Mengniu Earnings: Navigated Adverse Operating Environment With Lower Costs and Higher Margins

Narrow-moat China Mengniu 02319 posted first-half 2023 results that beat consensus, with higher gross margin flowing through to operating profit. It attributed gross margin expansion to lower raw milk costs. We think Mengniu’s share gain in liquid milk and smaller exposure to UHT yogurt led to faster growth versus Yili. Mengniu maintained its 2023 guidance of high-single-digit sales growth, including Milkground, and 50 basis points operating margin expansion. While we think the company can deliver the guided top-line growth, we are more cautious on our operating margin assumption as soft consumer sentiment could require higher channel expenses.

Overall, we maintain our fair value estimate at HKD 36.00 per share, which implies 21 times 2023 P/E, similar to Mengniu’s three-year historical average. The share price reacted positively after results, thanks to margin beat and outperformance of liquid milk growth versus Yili. The stock has been trading below our fair value due to investors’ concerns on liquid milk growth. From the earnings briefing, we think Mengniu management has identified the appropriate path to maintain longer-term growth of its core liquid milk segment, which is to expand the premium segment of its Deluxe lineup and the fresh milk business. We think this would be viewed positively by investors and drive share price converging to our fair value, assuming management continues to deliver positive results through executing the above strategies.

In first-half 2023, sales grew 7.1% year on year, broadly in line with our estimates. The liquid milk segment grew 5.0%, outperforming Yili’s. We think the outperformance was due to strong sales of Deluxe and fresh milk as well as smaller mix of UHT yogurt in Mengniu’s portfolio. Mengniu also leveraged its large procurement volume to drive down raw milk costs, translating to 180 basis points expansion in gross margin versus 2022. Operating margin improved by 110 basis points, weighed by higher selling expenses ratio.