China Feihe: Initiating Coverage; Slowing Industry Growth a Concern but Shares Undervalued

We initiate China Feihe 06186 with a narrow moat rating, which we think originates from the company’s premium pricing and entrenched retailer relationship. Our fair value estimate of HKD 7.10 per share implies 11 times 2023 P/E, which is below its three-year average of 14 times and reflects slowing industry growth. We believe Feihe’s moat remains intact despite a potentially lower birthrate in China. Near-term sentiment for the stock could continue to be suppressed as industry headwinds linger. But we think the market may have underappreciated Feihe’s ability, as the market leader, to maintain its margin level as it maneuvers on mix and distribution over the longer term.

We are aware of the challenges for infant milk formula, or IMF, producers amid a declining birthrate. Nevertheless, Feihe’s scalable distribution network and entrenched retailer relationship, conferred by its early entrance and solid track record in product quality, present its competitors with a barrier to scale. Increasing confidence in domestic IMF products following the implementation of the new national standard, as well as market consolidation, would also favor Feihe as a market leader over the longer term.