milk, live hog price and oil palm price on companies we cover. Within the dairy supply chain, margin impact on the downstream players will be less severe than that on the upstream players. 

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Prefer segments with better ability to pass on costs. We prefer companies that have higher pricing power, and sectors with higher market concentration. Our top picks are China Mengniu (2319.HK) and Yili (600887.CH) within the dairy sector as these companies can partly offset the impact of higher material prices through product mix adjustment. Based on current raw material price trends, we cut China Modern Dairy’s TP to HK$3.01 as we expect raw milk prices growth to slow in the medium term.  We also upgrade Tingyi to a Buy amidst room to raise pricing, and boosted demand from COVID-19 resurgence.