China Dairy Earnings: Industry Headwinds and Soft Consumer Sentiment Weigh on Earnings

Wide-moat Inner Mongolia Yili 600887 and narrow-moat China Feihe posted interim results that were broadly in line with our estimates. Sales growth for both was hurt by soft demand in the infant milk formula, or IMF, sector, due to low birthrates and inventory clearance of products under the old national standards. This is consistent with earlier results revealed by a2 Milk Company. Yili and Feihe management teams are optimistic about the second-half trend. Feihe said its excess inventory was mostly cleared in the first half, while Yili updated its full-year top-line and net margin guidance to mid-single-digit growth and 30 basis points of improvement, respectively. Top-line guidance is consistent with our estimates, but we continue to see difficulty in reaching the guided margin.

We retain our fair value estimates, which imply 25 times 2023 price/earnings for Yili and 12 times for Feihe. Both shares are undervalued versus our fair values. Feihe’s stock reacted positively after management laid out the plan to digitalize its distribution and pledged to increase its dividend payout ratio in the next few years. We think Yili’s share price could continue to be suppressed in the near term as the growth outlook for liquid milk demand remains uncertain amid soft consumer sentiment. Plus, we have yet to see any material moves by the company to reignite demand.