HK food & Drink Report.pdf

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Q1 2013www.businessmonitor.com

FOOD & DRINK REPORT

HONG KONG

INCLUDES BMI'S FORECASTS


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bli ti All i f ti i id d ith t t d B i M it I t ti l k t ti f t f ki d

HONG KONG FOOD & DRINKREPORT 2013INCLUDES 5-YEAR FORECASTS TO 2017

Part of BMI's Industry Report & Forecasts Series

Published by: Business Monitor International

Copy Deadline: October 2012


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Hong Kong Food & Drink Report 2013


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CONTENTS

BMI Industry View ............................................................................................................................................ 7SWOT Analysis ................................................................................................................................................. 9

Hong Kong Food Industry SWOT ............. ............. ............ ............. ............. ............ ............. .............. ............. ............. ............. ............. ............. .. 9Hong Kong Drink Industry SWOT ........... ............. .............. ............. ............. ............. ............. ............ ............. ............. ............ ............. ............. . 10Hong Kong Mass Grocery Retail Industry SWOT ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ ... 12

Business Environment .................................................................................................................................. 13BMIs Core Global Industry Views ............ ............. .............. ............. ............. .............. ............. ............ ............ ............. ............. ............. ............. ... 13

Table: Core Views ............................................................................................................................................................................................... 21Asia Pacific Food & Drink Risk/Reward Ratings ................... ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. . 22

Table: Food & Drink Risk/Reward Sub-Factor Ratings, Q113 (score out of 10) ............. ............. ............. ............ ............. ............. ............. ....... 23Table: Asia Pacific Food & Drink Risk/Reward Ratings, Q113 .......................................................................................................................... 26

Hong Kongs Food & Drink Risk/Reward Rating ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ....... 27Macroeconomic Outlook ............. .............. ............. ............. ............. ............. .............. ............ ............ ............. ............. ............. ............. ............. ..... 29

Table: Economic Activity ..................................................................................................................................................................................... 31Industry Forecast Scenario ........................................................................................................................... 33

Consumer Outlook .................................................................................................................................................................................................... 33Food.......................................................................................................................................................................................................................... 37

Food Consumption ............................................................................................................................................................................................... 37Table: Food Consumption Indications Historical Data & Forecasts ............. ............ ............. ............. ............. ............. ............ ............. .......... 38Canned Food ....................................................................................................................................................................................................... 38Table: Canned Food Value/Volume Sales Historical Data & Forecasts .......................................................................................................... 39 Confectionery....................................................................................................................................................................................................... 39Table: Confectionery Value/Volume Sales Historical Data & Forecasts .......................................................................................................... 40Meat ............ ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............ ........ 41Table: Meat ......................................................................................................................................................................................................... 41Pasta .................................................................................................................................................................................................................... 42Table: Pasta ......................................................................................................................................................................................................... 42Frozen Food ........................................................................................................................................................................................................ 43Table: Frozen Food ............................................................................................................................................................................................. 45Dairy ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ..... 46Table: Dairy ........................................................................................................................................................................................................ 47

Drink ............ ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............ ............. ............. ............ 49Alcoholic Drinks ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. . 49Table: Alcoholic Drinks Value/Volume Sales Historical Data & Forecasts ..................................................................................................... 50Soft Drinks ........................................................................................................................................................................................................... 51Table: Soft Drinks Value/Volume Sales Historical Data & Forecasts .............................................................................................................. 52 Hot Drinks ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ .......... 53Table: Hot Drinks Value Sales Historical Data & Forecasts............................................................................................................................ 53

Trade ........................................................................................................................................................................................................................ 54Table: Food & Drink Trade Indicators Historical Data & Forecasts............................................................................................................... 55

Mass Grocery Retail ............ .............. ............. ............. ............. ............. .............. ............. ............ ............. ............. ............. ............ ............. ............ 55Table: Mass Grocery Retail Sales Historical Data & Forecasts....................................................................................................................... 59Table: Sales Breakdown by Retail Format Type .................................................................................................................................................. 59

Food ................................................................................................................................................................. 60


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Industry Trends And Developments ................... ............. ............ ............. ............. ............ .............. ............. ............. ............ ............. ............. .......... 60Lindt & Sprngli Plans To Consolidate Its Hong Kong Unit ............. ............ ............. ............. ............ .............. ............. ............ ............. ............ 60Hong Kongs Chain Loses Out As Walmart To Deal Directly With Factories ............. ............ ............. ............ .............. ............ ............. ............ 60

Market Overview ....................... ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ....... 61Food Production .................................................................................................................................................................................................. 61

Drink ................................................................................................................................................................ 62Industry Trends And Developments ................... ............. ............ ............. ............. ............ .............. ............. ............. ............ ............. ............. .......... 62

Hong Kong-Listed Brewer Up For Sale ............. ............. .............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ... 62UKs Whisky Distiller Opens New Office In Hong Kong ..................................................................................................................................... 62Wine Remains Dynamic ....................................................................................................................................................................................... 62Innovation Still Crucial.................... ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............ .......... 63

Market Overview ....................... ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ....... 64Alcoholic Drinks ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. . 64Soft Drinks ........................................................................................................................................................................................................... 64Hot Drinks ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ............. ............. ............. ............ .......... 64

Mass Grocery Retail ....................................................................................................................................... 65Industry Trends And Developments ................... ............. ............ ............. ............. ............ .............. ............. ............. ............ ............. ............. .......... 65

Dairy Farm International Post Strong H112 Results ............ ............. ............. ............ ............. ............. ............. ............ ............. ............. ............ 65Intensifying Competitive Pressures Could Undermine Uny's Growth Potential...................... ............. ............. .............. ............. ............. ........... 66Premium Interest ................................................................................................................................................................................................. 67Morrisons Opens Office in Hong Kong ............ ............. .............. ............. ............. .............. ............ ............ ............. ............. ............. ............. ..... 67

Market Overview ....................... ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ....... 69Table: Structure Of Mass Grocery Retail Market By Estimated Number of Outlets ............................................................................................ 70Table: Structure Of Mass Grocery Retail Market Sales (HKDmn) By Format ................................................................................................. 70Table: Structure Of Mass Grocery Retail Market Sales (US$mn) By Format ................................................................................................... 70 Table: Average Sales Per Outlet By Format 2012 ............................................................................................................................................ 71

Competitive Landscape ................................................................................................................................. 72Key Players ............................................................................................................................................................................................................... 72

Table: Key Players In Hong Kong's Food Sector ................................................................................................................................................ 72Table: Key Players In Hong Kong's Drink Sector ............ ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ... 72Table: Key Players In Hong Kong's Mass Grocery Retail Sector ........................................................................................................................ 73

Company Monitor ........................................................................................................................................... 75Food.......................................................................................................................................................................................................................... 75

Golden Resources Development .......................................................................................................................................................................... 75Drink ............ ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............ ............. ............. ............ 77

Tsit Wing .............................................................................................................................................................................................................. 77San Miguel Hong Kong ........................................................................................................................................................................................ 80Vitasoy International ........................................................................................................................................................................................... 82

Mass Grocery Retail ............ .............. ............. ............. ............. ............. .............. ............. ............ ............. ............. ............. ............ ............. ............ 86Dairy Farm International ............. ............. ............. ............. ............. .............. ............. ............ ............. ............. ............. ............ ............. ............ 86AS Watson ............ ............. ............. ............. ............ ............. ............. ............. ............. ............. ............. ............. ............. ............ ............. ............ 88

Demographic Outlook .................................................................................................................................... 89Table: Hong Kong's Population By Age Group, 1990-2020 ('000) ...................................................................................................................... 90Table: Hong Kong's Population By Age Group, 1990-2020 (% of total) ............................................................................................................. 91Table: Hong Kong's Key Population Ratios, 1990-2020...................................................................................................................................... 92Table: Hong Kong's Rural And Urban Population, 1990-2020 ........................................................................................................................... 92

Risk/Reward Ratings Methodology .............................................................................................................. 93


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Table: Rewards .................................................................................................................................................................................................... 93Table: Risks ......................................................................................................................................................................................................... 94Weighting ............................................................................................................................................................................................................. 94Table: Weighting ................................................................................................................................................................................................. 94

BMI Food & Drink Industry Glossary ........................................................................................................... 95

Food & Drink ...................................................................................................................................................................................................... 95Mass Grocery Retail ............ ............. ............. ............. .............. ............. ............. ............. ............ ............. ............. ............. ............. ............. ....... 95

BMI Food & Drink Forecasting & Sourcing ................................................................................................. 97How We Generate Our Industry Forecasts ............ ............. ............. ............. ............. ............. ............. ............ ............. ............. ............. ............. ..... 97

Sourcing ............................................................................................................................................................................................................... 98


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BMI Industry View

BMI View: Hong Kong is one of Asia Pacific's smallest consumer markets, with its population standing

at just over the 7mn mark. Therefore, from a demographic standpoint, there are few attractions for

consumer industry investors. Additionally, we expect the reversal in Hong Kong's booming property

market to weigh on consumer purchasing power and curtail spending on higher value consumer goods.

Generally speaking, most food and drink segments are highly mature, although consumers remain

interested in novelty and convenience, which still provides opportunities for food and drink companies.

Headline Industry Data (local currency)

2013 per capita food consumption growth = +2.10%; forecast compound annual growth rate

(CAGR) to 2017 = +1.88%

2013 alcoholic drinks sales growth = +5.10%; forecast CAGR to 2017 = +4.42%

2013 soft drinks sales growth = +5.88%; forecast CAGR to 2017 = +4.57%

2013 mass grocery retail sales growth = +5.93%; forecast CAGR to 2017 = +5.04%

Key Trends And Developments

Dairy Farm International Post Strong H112 Results:Hong Kong-based retail company Dairy Farm

Internationalposted strong results for the first half of its financial year. The company's sales for the six-

month period ended June 30 2012 increased by 10% to US$5.5bn compared to H111, while its underlying

profit was up 12% to US$243mn. Dairy Farm's strong results were driven by some small acquisitions it

made during the six months, including a 70% share in a Cambodia-based supermarket chain and a 50%

stake in Philippines-based retailer Rustan's.

Hong Kong-Listed Brewer Up for Sale:In February 2012, Chinese brewers expressed interest in

acquiring the beer assets of Kingway Brewery, which is listed in Hong Kong. Potential buyers

included Tsingtao, Beijing Yanjing Brewery (which had emerged as a front runner, but abandoned the

plan over price disagreements), Guangzhou Zhujiang Brewery, as well as CR Snow, which is a joint

venture between China Resources Enterpriseand SABMiller. In September 2012, Kingway was

reportedly still in talks with potential partners. The company is mulling a sale of all or part of its business

as it struggles to generate profits amid a highly competitive environment.

Risks To Outlook

Political Risks:While we believe Hong Kong will remain at or near the top of our political risk ratings


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table over the next decade, a number of risks could lead to rising political instability. The sluggish pace of

democratic reforms will continue to cause anger among pro-democracy supporters, and there is the

potential for large-scale public protests. A lack of affordable housing and rising income inequality also

could pose threats to social stability.

Economic Risks:While a high degree of financial stability helps to counterbalance Hong Kong's long-

term economic weaknesses, namely its high dependence on trade and over-reliance on the export of

manufactured goods, Hong Kong is at risk of a larger-than-expected decline in the domestic property

market that would result in a sharp fall in domestic consumer confidence and spending. A sharper-than-

anticipated cooling of the Chinese economy as tighter credit conditions start to take effect could also

weigh on domestic consumer sentiment given the key trading relationship between the two countries.


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SWOT Analysis

Hong Kong Food Industry SWOT

Strengths Changing diets and lifestyles are increasing demand for higher-valueconvenience foods.

Hong Kong is a substantial re-exporter of processed foods to mainlandChina.

High disposable incomes ensure consumer susceptibility to premium andinnovative food and beverage items.

Weaknesses Hong Kongs limited natural resources mean it is heavily dependent onimports of raw materials and food; this is a particular weakness during this

period of volatile global food prices. The market is relatively mature, providing few opportunities for growth.

Domestic food production remains low and there is little prospect for growthas factories are increasingly being relocated to mainland China.

Opportunities Sales of packaged food and healthy products have increased due toincreasing consumer consciousness about food safety and hygiene followingvarious regional health scares.

Hong Kongs population is susceptible to new, innovative and premiumproduct launches, particularly in the countrys profitable soft drinks sector.

The Closer Economic Partnership Arrangement (CEPA) agreement offers anopportunity to boost imports to the mainland.

Hong Kong continues to serve as an Asian profit centre for producers,meaning that investment should remain even as manufacturers seek outhigher-growth opportunities.

Threats A slowdown in Chinas booming economy could have serious consequencesfor Hong Kongs food and drink industry, which is intrinsically linked to Chinain terms of both trade and attracting general regional investment.

A worse than expected property market slowdown could dampen domesticdemand for higher value food and beverage items in the coming quarters.

Hong Kongs higher labour and manufacturing costs are likely to result in anincreasing number of companies transferring production to mainland China,leading to a rise in unemployment, which will adversely affect consumerspending levels.


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Hong Kong Drink Industry SWOT

Strengths Wide acceptance of alcohol consumption maximises Hong Kongs alcoholic

drinks industrys otherwise small customer base. High disposable incomes ensure consumer susceptibility to premium and

innovative food and beverage items.

A dynamic tourism industry further strengthens sales of both alcoholic andsoft drinks.

Weaknesses Hong Kongs limited natural resources mean it is heavily dependent onimports of raw materials and food; this is a particular weakness during thisperiod of volatile global commodity prices.

The countrys alcohol industry has suffered from the attractive investment

and growth opportunity that China represents. The market is relatively mature, providing few opportunities for growth.

While alcohol consumption is widely accepted, relatively high prices do limitindustry participation for some.

Opportunities Hong Kongs population, encouraged by rising employment and disposableincomes, is susceptible to new, innovative and premium product launches,particularly in the countrys profitable soft drinks sector.

The CEPA agreement offers an opportunity to boost imports to the mainland.

Hong Kong continues to serve as an Asian profit centre for producers,

meaning that investment levels should remain high even as manufacturersseek out higher-growth opportunities.

Energy drinks, popular among young, aspirational consumers, are a highgrowth channel, while perceived healthy soft drinks, such as juices, shouldbenefit from rising global health consciousness.

The removal of excise duties on beer and wine improved Hong Kongsappeal as a regional alcohol trading hub.

The relatively small wine sector represents a significant growth opportunity,in terms of domestic sales, but more significantly in terms of regional exports.

Threats A slowdown in Chinas booming economy could have serious consequencesfor Hong Kongs food and drink industry, which is intrinsically linked to Chinain terms of both trade and attracting general regional investment.

A worse than expected property market slowdown could dampen domesticdemand for higher value food and beverage items in the coming quarters.

Weak global economic growth, particularly in higher-travelling developedmarkets, could once again harm the global tourism industry, with perceivedexpensive destinations likely to suffer particularly; this could hurt beveragesales.

Hong Kongs higher labour and manufacturing costs are likely to result in anincreasing number of companies transferring production to mainland China,

leading to a rise in unemployment, which will adversely affect consumer


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spending levels.


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Hong Kong Mass Grocery Retail Industry SWOT

Strengths Wet markets will continue to lose market share to the advantage of

supermarkets and other modern retail formats as the latter continue toreplicate traditional shopping experiences, but with the additional benefits ofconvenient opening hours and a hygienic environment.

Per capita consumer spending is high, which ensures a certain level of retailspending, regardless of the price conscious nature of consumers.

Affluent, but still aspirational consumers ensure a widespread audience forinnovative retail formats and innovative in-store offerings and services.

Weaknesses Strong competition in the MGR sector forces companies to offer almostpermanent discounts, with these costs usually passed onto suppliers.

The market is relatively mature, providing few real opportunities for growth. Hong Kongs geography limits the potential of the profitable hypermarket

sector, which has been the most typical avenue for success by multinationalsin neighbouring Asian markets.

Opportunities Private label products should continue to experience strong growth, withconsumers attracted to their price benefits.

Likewise, discounting is expected to continue to enjoy growth as consumersshed negative perceptions of low prices and instead focus on the improvedvalue on offer.

Consumers in Hong Kong are interested in the value-added services that

retailers are increasingly offering in order to attract more customers; newideas of this nature are likely to prove effective in boosting market share.

Capitalising on emotive consumer concepts such as organic retailing andgreen retailing represents an effective means of building customer loyalty.

Threats Rising operating costs could jeopardise retail margins, with profits alreadysqueezed by the need to offer competitive low prices.

A worse than expected property market slowdown could dampen domesticdemand for higher value food and beverage items.

As investment shifts to the mainland, there is a risk that the development of

Hong Kongs MGR sector will slow and innovation will stagnate, althoughconsumer spending remains attractive enough to ensure that not all retailerscompletely shift focus.


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Business Environment

BMIs Core Global Industry Views

The events of the last quarter have generally continued to support our core short- and long-term views.

The principal exception has been the performance of commodity prices. In June, we suggested that an

easing of commodity prices was likely to continue, thanks to global economic weakness and decent

stocks-to-use ratios in major commodity categories. However, this assessment had to be swiftly revised as

the US suffered its worst drought in 50 years, leading to massive production forecast downgrades for corn

and soybean.

This has led to a spike in prices across all grain categories (see chart). We do not expect further upward

pressure for the rest of the year, but we do expect prices to remain elevated as Southern Hemisphere crops

fail to compensate for crop losses in the Northern Hemisphere. This has already started to have an impact

on margins for food firms and will very likely continue to have an impact on results into 2013, with the

consumer environment across most developed markets still too weak to accommodate major price

increases without a subsequent reduction in volumes.

Spike In Prices

Select Grains Price Rebased (1 June 2012 = 100)

Source: BMI, Bloomberg


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Emerging Market Expansion

To offset developed market weakness, major food firms have been investing in emerging market assets,

and this trend featured heavily again during the last quarter. In general, US firms lag behind their

European counterparts with respect to emerging market exposure, and it is notable that in recent months,

US firms have been doing much of the running in an effort to close this gap.

US confectionery producer Hersheyhas announced that it is to take full control of its Indian operations

by buying out its joint venture partners. The firm will purchase the 43% stake in Godrej

Hershey,currently owned by local firm Godrej Industries,along with a 6% stake from a number of

smaller shareholders. The move follows speculation that Hershey was looking to restructure the business

to take greater advantage of the dynamic Indian market that the joint venture failed to fully exploit.

Hershey's decision to instead to buy out its joint venture partners suggests that the firm will use the

existing business as a platform to kick-start the distribution of its own brands. It may also see potential in

confectionery brands Nutrine and Maha Lacto, and beverage brands Jumpin and Sofit, which will be

included in the purchase.

Also in the last quarter, US-based spice and seasonings producer McCormick & Coagreed to buy

Chinese firm Wuhan Asia-Pacific Condiments(WAPC) for CNY900mn (US$141.5mn). In 2011,

McCormick announced its target to generate 12% of its revenue from emerging markets by 2015, which

compares with 9% currently, and to achieve this aim, the firm has recently stepped up its focus on

acquisitions. WAPC is focused on making chicken stock/bouillon and owns the DaQiao and

ChuShiLe brands, which have a strong position in central China. The firm has annual sales of

CNY730mn and registered sales growth of 25% on average between 2007 and 2011, highlighting the

attractiveness of the seasonings sector in China and across other emerging markets.

Meanwhile, US food giant General Millshas said that it is looking for acquisitions in India to cement its

exposure to the world's most attractive emerging markets. In an interview with the Financial Times, the

firm's CFO suggested that exposure to the Indian market would complement its strong growth in China

and improved position in Brazil following the acquisition this year of Yoki.

BMIhas regularly suggested that Campbell Soup Company's portfolio is currently poorly suited to

growth in emerging markets, as home-made soup is a cheap staple in many of these markets, and canned

soup has therefore been poorly received. This assertion now seems to be increasingly recognised by the

company, with the firm announcing that it would focus resources on its baking and snacking unit, and the

firm's CEO stating in an interview with the Wall Street Journal that it was eyeing acquisitions to boost

this part of the business. This would follow the footsteps of Kellogg, which has found cereal a relatively

tough sell in some of the most attractive emerging markets and has recently focused on the salty snack

category, most notably with the acquisition of Pringles.


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US Food Firms Lag Behind

Revenues From Emerging Markets (%)

Source: BMI, Nestl, Investor relations

Deals emanating from Europe have meanwhile been focused in the alcoholic drinks segment. Heineken

looks set to seal full control of Asia Pacific Breweries(APB) after reaching an agreement with ThaiBev

and its partner TCC Assets(both linked to Thai billionaire Charoen Sirivadhanabhakdi), which had

launched a cash bid for full control of Singapore conglomerate Fraser and Neave, which owns a

substantial stake in APB. The acquisition will give Heineken improved access to a large number of high-

growth markets including Thailand, Cambodia, Vietnam and Indonesia, putting the firm in a much

stronger position to develop its Asian business.

Also over the last quarter, Italian spirits group Campariannounced the acquisition of Jamaican rum

producer Lascelles DeMercadoin a deal worth up to US$415mn. Campari will pay US$338mn to

acquire the 81% stake owned by CL Financialand will make a public tender offer for the remaining

shares. The deal gives the firm exposure to the buoyant rum category and affords the firm two of the

strongest rum brands in the Caribbean: Appleton and Wray & Nephew. The move continues Campari's

strategy of buying neglected brands that it can bolster with its strong distribution system and marketing

expertise.

Diageois another firm growing quickly in emerging markets, but this growth is actually spurring

investments in the UK, with the firm announcing plans to invest GBP1bn in its Scotch whisky production

facilities. The move comes at a time when whisky export volumes have returned to growth, with


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voracious demand in emerging markets now looking sufficient to offset any weakness in developed

markets.

With export demand now growing at breakneck speed and finally offering up true scale, BMIexpects

widespread investment in the industry to resume, with Diageo's announcement likely to be followed by

further investment from all of the major players as they seek to develop capacity to meet the demands of

middle-class consumers across emerging markets.

Frontier Markets Increasingly Attractive

One of our core views is that multinationals will increasingly pursue frontier market investments as

opportunities in the traditional emerging markets become more scarce and competition increases. Over

the last quarter, this trend was exemplified by PepsiCoand The Coca-Cola Company, both announcing

plans to re-enter Myanmar. The untapped potential of Myanmar's consumer sector is also increasingly

attracting the sights of regional consumer goods investors, with Lawsonand Singharecently flagging up

expansion plans for the country. For Coca-Cola and Pepsi, Myanmar's youthful population and currently

low soft drink consumption levels are likely to translate into a lot of room for growth. The fact that these

two firms are among the first Western companies to make concrete plans for expansion demonstrates how

important first-move advantage is perceived to be within the soft drink sector.

Developed Market Consolidation

Within developed markets, consolidation has been relatively low on the agenda in 2012, with most firms

keen to expand their emerging market exposure instead. However, two notable deals have come to light

over the past three months. UK-based soft drink producers Britvicand AG Barrhave revealed that they

are holding merger discussions. This looks like a logical deal, with Britvic's Robinson's and PepsiCo

bottling franchise nicely complementing AG Barr's Irn-Bru and Rubicon brands. We have long suggested

that AG Barr looked like a potential takeover target given its attractive brands and strong growth.

However, the proposed deal would actually see AG Barr's CEO take the helm of the enlarged company,

reflecting AG Barr's strong performance and Britvic's recent weakness.

Meanwhile, Norwegian conglomerate Orklais to buy local food producer Rieber & Snin a deal worth

NKR6.1bn (US$1bn). The price represents a 78% premium on Rieber's closing share price ahead of the

announcement, and the substantial premium can be linked to Orkla's strong desire to reshape itself as a

fast-moving consumer goods firm with the scale to compete with industry majors such as Unileverand

Nestl. Orkla and Rieber have a strong geographical overlap across the Nordic region and emerging

Europe, but limited overlap within their product portfolio, which is likely to help the deal to gain approval

from Norway's antitrust authorities. With its heritage as a conglomerate, Orkla has interests in areas such

as power generation and aluminium production, and the firm is expected to continue to divest these assets


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and use the proceeds to bolster its food and drink operations. Given the firm's exposure to mature markets

in the Nordics, we would expect further acquisitions to be centred on emerging Europe, with deals such as

the 2010 acquisition of Estonian confectionery maker Kalev Chocolate Factoryserving as an example.

Emerging Markets Buying Developed

Last quarter, we outlined the increased trend for emerging market-based firms to acquire developed

market assets, and this has continued. Chinese soft drink firm Wahahahas emerged as a surprise front

runner in the battle to acquire the snack unit of United Biscuits, which controls brands such as Hula

Hoops and KP Nuts and has been put up for sale by its private equity owners. An acquisition would boost

Wahaha's portfolio of foreign brands in the Chinese market as well as help to diversify the firm's

geographic spread by providing access to high-spending European markets.

Meanwhile, state-owned Chinese food producer Bright Food announced plans to acquire a 70% stake in

Bordeaux wine exporter Diva, which generates 45% of its sales in China and 60% in Asian markets, to

gain a foothold in the wine sector. The acquisition forms part of its broader ambitions of building a

diversified portfolio, with the firm having previously acquired a 60% stake in UK breakfast cereal

Weetabix,along with food firms in Australia and New Zealand.

All Eyes On Indian Retail

In the retail sector, all the focus has been on Asia, in particular, India. In what may be in time

remembered as the most significant global retail event of 2012, India looks set to finally open up its retail

industry to foreign investors, potentially paving the way for global retailers Carrefour, Tescoand

Walmartto enter what is possibly an outstanding retail opportunity. Until now, India has stubbornly

stuck to its guns in refusing to allow foreign retailers to own controlling interests in domestic retailers.

This was perceived to be a protectionist stance benefiting the plethora of small kiosks that dominate the

retail landscape across most Indian states. The new legislation will allow foreign retailers to acquire 51%

controlling stakes in Indian retailers, and the policy reforms come at a time when the Indian economy is

facing its most testing period for a number of years, with economic growth slowing down markedly. That

said, retailers will still have to find willing states in India, as the government is allowing individual states

to decide whether to allow foreign retailers in.

The new legislation has been met very favourably by the pro-business lobby, and shares in some of

India's leading retailers, including Pantaloon Retailand Shoppers Stop, rose substantially when the new

policy measures were announced on the expectation that they may now be seen as key acquisition targets

for major Western firms.


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Outside of India, the news emanating from the Asian retail sector has been more mixed. Carrefour has

announced plans to exit Singapore, with the firm revealing it will close its two existing hypermarket

outlets by the end of 2012. The move comes after the firm failed to sell the business and continues the

firm's process of removing itself from Asian markets, in which it is not likely to become one of the top

three largest players.

The move to exit Singapore comes after the firm also exited Thailand in late 2010 by offloading its retail

stores to French mass grocery retail player Casino Guichard-Perrachon. The firm is also present in

Malaysia, having 24 stores in the country generating sales of around EUR405mn (US$559mn). Here the

firm has also failed to secure one of the top three market spots, and in 2010, put the assets up for sale, in

combination with its Singapore holdings (the two countries are geographically close and have cultural

ties). The sale process was subsequently discontinued after assets failed to achieve the expected bids.

However, the decision to exit Singapore suggests that a decision to exit Malaysia may soon also be

forthcoming.

China is also proving challenging. A drop in profits at Chinese retailer Lianhua, combined with Tesco's

announcement that it is to shut four stores in the country, highlights the difficult state of the underlying

market, which has high levels of competition and weakening demand. Tesco announced it is to shut four

of its current hypermarkets, with a spokesperson stating that it was taking 'a more cautious approach to

our capital investment in the market'. The stores to be shut are in the country's second- and third-tier

cities, suggesting that the firm's store format is not well adjusted to less well-developed parts of the

country, where local supermarkets have established a loyal base. In its latest quarter, Tesco reported like-

for-like sales growth of just 0.6% in China, and this is clearly a long way off the dynamic growth levels

that would be expected of such a promising consumer market.

As well as shutting these four outlets, Tesco has previously scaled back its expansion plans for China and

now intends to open only 15-20 new hypermarkets a year. The firm's flagship 'Lifespace' shopping malls

have proven to be difficult to execute, and the firm now operates just eight, making it very unlikely that it

will come anywhere close to its target of 50 by February 2016. Tesco is not alone in finding China hard

going. Over the last two years, Carrefour has closed a number of underperforming stores and has alsoreined in its pace of expansion. Walmartis also witnessing slower customer traffic and has struggled to

maintain control of standards under its franchise operating structure a position that has seen the firm

face a number of regulatory complaints and has damaged its reputation.


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The Power Of Innovation

Nespresso Sales Growth

Source: Investor relations

Protecting Innovations Becoming More Crucial

Another of our core long-term views is that investment in innovation will increase as producers seek

differentiation, and that emphasis will be placed on protecting innovations. The actions of Nestl over the

last quarter have clearly demonstrated this trend. In June, the firm inaugurated a new clinical development

unit in Lausanne, Switzerland that will conduct clinical-style trials to establish the efficacy of its product

innovations in the areas of health and wellness. The move comes after an increase in scrutiny of the

validity of health claims made within the food sector across the EU and North America. BMI has

previously posited that this increased level of scrutiny will actually be beneficial to larger players as they

will have the funding available to conduct the trials that are required to scientifically support the claims

made in the functional sector.

Innovation has also played a key role in the development of the Nestl Nespresso coffee pod system and

has helped make coffee pods the fastest growing part of the coffee industry in Europe. In stronger

economies, it has benefited from consumers trading up from instant coffee (based on taste) and freshly

ground coffee (based on convenience). In weaker economies, such as Italy and Spain, the sector has

benefited from a move away from the on-trade sector, with coffee pods offering a price advantage over

cafes and restaurants despite their premium positioning. However, in August, Nestl was dealt a blow in

its bid to secure exclusivity over its Nespresso coffee pod system in Europe after a German court ruled in

favour of a rival selling unofficial capsules that were compatible with Nestl's Nespresso machine. Nestl


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had sought an injunction against the Ethical Coffee Companyand its distributor Betron, but

Dusseldorf's regional court has rejected the request.

With the Ethical Coffee Company'scapsules selling for around 30% less than Nespresso's officialversions, Nestl faces the prospect of losing its monopoly on the market. Further court cases are ongoing,

including a battle with D.E Master Blenders 1753 (formerly part of Sara Lee) in the Netherlands,

France and Belgium. The CEO of the Ethical Coffee Company suggested that he was not surprised by the

ruling and likened it to developments in the printer industry, with unofficial printer cartridges successfully

challenging the monopoly position of printer makers and now being a ubiquitous part of the market.

Producers Facing Private Label Choice

Another of our core views is that some consumer goods manufacturers will leave sectors under threat

from private labels, while others will calibrate their portfolios toward private labels to capitalise on their

growing demand. This was again in evidence in the last quarter, with US food producer Dolereaching an

agreement with Japanese conglomerate Itochu Corpto sell its global packaged food business and its

Asian fresh produce unit for US$1.7bn. The move will leave the firm focused on fresh produce and is a

move away from the added-value sector. The sale represents a big injection of cash that will bring the

firm's debts down to a much lower level and will put the firm in a much better position to take advantage

of growth opportunities in the currently unfashionable fresh produce category.

Meanwhile, Italy's Barillalooks to be moving in the other direction, with the firm announcing that former

Unilever executive Claudio Colzani is to be the company's new CEO. The move comes shortly after

Barilla revealed it was looking to offload its German bakery business, Lieken. Taken together, these

moves are a signal of the firm's underlying strategy, with a focus on its core consumer brands likely to

take centre stage. Barilla is the world's largest pasta producer, and therefore looks particularly threatened

by the growth in private labels, with pasta proving to be a sector for which the advantages of branded

products are harder to convey. However, with strong brands and a focus on its premium positioning

alongside innovation, we believe Barilla is likely to be able to keep this threat at bay over the longer term.


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Table: Core Views

Short-Term Outlook

The recent spike in commodity prices will put pressure on margins into 2013.

Developed markets will still feel the pinch, with economic weakness and political uncertainty weighing on spending.There are tentative signs of improvement in the US consumer market.

The value theme is still very important across the developed world, with price consciousness inherent.

Long-Term Outlook

Companies with strong emerging market exposure will continue to outperform.

Multinationals will increasingly pursue frontier market investments.

Emerging market-based firms will increasingly pursue developed market investments for the purposes of diversification.

Investment in innovation will increase as producers seek differentiation; emphasis will be placed on protectinginnovations.

Some consumer goods manufacturers will continue to leave sectors under threat from private labels, while others willcalibrate their portfolios toward private labels to capitalise on their growing demand.

Government legislation will play an increasing role in marginalising unhealthy food and beverage products.

Premiumisation will re-emerge as a key driving force behind revenue growth.

Demand for convenience in retail and food will continue to grow.

Functional foods will provide considerable opportunities in developed markets in particular.

Consolidation will continue as producers seek greater efficiencies.

Beverage companies will continue to invest in diversification away from carbonated beverages and into healthier sub-sectors.

Private equity companies will continue to be attracted to unfashionable food and drink categories.

Source: BMI


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Asia Pacific Food & Drink Risk/Reward Ratings

China Outperforms On Impressive Risk/Reward Balance

There have been minimal changes in BMI's Asia Pacific food and drink risk/reward ratings over the past

quarter. China continues to lead our ratings, while the Philippines and Pakistan continue to lag behind the

rest of the pack. In this article, we examine the relative attractiveness of the Asian food and drink markets

from the aspects of both risks and rewards, stressing the importance of striking a balance between risks

and rewards to achieve robust investment appeal.

There are two aspects to our risk/reward analysis: the reward part of the rating takes into account market

size, current consumption levels, future industry growth prospects (based on our five-year industry

forecasts), market fragmentation (with greater fragmentation indicating higher opportunities) and the size

of the youth population. Meanwhile, the risk part of the rating takes into account the legislative

environment, the level of development of the organised retail sector (with higher development leading to

lower risks), as well as relevant aspects of the economic and political environment.


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Table: Food & Drink Risk/Reward Sub-Factor Ratings, Q113 (score out of 10)

Australia

China

HongKon

g

India

Indonesia

Japan

Malaysia

Pakistan

Philippine

s

Singapore

SouthKorea

Taiwan

Thailand

Vietnam

Reward

Food consumption per capita 6 3 10 1 4 10 4 1 2 9 9 10 3 1

Market fragmentation 2 8 2 9 8 1 5 10 5 1 2 2 8 9

Per capita food consumption 5-year compound annual growth 1 7 2 6 5 1 3 4 4 3 5 4 5 5

Population size 4 10 2 10 9 8 4 8 7 2 5 4 6 7

GDP per capita, US$ 10 3 9 2 2 10 4 2 2 10 7 6 3 2

Youth population (%) 3 2 1 6 5 2 6 8 8 2 2 2 3 4

Risk

MGR penetration 8 6 7 1 3 9 6 1 2 7 8 7 6 1

Regulatory environment 7 6 8 3 4 7 7 1 5 9 8 9 7 5

Short-term economic growth 7 8 9 6 7 6 8 5 7 9 9 9 7 6

Income distribution 9 7 9 6 7 9 6 7 6 9 9 9 7 7

Lack of bureaucracy 8 5 8 4 3 8 7 3 4 8 5 7 6 4

Market orientation 7 4 9 4 5 6 7 4 6 8 6 6 7 5

Physical infrastructure 7 6 5 7 5 8 7 6 6 10 7 8 6 7

Source: BMI

India And Pakistan Lead The Pack In Rewards

Intuitively, developed Asia Pacific markets score high on the indicator of food consumption per capita,

with the premiumisation trend particularly well entrenched in markets such as Singapore and Japan.

However, while these countries boast high food and drink spending levels, the relative maturity of their

markets mean that they are viewed less favourably on the indicator of market fragmentationand per

capita food consumption, five-year compound annual growth. Pakistan, India and Vietnam are among

the most fragmented markets in the Asia Pacific region, which means there remains tremendous room for

growth in the longer term. Although Pakistan, India and Vietnam are home to established, risk-averse

food and drink players such as The Coca-Cola Companyand Nestl, the fragmented and massive size of

these markets is likely to provide relative ease of entry for regional consumer-facing companies.

Comparatively, in markets such as China, Thailand and Indonesia, the rapid emergence of competition


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serves as a stronger headwind for potential market entrants. Not surprisingly, it is the underdeveloped

markets that score high on the indicator of per capita food consumption growth.

The indicators of youth populationand population sizeassess the attractiveness of the Asia Pacific

markets from a demographic perspective. A massive population offers greater scope for organic growth

for food and drink companies, which partly explains the increasing flurry of investments in China and

India in recent years. Meanwhile, a youthful population generally translates into exciting opportunities in

the mass-market segment. Philippines and Pakistan are perceived favourably on this front.

The final factor in the reward part of the table is GDP per capita. This metric is similar to the indicator

of food consumption per capita, as both assess the markets appeal in terms of consumer spending power.

Similarly, developed countries score well on the indicator of GDP per capita, with Singapore, Japan and

Australia leading the pack.

Singapore Performs Most Strongly In Risks

On the risks side, factors such as mass grocery retail (MGR) penetration, regulatory environment, short-

term economic growth, income distribution, lack of bureaucracy, market orientation and physical

infrastructure combine to assess the structural challenges present in respective markets.

MGR penetrationmeasures the maturity of the organised retail market in terms of food retailing. A high

MGR penetration score reflects better routes to market and more developed retail distribution networks,

which eases the distribution of goods to the end-consumer. Japan, Australia and South Korea are ahead of

the curve in terms of organised retail development. The concept of modern retailing has quickly diffused

in markets such as Australia, Japan, Hong Kong, Singapore and South Korea, and this can be linked to

rapid urbanisation and continued expansion of affluent consumer bases in these economies over the past

decades. Elsewhere in emerging markets (EMs), the development of the MGR sector continues to be held

back by restrictive regulations and income inequalities. The lack of established formal food retailing

systems in EMs such as India, Vietnam and Pakistan complicates distribution efforts for food and drink

companies and remains a major hurdle for potential investors.

The second factor, regulatory environment, evaluates the impact of regulatory hurdles such as foreign

direct investment (FDI) regulations and restrictive sub-sector legislation on the expansion efforts of

consumer-facing companies. Countries such as Pakistan, India and Indonesia remain plagued by

investment risks such as heavy bureaucracy and red tape, which deter less hardy investors from setting up

shop in these markets. While consumer goods investors typically face greater regulatory hurdles in

developing markets, government regulations continue to play a prominent role in shaping the developed

food and drink markets as well. In South Korea, for instance, the government passed a bill in November

2010 mandating that supermarkets could not open within 500m of traditional markets and family-run


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stores without seeking approval from local authorities and small-business associations. This cordon was

subsequently widened to 1km in July.

The third factor, short-term economic risk rating, assesses the degree to which the country

approximates the ideal of non-inflationary growth with falling unemployment, contained fiscal and

external deficits and manageable debt ratios. On this front, we caution that growing headwinds are piling

on the near-term horizons for Asia Pacific food and drink markets due to economic uncertainties in the

US, eurozone debt woes and a Chinese hard landing.

Income distribution, which is another risk factor taken into consideration, is measured by the proportion

of private consumption accounted for by the middle 60% of earners. High levels of income inequality are

pervasive in developing markets, which warrant them as tricky places to do business as consumer goods

investors often have to plough in more marketing and advertising expenditures to encourage consumer

uptrading. India, Malaysia and the Philippines do not compare as favourably as their peers in this regard.

The fifth factor, lack of bureaucracy, is a measure of the hurdles that any producer is likely to face in

areas such as starting and closing businesses, paying taxes, dealing with licences, and registering

property. Bureaucracy is viewed as a major problem in countries such as Indonesia, India, Pakistan,

Philippines and Vietnam.

Market orientationis a measure of how business oriented an economy is and measures the level of FDI

protectionism, tax rates and the level of government intervention. India, China and Pakistan are judged

most negatively on this front, posing considerable challenges to consumer goods investors.

The last factor, physical infrastructure, underlines the nature of the transport and distribution

infrastructure. The lack of well-developed physical infrastructure in EMs such as Indonesia, Pakistan,

Thailand and the Philippines continues to frustrate distribution efforts for consumer goods companies,

particularly in rural areas. In these markets, food and drink players have to invest substantially in

developing their own distribution infrastructure to successfully entrench themselves and build brand

awareness. Without a doubt, developed markets are viewed favourably on the indicator of physical

infrastructure, with well-developed routes to market facilitating expansions of consumer-facing players.


27/100


Risk/Reward Balance Counts The Most

China, Pakistan & Philippines Risk/Reward Ratings Breakdown

Scores out of 100, 100 being the highest. Source: BMI

While EMs generally score well on the aspect of investment rewards, and developed markets score highly

in terms of investment risks, it is the balance of risks and rewards that matters the most. Thanks to its

impressive balance of strong rewards and risks, China remains a regional outperformer. Lacking a healthy

balance between risks and rewards, Pakistan and the Philippines remain stuck at the bottom of the pile.

Table: Asia Pacific Food & Drink Risk/Reward Ratings, Q113

IndustryRewards

CountryRewards Rewards

IndustryRisks

CountryRisks Risks

OverallScore Rank

China 66 52 59 60 60 60 59.4 1

Japan 28 63 45.7 80 74 77 58.2 2

South Korea 46 44 45.2 80 72 75.9 57.5 3Singapore 34 41 37.7 80 88 84 56.2 4

Thailand 58 41 49.5 65 67 65.9 56.1 5

Taiwan 44 38 41 80 77 78.3 55.9 6

Australia 32 52 42.2 75 76 75.5 55.5 7

Indonesia 60 57 58.3 35 55 44.8 52.9 8

India 62 64 63 20 55 37.3 52.7 9

Malaysia 40 47 43.7 65 67 66.1 52.6 10

Hong Kong

36

35

35.5

75

77

76

51.7

11


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Table: Asia Pacific Food & Drink Risk/Reward Ratings, Q113

IndustryRewards

CountryRewards Rewards

IndustryRisks

CountryRisks Risks

OverallScore Rank

Vietnam 58 46 41.8 35 56 45.6 49.3 12

Philippines 40 60 50.2 35 58 46.5 48.7 13

Pakistan 58 64 61 10 49 29.7 48.5 14

Source: BMI, The Food & Drink Risk/Reward Rating is the principal rating. It comprises two sub-ratings, 'reward' and'risk', which have a 60% and 40% weighting respectively.

Hong Kongs Food & Drink Risk/Reward Rating

Hong Kong remains placed towards the bottom of our latest risk/reward ratings for the Asia Pacific

region, ranking only above Vietnam, Philippines and Pakistan in terms of its longer-term commercial

potential for food and drink companies. A fairly uninspiring growth outlook is insufficient to offset the

appeal of a favourable investment climate, thus placing downwards pressure on Hong Kongs overall

risk/reward score.

In BMIs improved risk/reward ratings, we use indicators such as market fragmentation and youth

population to better assess the potential scope for growth across the Asian Pacific food and drink markets.

Not surprisingly, Hong Kong scores low on these growth-oriented indicators, implying limited growth

opportunities in the market. The Hong Kong food and drink market is considerably mature and

consolidated, and the presence of strong incumbents in its sub-sectors means that multinationals have

found it difficult to make any meaningful headway in the market. Moreover, Hong Kong has a small and

ageing population, and this demographic characteristic clearly would not appeal strongly to growth-

oriented consumer facing players.

Although Hong Kong has a reasonably conducive investment climate, this was not sufficient to offset the

limited prospects for growth in the market, which explains its lowly position among its Asian Pacific

peers. In terms of investment risks, Hong Kong scores relatively high in the aspect of industry and

country risks. On the aspect of industry risks, Hong Kong already has a relatively well-developed food

retailing sector, which makes it easier for consumer goods manufacturers to distribute their products to

the end-consumer market and facilitate the awareness of their brands. Hong Kong is also relatively

receptive to foreign investments, as illustrated by its score of 8 on the aspect of regulatory environment,

which is another positive supporting its investment appeal.


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Meanwhile, Hong Kong scores well in terms of country risks thanks to its sturdy macroeconomic

fundamentals, low bureaucracy levels, low income inequalities and well-established physical

infrastructure. With well-connected transport systems across Hong Kong, investors need not plough in

substantial capital expenditures to build up their own distribution networks in the country.


30/100


Macroeconomic Outlook

Property: Scope For Upside, But Corrective Pressures Mount

BMI View: While the recent leg-up in prices runs against our call for a correction in the real estate

market, we are not abandoning our bearish take on the market. Prices have become even more

overstretched. We are not discounting a further marginal near-term upside in prices, as investors ride on

bullish sentiment from the equity markets, as well as the third round of quantitative easing. That said, we

believe that receding demand, stemming from further economic deterioration and the government's

tightening measures, coupled with the anticipation of a meaningful increase in the housing supply in the

coming years, will combine to enforce a correction in property prices in 2013.

Since the trough it hit in 2008, Hong Kong's property prices have surged more than 95%. The rapid rise in

prices has been the subject of much popular discontent and the topic of housing affordability has

increasingly become a social and political issue. A 4.5% fall in private property prices in the latter half of

2011 proved to be transitory as prices have now increased almost 14% since the start of 2012. The surge

in prices has been contrary to our call for a correction; property prices are even more overvalued and due

a correction. While we see scope for a marginal rise in prices, this trend is likely to be unsustainable and

we maintain our view of a correction within the real estate market over the coming quarters.

Marginal Near-Term Upside:A considerable portion of the surge in property prices has been

underpinned by foreign investors and wealthy locals, particularly investors from mainland China. This

group of investors has been participating heavily in the luxury and higher-end homes, which, have in turn

been driving up broader market prices. Chinese buyers were estimated to account for an estimated 51% of

home transactions in Q311 and have reportedly commanded more than a 30% share of property

transactions in recent months. The optimism in the housing market has also been reflected in the equity

markets, with the Hang Seng Property Index having soared more than 50% since the bottom it hit in 2011.

In our view, the third round of quantitative easing could possibly drive more bullish sentiment, as

investors harbour expectations of a sustained period of abundance in liquidity and a low interest rate

environment.

But Corrective Pressure To Win Out Eventually:Looking ahead, against a backdrop of extreme

valuations, the city's property market continues to face considerable corrective pressures, with the most

crucial being that of further economic deterioration. With Hong Kong's entrepot economy closely tied to a

weakening global, and more crucially Chinese economy, we do not envision an improvement in Hong

Kong's growth prospects. Local homebuyers are consequently likely to maintain a level of cautiousness.

The global economic slide is also expected to stem, to a certain extent, interest from Chinese buyers. The

new government administration also appears to be making meaningful efforts to curb the rise in property

prices. The most recent set of measures saw the government tightening mortgage lending, as well as

attempting to limit the influx of foreign buyers. Loan tenors across the board were reduced to a maximum


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of 30 years from 40 years previously. Homebuyers taking a second mortgage onwards will face a higher

down payment requirement, while buyers with incomes that originate from outside Hong Kong will be

subjected to the applicable down payment requirements, plus an additional 10 percentage points (pp).

Alongside the downside pressure on demand, supply-side issues support our contention for a property

correction. The most recent policy measures saw the government announcing plans to rezone 36 sites

meant for public use into use for residential purposes, as well as expediting the approval of permits for

private home sales. This comes on the back of a pledge by the Chief Executive to speed up home sales

and the supply of land. The scaling back in demand owing to economic deterioration, supplemented by an

increase in housing supply, would combine to lead prices lower. Additionally, we remain unconvinced by

the false sense of comfort investors may find in the abundance in liquidity as we cannot discount a

tightening in bank lending when the downturn starts to kick in.

Upside Risk Stemming From Prioritising Local Buyers:Under the Hong Kong Land For Hong Kong

People policy, sales of certain properties will be restricted to only Hong Kong citizens. While this

measure may help curb social discontent and improve home ownership, we highlight that such a policy, if

mismanaged, may have the unintended consequences of pushing property prices even higher. If the

government fails to increase supply adequately to the broader range of investors, and places too much

focus on local buyers, the pool of investable property available to all investors would be constricted,

potentially leading prices higher.

With these factors in mind, we have seen fit to downgrade our forecasts for Hong Kong's real GDP

growth. We now see 2012 growth in the city slowing from a previous estimate of 2.2% to 1.6%. This

remains below consensus' projection of 2.5% and close to the midpoint of the government's recently

revised forecast range of 1.0% to 2.0%. Our 2013 forecasts have also been revised downward to 2.5%

from a previous estimate of 3.5%.

Private Consumption

The expected slowdown in Hong Kong's consumption story is starting to kick into full force. Retails

sales, in terms of both value and consumption, are now printing single-digit growth figures, down sharply

from a average 22.0% over 2010 and 2011. Much of the slowdown can be attributed to the tightening of

mainland Chinese shoppers' purse strings. Retail sales during the festive Golden Week are projected to

witness double-digit declines, according to the Hong Kong Retail Management Association. The

retrenchment in spending comes even amid a rise in mainland tourist arrivals. We expect the falling trend

in consumption spending to maintain course for the rest of 2012 and extend into 2013 as recessionary

pressures continue to mount and an expected uptick in unemployment starts to materialise. The expected

property correction (as explained above) is also expected to significantly curb consumption spending. For

these reasons, we are forecasting private consumption to grow 4.5% 2012, before slowing to 3.0% next

3.0% in 2013, contributing 2.8pp and 1.9pp respectively.


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Government Consumption

In light of continued weakness in the economy, as well as an expected correction in property prices, we

expect the government to once again embark on another round of budgetary expansion in 2013. We have

yet to witness any signs of a turnaround in the Chief Executive's popularity ratings and we expect this to

also be an added factor when budget plans are announced in 2013. Alongside our anticipation for a

further rise in welfare expenditures, we expect broader public consumption to also receive a boost,

growing from a forecasted 2.5% in 2012, to 3.0% in 2013. This would imply a 0.2pp contribution to

headline expansion in both years.

Investment

Investment activity 2012 has been well supported by public sector infrastructure expenditure. Looking

into 2013, however, we are unlikely to see a similar occurrence transpire. While it may be reasonable to

expect another boost in public infrastructure spending, against the backdrop of subdued economic

activity, we do not envisage public sector investments of a similar magnitude in 2013. We are of the view

that public funds are more likely to be directed towards welfare expenditure, than public infrastructure

spending. On the flip side, investment activity could find supportive pressure from the government's

pledge to increase land supply, thereby boosting construction activity. On aggregate, we expect

investment growth to slow in 2013, growing 3.0% compared to a forecasted 6.0% in 2012, which would

equate to a 0.6pp and 1.2pp contribution to real GDP growth.

Net Exports

With China accounting for more than half of the city's exports, any hope of a V-shaped recovery in Hong

Kong's dismal trade performance thus far rests on the mainland. However, given that we harbour

expectations for continued weakness in China's economy, a strong pick-up in Hong Kong's trade activity

is an unlikely scenario. In that we envision a stabilisation in global economic momentum in 2013, we

expect a marginal recovery in external demand to provide supportive pressure for the city's exporters. We

expect exports to recover from a 0.5% contraction in 2012 to 3.7% in 2013, as import growth accelerates

from 0.6% to 4.0%. The outpacing of imports over exports should see net exports shave 0.4% off real

GDP growth.

Table: Economic Activity

2011 2012f 2013f 2014f 2015f 2016f

Nominal GDP, HKDbn 2 1,925.3 2,039.1 2,163.3 2,295.8 2,424.0 2,560.5

Nominal GDP, US$bn 2 247.3 262.3 278.4 295.5 312.0 329.5

Real GDP growth, %change y-o-y 1,2 5.0 1.8 2.5 3.6 3.6 3.7

GDP per capita, US$ 2 34,728 36,453 38,273 40,182 41,979 43,891


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Table: Economic Activity

2011 2012f 2013f 2014f 2015f 2016f

Population, mn 3 7.1 7.2 7.3 7.4 7.4 7.5

Industrial productionindex, % y-o-y, ave 2 -1.0 1.2 1.5 1.5 1.5 1.0

Unemployment, % oflabour force, eop 2 3.4 3.9 3.8 3.8 3.8 3.8

Notes: e BMI estimates. f BMI forecasts. 1 Base year: 2008. Sources: 2 Census and StatisticsDepartment/BMI; 3 World Bank/UN/BMI.


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Industry Forecast Scenario

Consumer Outlook

Domestic Demand Cooling In The Near Term

Hong Kong is one of Asia Pacific's smallest consumer markets, with its population standing at just over

the 7mn mark. Therefore, from a demographic standpoint, there are few attractions for consumer industry

investors.

Indeed, over the longer term, Hong Kongs small population limits the potential consumer base. This

factor is compounded by the fact that the country has a steadily ageing population, meaning that Hong

Kong is unable to entice investors by offering a youthful consumer pool that is typically more active in

terms of purchasing non-essential and higher-value consumer goods.

In the shorter term, we have a slightly bearish outlook on the Hong Kong consumer. A reversal in Hong

Kong's booming property market will inevitably weigh on consumer purchasing power and curtail

spending on higher value consumer goods. Global headwinds are also likely to weigh on Hong Kong's

export-oriented economy, with negative spillover effects on the labour market. These dynamics are likely

to take their toll on the Hong Kong consumer, although we acknowledge that waning inflationary

pressures should help lend some upward support to domestic demand.

Residential property prices in Hong Kong are significantly over-extended and core view calls for a

correction in property prices in 2013. In fact, as expected, prices have begun to fall. Additionally, we

foresee that an expected rise in social welfare expenditure is also likely to have some bearing on the

government's fiscal position.


35/100


Property: Half The Pie

Property-Related Contributions To Operating Revenues

Source: BMI, Hong Kong Treasury

In the meantime, Hong Kong's trade prospects look increasingly bleak, which will weigh on GDP growth.

The export sector saw a marked deterioration in Q312 and we expect this downward trajectory to extend

into the fourth quarter as the performance in forward looking electronics and machinery sectors continues

to disappoint. Looking ahead into 2013, while we could possibly see a stabilisation in economic

momentum, we do not envision a strong recovery in the Hong Kong's exports given our expectations of

continued economic weakness on the mainland, the city's largest source market.


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No Respite In Sight

HKTDC Export Index

Source: BMI, HKTDC

Meanwhile, food inflation, which has been a major driver behind overall inflation in Hong Kong, is

showing signs of peaking as well. Given that the global agriculture market remains better supplied than it

was during the 2008 food crisis, implying lower risks of food price inflation occurring as a result of

supply shortages, we believe global food prices will continue to be moderate in the coming months,

further alleviating inflationary pressures in Hong Kong.

Nevertheless, while investment by Hong Kong consumer-facing players and especially by multinationals

has switched to neighbouring China, which presents much more exciting prospects, Hong Kong thanks

to its high food spending levels still represents a very important sales and profit centre for consumer

investors. A strong scope for premiumisation growth means that it remains worthy for firms already

present in Hong Kong to maintain their domestic footprint, balancing it against their Chinese ambitions,

rather than focusing solely on the mainland.

Labour Market Loosening

The ongoing property market correction is likely to exacerbate the forthcoming weakness in Hong Kong's

economy and, by extension, the employment market. While labour market conditions to date have been

supported by strong trade performance within Hong Kong's export-dependent economy, global headwinds

such as a sharp slowdown in China, a faltering US economy and a sovereign debt crisis in Europe are

increasingly clouding the country's near-term export outlook. These dynamics mean that the export

market may not be able to provide sufficient strength to prop up labour demand in the near term. This,


37/100


coupled with a continued property market correction in Hong Kong, is factored into our wary outlook for

Hong Kong's employment market in the coming quarters.

Risks To Outlook

Political Risks:While we believe Hong Kong will remain at or near the top of our political risk ratings

table over the next decade, a number of risks could lead to rising political instability. The sluggish pace of

democratic reforms will continue to cause anger among pro-democracy supporters, and there is the

potential for large-scale public protests. A lack of affordable housing and rising income inequality also

could pose threats to social stability.

While a high degree of financial stability helps to counterbalance Hong Kong's long-term economic

weaknesses, namely its high dependence on trade and over-reliance on the export of manufactured goods,

Hong Kong is at risk of a larger-than-expected decline in the domestic property market that would result

in a sharp fall in domestic consumer confidence and spending. A sharper-than-anticipated cooling of the

Chinese economy as tighter credit conditions start to take effect could also weigh on domestic consumer

sentiment given the key trading relationship between the two countries.

Nevertheless, the territory benefits from a transparent legal system and highly skilled workforce that have

made the city a major hub for international finance, while the pro-investor climate is augmented by the

absence of red tape, significant corruption or major security threats. However, the city-state still lags

behind regional competitor Singapore, which sits atop the emerging Asia rankings.


38/100


Food

Food Consumption

Total food

consumption forecast

compound annual value

growth to 2017 (local

currency): +2.95%.

Per capita forecast food

consumption

compound annual valuegrowth to 2017 (local

currency): +1.88%.

A correction in the

domestic property market is

likely to weigh on

household purchasing power, and in turn curtail spending on higher value food and beverage

products. An about turn in the Hong Kong property market has been precipitated by the introduction

of a series of cooling measures by the government as well as slowing mainland demand. We are

relatively cautious about the near-term domestic demand outlook for Hong Kong, and currently

pencil in growth of 2.40% in overall food consumption in 2013, compared with 3.61%

Documents

HK food & Drink Report.pdf