Mead Johnson Stands to Benefit From a
Repeal of the One-Child Policy in China
An end to childbirth regulation in China could give new life to the company's growth.
January 22, 2013
Analyst
Ken Perkins
Associate Equity Analyst
Consumer Defensive
[email protected]
+1-312-244-7360
Featured Stocks
Mead Johnson (MJN)
QQ
Moat: Narrow
Moat Trend: Stable
Mkt Cap: 13.6B
Uncertainty: Medium
Mkt Price: 66.96
Fair Value: 60.00
2011A 2012E 2013E
Earnings/Share
3.03
3.33
3.79
Price/Earnings
22.1x 20.1x 17.7x
EBITDA
975 1,102 1,221
EV/EBITDA
14.7x 13.0x 11.7x
EXECUTIVE SUMMARY
Proposals for ending China's one-child policy, which was put in place in 1979 to control population growth, have
surfaced over the past several months, reflecting concerns about several issues, such as gender imbalance and an
aging population. However, similar proposals have been circulating for quite some time, and we believe that a
gradual impact from the policy changes is most probable. We remain cautious that the growth rate of infant and
child nutrition sales in China could slow over the long term because of declining birth rates in the region, particularly
if companies are unable to extend product usage into early childhood. Still, we still think abolishing the one-child
policy could result in incremental volume upside to infant nutrition companies and to Mead Johnson (MJN) in
particular, although the range of potential outcomes is wide.
KEY TAKEAWAYS
×
The key drivers of infant formula consumption are fertility rates and per capita consumption; we
believe both are related to wealth. Total fertility rates in comparable Asian countries have historically
declined as wealth and female labor force participation rates have increased. However, rising middle-class
incomes could make infant formulas more affordable for many families, and greater female labor force
participation could actually increase the demand for infant formulas if the convenience of these products
becomes more appealing.
×
Assuming the one-child policy is not repealed, we believe declining birth rates in China could
weigh on infant formula volume growth even if per capita consumption increases. The United
Nations estimates that around 150 million babies will be born in China between 2011 and 2020 (its base-case
forecast, which does not reflect a change in birth policies). This is around 20 million babies fewer than
between 2001 and 2010. If these declines occur even while China's infant formula/growing-up milk
consumption increases from 16 kilograms per birth to 24 kg/birth by 2022, we estimate that industry volume
would only increase 2% annually over the next 10 years (2013-22).
×
Although fertility rates could decline (on average) in emerging markets as female labor force
participation rates and wealth increase over time, we believe China's birth rate could increase if
the one-child policy is abolished. We estimate that China's fertility could bounce to 49.5 births per 1,000
females ages 15 and 49 (from 43.1 in our base case) in 2015 if the one-child policy is removed. We estimate
that this change would increase China's crude birth rate to around 13.0 births/1,000 population (from 11.3 in a
base-case scenario), representing a 170-basis-point change in the birth rate percentage and implying 2.3
million more births in 2015 than we assume in our base case.
×
There is considerable uncertainty around the assumption for the percentage of China's
childbearing population that is likely to change behavior in the event of a policy change. Not only is
the number of individuals currently covered by the one-child policy uncertain because of various exceptions to
the law, but identifying the number of individuals who desire to have a second child (and have not already
found a way to do so) is equally challenging.
×
Large multinational competitors could benefit from a policy change, but we believe changes to the
number of births and formula consumption in China would have the biggest impact on Mead
Johnson. Mead Johnson is the only company solely focused on selling infant and child nutrition products, and
given that around 30% of company's revenue is generated in China, we estimate that a policy change would
add 5%-10% to our current $60 fair value estimate, all else equal. Shares trade at a modest premium to our
fair value, but we'd be buyers on any potential weakness, given the upside associated with possible changes
in China's one-birth policy.
Morningstar Institutional Equity Research
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
2
Fertility Rates and Per Capita Consumption Drive Infant Nutrition Volume
The key drivers of infant formula consumption are fertility rates and per capita consumption; we
believe both are strongly related to wealth. Total fertility rates (see Appendix B for a glossary of key terms) in
comparable Asian countries have historically declined as wealth and female labor force participation rates have
increased. However, rising middle-class incomes could make infant nutrition formula more affordable for many
families, and greater female labor force participation could actually increase the demand for infant formulas if the
convenience of these products becomes more appealing.
Exhibit 1 illustrates that as wealth has increased in China and several comparable Asian countries over 2003-10,
the total fertility rate in each country has decreased. Exhibit 2 shows the negative relationship between female
labor force participation and the number of births per female. Given that around 57% of the variation in total fertility
is explained by female labor force participation alone, we believe that as the opportunity cost of having an
additional child increases, the number of births per female will probably decline.
Exhibit 2: …As Does the Relationship Between Female Labor
Force Participation and Total Fertility Rates
Births per female and female labor force participation
4.00
4.00
3.50
3.50
3.00
3.00
Births/Female
Births/Female (2003-2010)
Exhibit 1: Total Fertility Rates Appear Inversely Related to
Wealth in China and Comparable Countries…
Births/female (over a female's life) and GDP per capita (in 2005 dollars,
2003-10 )
2.50
2.00
1.50
2.00
1.50
1.00
1.00
0.50
0.50
0.00
0
2,000
4,000
6,000
8,000
Real GDP Per Capita (2003-2010)
China
Malaysia
Vietnam
Philippines
10,000
Source: World Bank, USDA International Macroeconomic Data Set, Morningstar equity research.
R² = 0.5671
2.50
0.0%
10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%
Female Labor Force Participation Rate
Source: World Bank, Morningstar equity research.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
3
Declining Birth Rates May Weigh on Long-Term Volume Growth
Assuming the one-child policy is not repealed, we believe declining birth rates in China could weigh on
infant formula volume growth even if per capita consumption increases. The United Nations estimates
that around 150 million babies will be born between 2011 and 2020 (its base-case forecast, which does not reflect
a change in birth policies). This is around 20 million babies fewer than between 2001 and 2010. If these declines
occur even while China's infant formula/growing-up milk consumption increases from 16 kg/birth to 24 kg/birth by
2022, we estimate that industry volume would only increase 2% annually over the next 10 years (2013-22).
Exhibit 3 illustrates the sensitivity of industry volume growth to estimates for ending consumption (in 2022) and the
fertility assumptions used by the United Nations in its population forecasts. Note that a declining birth rate could
result in a decrease in industry volume over the next 10 years despite increased per capita consumption under
current childbirth regulations. This potential scenario demonstrates that while infant nutrition companies have
strong brands, their revenue bases are not entirely sticky because they are highly dependent on the number of
babies born each year. Still, some infant nutrition companies have been able to moderate the sensitivity of revenue
to births by leveraging brand equities to extend product use beyond infant formulas, most notably by providing
nutrition products to children. If successful, these efforts could result in increased per capita consumption (as
measured in kg/birth). We also believe that leading multinational infant nutrition suppliers have enough pricing
power to offset volume declines, primarily because Chinese consumers have shown a willingness to pay up for the
perceived quality and safety of Western-made products. In addition, parents may prove willing to pay up for infant
nutrition formula in order to give their only son or daughter the best start in life. However, even with increased per
capita consumption, the number of births could have a more dominant effect on volume growth.
Exhibit 3: Fewer Births Could Weigh on Volume Growth Despite Higher Per Capita Consumption
14.0%
10 Year Industry Volume CAGR (2013-2022)
W. Europe Average:
35 kg/birth
Asia Average:
20 kg/birth
12.0%
North America Average:
47 kg/birth
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
-4.0%
-6.0%
16.0
18.0
20.0
22.0
24.0
26.0
28.0 30.0 32.0 34.0 36.0 38.0 40.0 42.0
Infant Formula Consumption (kg/birth) in 2022
Medium Fertility Variant
High Fertility Variant
Source: United Nations World Population Prospects 2010 Revision, Morningstar equity research.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
44.0
Low Fertility Variant
46.0
48.0
50.0
52.0
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
4
A Policy Change Could Present Volume Upside to Infant Nutrition Companies
Although fertility rates could decline (on average) in emerging markets as female labor force
participation rates and wealth increase over time, we believe China's birth rate could increase if the
one-child policy is abolished. We estimate that China's fertility could bounce to 49.5 births/1,000 females ages
15 and 49 (from 43.1 in our base case) in 2015 if the one-child policy is removed. We estimate that this change
would increase China's crude birth rate to around 13.0 births/1,000 population (from 11.3 in a base-case scenario),
representing a 170-basis-point change in the birth rate percentage and implying 2.3 million more births in 2015
than we assume in our base case.
We have used the gap between total fertility rates in comparable Asian countries to estimate the magnitude of a
potential change in China's total fertility rate. Exhibit 1 (on Page 2) illustrates the relationship between the total
fertility rate and real GDP per capita. In 2010, China's GDP per capita stood at around $4,500 while its total fertility
rate stood at around 1.5 births/female, or around half the total fertility rate of Malaysia when its per capita GDP
was around $4,500 per year. The GDP equivalent gap of China's total fertility rate relative to Malaysia may suggest
that China's total fertility rate is depressed by around 50%, all else equal.
Still, not all of China's population is equally affected by the one-child policy, which complicates and adds
uncertainty to our calculations. To determine the impact that a policy change could have on future births in China,
we've broken down the components of China's crude birth rate into three parts: the fertility effect, the age effect,
and the gender effect. The relationship among these variables is demonstrated in Exhibit 4. We've specifically
isolated the fertility effect when sizing up the impact of a policy change, primarily because the contributions of the
age effect and gender effect would be very small.
Exhibit 4: Crude Birth Rate Composition
Fertility rates, age distribution of the female population, and the gender mix of total population impact birth rates
Crude Birth Rate
Births
Total Population
=
=
1
Fertility Effect*
X
2
Age Effect
X
3
Gender Effect
Births
Females (Age 15-49)
All Females
X
X
Females (Age 15-49)
All Females
Total Population
Source: United Nations World Population Prospects 2010 Revision, company presentations, Morningstar equity research.
*We use a weighted average fertility rate for the childbearing female population.
Exhibit 5 details our estimate for the change in the births/1,000 females (15-49) and the crude birth rate. Using the
United Nations' medium variant fertility forecasts for 2010-15, we estimate a 2015 fertility variant of around 43
births/1,000 females (15-49). With this estimate, we've attempted to estimate the potential impact that a policy
change could have on this variable.
If all families desired a second child but were prohibited by the one-child policy, we'd expect the rate of
births/1,000 females (ages 15-49) to double if the policy were removed. However, because some individuals are
already allowed to have two children, we're forced to estimate how many childbearing mothers are likely to change
their behavior. In research published in Science Magazine, Lisa Cameron of Monash University reports around 91%
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
5
(80%) of Chinese individuals born in 1983 (1980) who were surveyed in Beijing identified themselves as being only
children. (These individuals would be around 30 years old, in the middle of the childbearing age.) Since parents are
currently allowed to have two children if neither parent has siblings, we assume China's current fertility rate reflects
the parental plans for this proportion of the population. In other words, we assume no change in the births/1,000
childbearing females for 85% percentage of the childbearing population, though this is difficult to forecast with a
high degree of confidence.
For the other 15%, we assume all of these mothers decide to have a second child, doubling the number of
births/1,000 females (15-49) to 86 for this cohort. The weighted average fertility effect increases the number of
births/1,000 childbearing females to around 49.5 births/1,000 females (15-49) and increases the crude birth rate to
around 13.0 births/1,000 (total population) from around 11.3.
Exhibit 5: Impact of Policy Change on Crude Birth Rate
Birth rate and fertility rates, measured in births/1,000
Parent Segment
No Change to Behavior
Change to Behavior
Total Child-Bearing Population
Base Case
One Child Policy Removed
Difference
% of Child-Bearing Population
85.0%
15.0%
100%
Birth Rate
11.3
13.0
1.7
=
Fertility Effect
43.1
49.5
6.5
X
Age Effect
54.3%
54.3%
0.0%
Fertility Rate
43.1
86.2
49.5
X
Gender Effect
48.3%
48.3%
0.0%
Source: United Nations World Population Prospects 2010 Revision, company presentations, Morningstar equity research.
There is considerable uncertainty around this assumption for the percentage of China's childbearing
population that is likely to change behavior in the event of a policy change. We have made the
assumption that the current fertility rate already reflects the parental desires for about 85% of the total childbearing
age population. However, not only is the number of individuals currently covered by the one-child policy uncertain
because of various exceptions to the law, but identifying the number of individuals who desire to have a second
child and have not already found a way to do so is equally challenging.
Exhibit 6 shows the sensitivity of China's crude birth rate, the number of births (in 2015), and our hypothetical fair
value estimate to the assumed percentage of China's population that does not intend to change parental decisions
based on a policy change. For example, if 100% of the childbearing population decides not to alter parental plans,
we would not assume any change in the birth rate (from the base case), and thus our fair value estimate would not
be affected. However, as the percentage of individuals deciding to have a second child increases (the percentage
of people forgoing a second child decreases), the potential upside to the birth rate and our fair value increases.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
6
Exhibit 6: Birth Rate and Fair Value Sensitivity
Birth rate and fair value sensitivity to the percentage of the population unlikely to change parental plans
% of Child-Bearing Population
Unlikely to Alter Parental Plans
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
55.0%
60.0%
65.0%
70.0%
75.0%
80.0%
85.0%
90.0%
95.0%
100.0%
Fertility Effect
Birth Rate
77.5
75.4
73.2
71.1
68.9
66.8
64.6
62.5
60.3
58.2
56.0
53.9
51.7
49.5
47.4
45.2
43.1
20.3
19.7
19.2
18.6
18.1
17.5
16.9
16.4
15.8
15.2
14.7
14.1
13.5
13.0
12.4
11.8
11.3
Crude Birth Rate:
Delta vs. Base Case
9.03
8.46
7.90
7.34
6.77
6.21
5.64
5.08
4.51
3.95
3.39
2.82
2.26
1.69
1.13
0.56
0.00
2015 Births
27,988
27,211
26,433
25,656
24,878
24,101
23,323
22,546
21,769
20,991
20,214
19,436
18,659
17,881
17,104
16,326
15,549
Source: United Nations World Population Prospects 2010 Revision, Morningstar equity research.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
Total Births: Delta vs. Base Case
Impact to Fair Value
12,439
11,662
10,884
10,107
9,329
8,552
7,774
6,997
6,220
5,442
4,665
3,887
3,110
2,332
1,555
777
0
$21.52
$20.18
$18.83
$17.49
$16.14
$14.80
$13.45
$12.11
$10.76
$9.42
$8.07
$6.73
$5.38
$4.04
$2.69
$1.52
$0.00
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
7
A Policy Change Could Add 5%-10% to Our Fair Value Estimate for Mead Johnson
Large multinational competitors could benefit from a policy change, but we believe changes to the
number of births and formula consumption in China would have the biggest impact on Mead Johnson's
consolidated operations. As illustrated in Exhibit 7, Mead Johnson is the only company solely focused on selling
infant and child nutrition products, and given that around 30% of its revenue is generated in China, we estimate
that a policy change would add 5%-10% to our current $60 fair value estimate, all else equal.
Exhibit 7: Mead Johnson's Consolidated Growth Is Most Exposed to Infant Formula/Growing-Up Milk
Consumption
Percerntage of total sales derived from infant/children's nutrition
100.0%
90.0%
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Mead Johnson
Nestle
Abbott Laboratories
Danone
Heinz
Source: Company filings and presentations, Morningstar equity research.
We estimate that a change in the one-child policy could add just under 2% to our 7% (10-year compound annual
growth rate) base-case sales growth forecast for Mead Johnson's China/Hong Kong segment. Exhibits 8 and 9
contrast our base-case sales projections with our sales growth estimates in the event that the one-child policy is
abolished in 2015. Our base-case sales forecast is based on the United Nations' medium fertility variant population
prospects for China and assumes that Mead Johnson's market share remains constant over the next 10 years.
While Mead Johnson could continue to gain value share over time, it has fierce competition from other
multinational firms such as Nestle (NSRGY), Abbott Laboratories (ABT), Danone (BN), and Heinz (HNZ).
Concerns about the safety of local products have benefited large multinationals over the past several years, as
Chinese consumers have shown a willingness to pay up for the perceived quality of American-produced products.
However, if the quality of local products improves and consumers prove much more willing to switch brands, or if
more women decide to breastfeed, Mead Johnson's pricing power could be reduced.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
Exhibit 8: Base-Case Forecast
Mead Johnson China/Hong Kong Sales (2011-17E)
Exhibit 9: One-Child Policy Abolished
Mead Johnson China/Hong Kong Sales (2011-17E)
$18,000,000
$18,000,000
$16,000,000
$16,000,000
$14,000,000
$14,000,000
$12,000,000
$12,000,000
$10,000,000
$10,000,000
$8,000,000
$8,000,000
$6,000,000
$6,000,000
$4,000,000
$4,000,000
$2,000,000
$2,000,000
$-
$-
2012
2013
2014
2015
2016
MJN Sales
2017
2018
2019
2020
2021
2012
2022
2013
2014
2015
Retail Category Value
Category (Ex. MJN) Sales
CAGR (2013-2022)
CAGR/Total Gain
7.2%
2016
MJN Sales
MJN Sales CAGR
(2013-2022)
7.2%
2017
2018
2019
(comparable to the Asia average) by 2022
Industry pricing increases at 5% annually
Mead Johnson's market share remains constant over this period
2021
2022
MJN Sales CAGR
(2013-2022)
8.8%
One-Child Policy Abolished in 2015:
 Birth rates reflect the United Nations medium variant estimates but jump after 2015



Source: Company reports, Morningstar estimates.
2020
Retail Category Value
Category (Ex. MJN) Sales
CAGR (2013-2022)
CAGR/Total Gain
8.8%
Base-Case Scenario:
 Birth rates reflect the United Nations medium variant fertility estimate
 Infant formula consumption increases from 16 kg/birth to around 24 kg/birth


8
policy change
Infant formula consumption increases from 16 kg/birth to around 24 kg/birth
(comparable to the Asia average) by 2022
Industry pricing increases at 5%
Mead Johnson's market share remains constant over this period
Source: Company reports, Morningstar estimates.
Key Assumptions for the Valuation Impact to Mead Johnson
 China segment EBIT margins of 33.5%, comparable with current Asia/Latin America segment EBIT margins
 25% corporate tax rate in China
 Terminal multiple of 20 times earnings per share
 204 million shares outstanding (we do not assume repurchases)
 9% discount rate
 Number of births/1,000 females (15-49) jumps to 49.5 from 43.1 in 2015 and remains at a constant spread
(6.5 births/1,000 females 15-49) above our base-case forecast
Exhibit 10: Incremental Upside If One-Child Policy Results in a Temporary Increase in Birth Rate
Per share values
Year 10 (2022) Terminal Value Per Present Value Difference vs. Percentage Impact
EPS
Multiple Share
Per Share
Base Case
to Fair Value
Base Case
One Child Policy Removed
$3.42
$3.96
20
20
$68.34
$79.17
$29.00
$33.00
Source: Company filings, Morningstar equity research.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
$0.00
$4.00
0.0%
6.7%
Morningstar Institutional Equity Research: Mead Johnson Stands to Benefit From a Repeal of the One-Child Policy in China
January 22, 2013
9
Appendix A: Financial Summary and Forecasts
Mead Johnson Nutrition Company (MJN)
Market Cap: $14.2 Billion
Five-Star Price
Sector: Consumer Defensive
42.00
Economic Moat
Industry: Household & Personal Products
Narrow
Fair Value Estimate
60.00
Moat Trend
Stable
One-Star Price
81.00
Uncertainty
Medium
Market Price
66.96
Estimated COE
Valuation Multiples (2012 Estimates)
Morningstar Credit Rating
1.12
N/A
3-Yr Historical
CAGR/AVG
10.0%
Scenarios
Adjusted P / E
22.1
Bull Case
93.00
EV / Adjusted EBITDA
14.7
Base Case
60.00
3.7
Bear Case
49.00
EV / Sales
Price / Fair Value Estimate
Stewardship: Standard
Price / Book
125.1
Pre-Tax Cost of Debt
4.3%
FCF Yield
3.6%
Estimated WACC
9.3%
Dividend Yield
1.8%
FY Ends:
Forecast
2009
2010
2011
2012
2013
2014
2015
2016
December
5-Yr Projected
CAGR/AVG
All values (except per share amounts) in: USD Millions
Income Statement
Revenue
2,827
3,142
3,677
3,883
4,178
4,492
4,831
5,191
Gross Profit
1,852
1,992
2,315
2,409
2,609
2,830
3,048
3,276
Operating Income
713
712
794
896
1,016
1,127
1,222
1,319
Net Income
399
451
507
599
670
749
818
887
Adjusted EPS
1.99
2.42
2.79
3.03
3.33
3.77
4.15
4.55
Adjusted EBITDA
772
777
869
975
1,102
1,215
1,321
1,424
11.1%
17.0%
5.6%
7.6%
7.5%
7.6%
7.5%
7.6%
16.2%
4.1%
8.3%
8.5%
7.7%
7.5%
7.2%
Operating Income
-0.1%
11.5%
12.9%
13.4%
11.0%
8.4%
7.9%
10.7%
Net Income
13.1%
12.4%
18.2%
11.8%
11.8%
9.1%
8.5%
11.8%
Adjusted EPS
21.9%
15.1%
8.5%
10.2%
13.0%
10.2%
9.6%
10.3%
0.7%
11.9%
12.2%
13.1%
10.2%
8.8%
7.8%
10.4%
Growth (% YoY)
Revenue
Gross Profit
Adjusted EBITDA
7.1%
Profitability (%)
Gross Margin
64.0%
65.5%
63.4%
63.0%
62.0%
62.4%
63.0%
63.1%
63.1%
62.7%
Operating Margin
23.2%
25.2%
22.7%
21.6%
23.1%
24.3%
25.1%
25.3%
25.4%
24.6%
Net Margin
14.1%
14.1%
14.4%
13.8%
15.4%
16.0%
16.7%
16.9%
17.1%
16.4%
Adjusted EBITDA Margin
25.2%
27.3%
24.7%
23.6%
25.1%
26.4%
27.0%
27.3%
27.4%
26.7%
-103.5%
-38.4%
-86.6%
-185.6%
-1718.0%
443.4%
224.5%
130.7%
94.5%
-165.0%
Adjusted ROIC
50.4%
55.5%
51.8%
43.9%
46.2%
51.2%
47.1%
43.4%
40.3%
45.6%
Adjusted RONIC
19.2%
39.1%
-0.7%
66.6%
134.4%
25.4%
22.5%
20.7%
53.9%
76.6%
Return on Equity
Leverage
Debt / Capital
139.1%
172.6%
131.5%
113.2%
93.3%
88.8%
76.4%
66.4%
58.2%
Debt / EBITDA
2.0
2.2
2.1
1.8
1.6
1.4
1.3
1.2
1.1
1.3
EBITDA / Interest Expense
13.2
8.0
15.4
16.3
14.6
16.5
18.2
19.8
21.3
18.0
Dividends per Share
0.70
0.90
1.04
1.20
1.40
1.64
1.86
2.07
Free Cash Flow to the Firm
541
366
521
312
693
760
855
922
FCFE (CFO-Capex)
481
342
523
488
676
747
844
914
Cash Flow
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
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10
Appendix B: Glossary of Key Terms Used in United Nations' World Population Prospects
We have used the United Nations' World Population Prospects (2010 Revision) extensively in our demographic
analysis. Below are key terms, as defined by the United Nations.
Key Terminology
×
Births by age of mother (which we refer to as fertility throughout this report): Number of births over
a given period classified by age group of mother (15-19, 20-24, 25-29, 30-34, 35-39, 40-44, 45-49). Refers to
five-year periods running from July 1 to June 30 of the initial and final years. Data are presented in thousands.
×
High-fertility assumption: Under the high variant, fertility is projected to remain 0.5 children above the
fertility in the medium variant over most of the projection period. By 2020-25, fertility in the high variant is
therefore half a child higher than that of the medium variant. Countries reaching a total fertility of 2.1 children
per woman in the medium variant have a total fertility of 2.6 children per woman in the high variant.
×
Medium-fertility variant assumption: This is a probabilistic forecast. For further details, consult the
Department of Economic and Social Affairs' Population Division's work "Assumptions Underlying the 2010
Revision."
×
Low-fertility variant assumption: Under the low variant, fertility is projected to remain 0.5 children below
the fertility in the medium variant over most of the projection period. By 2020-25, fertility in the low variant is
therefore half a child lower than that of the medium variant. Countries reaching a total fertility of 2.1 children
per woman in the medium variant have a total fertility of 1.6 children per woman in the low variant.
×
Old-age dependency ratio (1): Age 65-plus / Age 15-64.
×
Total dependency ratio (1): (Age 0-14 + Age 65-plus) / Age 15-64.
×
Total fertility rate: The average number of children a hypothetical cohort of women would have at the end of
their reproductive period if they were subject during their whole lives to the fertility rates of a given period and
if they were not subject to mortality. It is expressed as children per woman.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
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11
Appendix C: China's One-Child Policy Was Passed to Control Population Growth
China's one-child policy was enacted to control population growth, but several other measures were
taken to control population growth before that. In the early 1970s, for example, the Chinese government
promoted the idea of "later, longer, fewer," which encouraged families to have children later, increase the length of
time between births, and have fewer children. Despite these efforts, the Chinese government believed that more
aggressive measures were needed, and the one-child policy was enacted in 1979.
Details and Impact of the Current Policy
Not all families have been equally affected by the one-child policy because of nuances in the law. For example:
×
×
×
×
If parents live in an urban area, they are allowed:
 One child if either parent has siblings
 Two children if neither parent has siblings
If parents live in a rural area, they are allowed:
 Two children if the first child is a girl
 One child if the first child is a boy
Minority ethnic groups are not subjected to the one-child policy
Some regions, such as Hong Kong and Macau, are not subject to the one-child policy
Since China passed the one-child policy in 1979, its crude birth rate declined almost 50%. However, many
developed and developing countries also had declining birth rates during this time frame. Some commentators
have estimated that the one-child policy has prevented around 400 million births (representing around 30% of
China's current population) since it was enacted.
Exhibit 11: China's Crude Birth Rate Has Declined, but So Has That of Many Other Countries
Births per 1,000 population
50
45
40
35
30
25
20
15
10
5
0
WLD
BRA
CHN
IND
Source: World Bank, Morningstar equity research.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.
RUS
USA
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12
Appendix D: China's Current Demographic Outlook
We believe the primary motivations spurring a change in policy may relate to the country's long-term
prospects for economic growth. China's economy could be negatively affected if the country's ratio of males to
females becomes increasingly imbalanced. Moreover, the country's population is growing older; not only will these
individuals need to be cared for (placing a greater burden on the working-age population), but a potential decline in
the total working-age population could further weigh on economic growth.
Sex ratio imbalance. While China's male/female ratio (Exhibit 12) has historically remained higher than the world
in general (which hovers a little over 1.0), the ratio of male/female births has become imbalanced since the onechild policy was enacted. As illustrated in Exhibit 13, the ratio of male to female births in China, excluding Hong
Kong (which is not subject to the one-child policy), stood at around 1.2 between 2005 and 2010, which is well
above the consistent 1.07 ratio reported from 1950 through 1985. We think this growing imbalance reflects a
cultural preference for male babies, as many parents allowed only one child may choose to abort female babies.
Exhibit 12: Although Above Aggregate World Levels, China's
Total Sex Ratio Has Held Steady Over Past Several Decades…
Males per 100 females
Exhibit 13: …but Ratio of Male/Female Births Has Become
Imbalanced Since One-Child Policy Was Enacted
Male births per female birth
125.0
1.25
120.0
1.20
1.15
115.0
1.10
110.0
1.05
105.0
1.00
0.95
100.0
0.90
95.0
0.85
90.0
85.0
1970
1975
1980
1985
1990
1995
China (Excl. Hong Kong and Macao)
2000
2005
2010
World
Source: United Nations World Population Prospects 2010 Revision, Morningstar equity research.
World
China (Excl. Hong Kong and Macao)
Source: United Nations World Population Prospects 2010 Revision, Morningstar equity research.
These imbalances could lead to further imbalances down the road. For example, as the percentage of males of
childbearing age continues to exceed the number of childbearing women, the country's birth rate would continue to
decline (as a percentage of the total population) if the one-child policy were to remain in place. Under these
circumstances, it would take much longer for China to correct these imbalances, assuming that its political leaders
would want to do so. All the while, these imbalances could have economic and social implications.
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Aging population. We believe the steady rise in the median age of China could weigh on China's economic
growth over the long term. China's working-age population could become increasingly burdened by the need to
take care of its elderly population. As illustrated in Exhibit 14, the United Nations projects that China's median age
could increase from under 40 at the end of 2010 to around 45 by 2025 and around 50 by 2040.
Exhibit 14: Median Age of China's Population Is Expected to Continue Increasing
Measured in years
70.0
60.0
50.0
40.0
30.0
20.0
10.0
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065
2070
2075
2080
2085
2090
2095
2100
0
Medium Fertility Variant
High Fertility Variant
Low Fertility Variant
Source: United Nations World Population Prospects 2010 Revision, Morningstar equity research.
While these changes in the median age of China's population may not seem to be relatively large, we believe
China's dependency ratios tell a more interesting story. Exhibit 15 illustrates the United Nations' historical and
future estimates for China's total dependency ratio, which measures the percentage of people younger than 14 and
older than 65 as a percentage of the working-age population. Partly influencing the increase in China's total
dependency ratio are expectations for the number of babies born. However, Exhibit 16 illustrates that a majority of
the projected increase is due to an aging population (as measured by the old-age dependency ratio).
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
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Exhibit 15: China's Total Dependency Ratio Is Expected to
More Than Double Over the Next Two Decades…
Population ages 0-14 and 65-plus as a percentage of the working-age
population (15-64)
14
Exhibit 16: …Largely Due to a Signifciant Increase in the Elderly
Population
Population ages 65-plus as a percentage of the working-age population
(15-64)
90.0
120.0
80.0
100.0
70.0
80.0
60.0
50.0
60.0
40.0
40.0
30.0
20.0
20.0
10.0
Medium Fertility Variant
High Fertility Variant
Low Fertility Variant
Source: United Nations World Population Prospects, Morningstar equity research.
0
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065
2070
2075
2080
2085
2090
2095
2100
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065
2070
2075
2080
2085
2090
2095
2100
0
Medium Fertility Variant
High Fertility Variant
Low Fertility Variant
Source: United Nations World Population Prospects, Morningstar equity research.
Social concerns. While we believe the aforementioned two factors are the primary reasons for a potential policy
change, social complaints about China's one-child policy may also be prompting discussions. For example, many
human rights activists have complained about (potentially brutal) forced abortions for mothers carrying a second
child. In addition, the World Health Organization's 2011 estimates indicate that China's (excluding Hong Kong)
female suicide rate (14.8 per 100,000 people) was higher than all the other countries studied except South Korea
and Sri Lanka. Some also suggest that female suicides are highest for women 25-34 years old. We have opted to
refrain from taking a stance on social issues outside our primary concern, but the increased publicity could add
pressure to policymakers, especially since the original policy was only intended to last 30 years.
©2013 Morningstar, Inc. All rights reserved. The information contained herein is not represented or warranted to be accurate, correct,
complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. For licensing or permission to use this information, call +1 312-696-6869.