Company Reports

Narrow-moat Mengniu reported 2023 results that trailed our expectations across revenue and net profit. Although operating margin expanded by 40 basis points year on year and was consistent with management’s guidance, net profit fell 9%, dragged down by a decline in nonoperating income. We reduced 2024-28 net profit projections by 5%-15% to account for impairment costs of raw milk in 2024 and lower nonoperating income in the next few years. Consequently, we lowered our fair value estimate to HKD 27 per share from HKD 30, which implies 19 times 2024 P/E, 11 times EV/EBITDA, and a 2.3% dividend yield.

Mengniu is the second-largest dairy producer in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller segments. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

We trim our 2023-24 earnings forecasts for wide-moat Yili and narrow-moat Mengniu by 4%-15% as we expect only a mild recovery in China's dairy demand. We project the liquid milk segments of both companies to grow in the low to mid-single digits in 2024, while Mengniu continues to slightly outpace Yili. Although the raw milk price is set to trend lower in 2024 and will benefit margins, this also increases the likelihood of price competition from smaller players.

Mengniu is the second-largest dairy producer in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

Narrow-moat China Mengniu 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.

Mengniu is the second-largest dairy producer in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. The company is leveraging its acquired companies including Yashili and Bellamy to expand its milk powder segment. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

With weaker-than-expected dairy and infant milk formula demand, we lower our 2023 revenue and profit projections for wide-moat Yili and narrow-moat Mengniu ahead of first-half earnings. We think sluggish consumer sentiment will persist for longer, hurting demand for premium liquid milk products. Infant milk formula, or IMF, sales are also set to slow for both companies, due to headwinds from a low birthrate in 2023. Yili has larger exposure to IMF than Mengniu. We think it would be difficult for both companies to reach their full-year profit guidance, given soft consumer confidence and elevated channel spending. Our fair value estimate for Yili slides to CNY 40 from CNY 42, and for Mengniu to HKD 36 from HKD 39.

Mengniu is the second-largest dairy producer in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. The company is leveraging its acquired companies including Yashili and Bellamy to expand its milk powder segment. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

Narrow-moat China Mengniu Dairy reported 2022 results that met Refinitiv consensus and our estimates on the top line and moderately outperformed our expectations on operating margin. But the stock reacted negatively following earnings likely due to the below-consensus top-line guidance for 2023, which may have caused concern about the growth outlook of its liquid milk business. We think there is moderate upside to the company's revenue guidance and its operating margin target should be achievable. As a result, we maintain our fair value estimate at HKD 39 per share and think the shares remain undervalued, with an implied 2023 P/E of 17 times (below historical average of 25 times).

We revised our 2022 forecasts for narrow-moat Mengniu following our discussion with management and the third-quarter results of major competitors. We have lowered our second-half revenue projection for Mengniu mainly due to a slower-than-expected pace of recovery across liquid milk and milk powder segments. But we only reduced our operating profit estimates moderately and still forecast a mid- to high-single-digit increase in operating profit for the second half. We think Mengniu, just like its peers, will face pressure from slowing consumer demand for premium dairy, but its geographical sales distribution and smaller exposure to the UHT yogurt segment should drive near-term outperformance in the bottom line versus Yili. We have reduced our fair value estimate to HKD 39 per share (from HKD 44 per share), primarily due to the recent strength of the Hong Kong dollar against the Chinese yuan. Our fair value implies 22 times 2023 P/E, broadly consistent with the five-year historical average of 24 times.

Mengniu is the second-largest dairy processor in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. The company is leveraging its acquired companies including Yashili and Bellamy to expand its milk powder segment. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

Narrow-moat Mengniu reported mixed first-half results as lockdowns caused muted top-line growth but margin levels fell only moderately year on year thanks to stable raw milk prices. We think Mengniu has appropriately identified top-line growth drivers amid the tough operating environment for liquid milk and milk powder in the first half, while effectively controlling costs to protect margins. We retain our fair value estimate of HKD 44 per share and think share price weakness in the past six months has priced in the unfavorable environment of the first half of 2022. Recovering sales and continued stability in the raw milk price should drive sequentially improving operating margins, serving as near-term catalysts. We still see further upside, and our fair value estimate imply 26 and 23 times 2022 and 2023 P/E. These multiples are slightly lower than our valuation of Yili given our more constructive view on the execution and growth outlook of the latter.

Mengniu is the second-largest dairy processor in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. The company is leveraging its acquired companies including Yashili and Bellamy to expand its milk powder segment. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

Narrow-moat Mengniu reported 2021 revenue that was largely in line with our estimate, but gross margin and net profit margin slightly missed our forecasts. Liquid milk, ice cream, and cheese categories drove top line strength for the year, whereas liquid milk continued to drive profits for Mengniu, more than offsetting losses in milk powder.

The recent acceleration in commodity prices as a result of the Russia-Ukraine conflict has exacerbated the margin pressure on packaged food companies brought about by supply disruptions throughout 2021. Various food and beverage companies in China have engaged in price hikes since the third quarter last year to mitigate margin compression. We continue to highlight Yili as our top pick, with our fair value estimate at CNY 46 per share, as we think the premiumization trend and continued penetration of dairy products in China are unchanged. The raw milk cost curve continued to moderate in early March, which should mitigate margin pressure observed since the second half of 2021. Robust sales reported for January and February at 15% growth year on year also confirm our constructive view. We expect categories with more room to maneuver on premiumization and higher concentration of share to command stronger pricing power and face lower margin pressure in the near term.

We reinitiate coverage of Inner Mongolia Yili Industrial Group, or Yili, and and China Mengniu Dairy, or Mengniu, with updated wide and narrow moat ratings, respectively. Yili is our top pick from the two as it offers the most upside to our valuations. We think Yili’s share price is overshadowed by recent raw milk price hikes but the company’s long-term competitive advantages remain intact in our view.

Mengniu is the second-largest dairy processor in China, with majority of its revenue derived from the liquid milk business, while ice cream and cheese are smaller revenue drivers. The company is leveraging its acquired companies including Yashili and Bellamy to expand its milk powder segment. After management change in 2016, Mengniu has restructured its organization and distribution channel, which in our view has rejuvenated its liquid milk business and resulted in rebounding profit growth. The company’s premium shelf stable milk lineup, Deluxe, has become the number one brand in China since 2020, which we think reflects improving channel execution and effective portfolio construction. Mengniu has currently built out a competitive liquid milk portfolio spanning shelf stable, yogurt and chilled products.

Despite sluggish retail sales in China, liquid milk demand remains robust, with nationwide dairy food production volume rising 11.5% year over year in December, up from a 7.5% growth in November. We expect Mengniu and Yili to also report accelerating revenue growth in the fourth quarter. We think increasing health awareness and an earlier Lunar New Year should help to support milk sales. We lift both our full year 2021 revenue and net profit forecasts for no-moat Mengniu by 3%, to CNY 88.3 million and CNY 4.9 million, respectively, to reflect stronger sales growth, which represents 16.1% revenue growth and 42.2% net profit growth from a year ago. Management targets low-double-digit sales growth in 2022, and a 50 basis point margin expansion on product mix upgrade and improving operating efficiency. This is largely within expectations. We maintain our fair value estimate at HKD 36.00 per share, and we expect the company’s net profit to grow at a CAGR of 24% between 2020 and 2025.

After transferring coverage of China Mengniu Dairy to a new analyst, we maintain our no-moat rating but raise our fair value estimate to HKD 36 per share from HKD 24, on a more upbeat view of the company's long-term growth outlook, following its reforms on sales channels and marketing strategy, as well as product innovation and optimization. We think growing per capita dairy consumption, the recent introduction of the three-child policy, and other favorable policy tailwinds, will bolster the China dairy product industry’s long-term healthy growth. And Mengniu is on the right track to restore its competitiveness, with market share gains and margin improvement over the next five years. Our fair value estimate of HKD 36 implies fiscal-year price/earnings of 25 times, and an enterprise value/EBITDA multiple of 17 times, a free cash flow yield of 2.3% and a dividend yield of 0.9%. These valuation multiples are consistent with the company’s recent historical valuation range between 2017 and 2019. We think the shares are slightly overvalued presently.

Mengniu has been benefiting from China’s dairy food consumption boom, with revenue more than tripling over the past two decades. This was driven by strong growth in room-temperature product ultra-high-temperature milk, or UHT milk. As China’s per capita consumption is still less than half that of Japan and at about a third of the world average, Mengniu should have ample room to grow with secular drivers of per capita consumption growth. Deeper penetration in lower-tier cities and rural areas, and expansion of premium product offerings in higher-tier cities, will be the key growth drivers in the midterm. Mengniu is also actively cultivating and developing new products, such as fresh milk and cheese products, bringing additional growth engines.