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Margin pressure to persist in the coming quarters

  • UPC reported 9M21 profit after tax of Rmb1,489m, down 11.6% yoy, and 3Q21 profit after tax of Rmb641m, up 3.8% yoy, below our expectations because of higher-than expected raw material costs.
  • Management expects raw material costs to start to ease in 2Q22F. We now expect UPC to continue to make a loss in 4Q21F.
  • UPC is considering price hikes for important products and will make a decision in the next two weeks. We need to watch the sales performance and market feedback after the price increases, given the weak macro-economic situation.
  • Reiterate Hold with a new DCF-based TP of HK$6.7.
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Pick-up in the top line but continued pressure on the gross margin

Total sales in 3Q21 grew by the low teens yoy. Beverage sales saw low-teen yoy growth in 3Q21, lower than the 25% yoy growth in 1H21. Food sales picked up, with mid-teen yoy growth in 3Q21 after a 9.5% yoy drop in 1H21. Sales of high-end noodle products with a retail price of over Rmb5 grew by the high teens and contributed about 40% of total noodle sales in 3Q21 vs. 35.6% in 3Q20. 9M21 sales of high-end food product Kai Xiao Zao grew by 50% yoy. Its 3Q21 gross margin was under pressure because the overall price increase for soft commodities pushed up raw material costs. Management said 3Q21 operating
costs declined by single digits yoy. However, we expect the gross margin pressure to continue for the rest of the year and in 1Q22F.

Raw material prices still face headwinds

Raw material prices started to rise in 1H21, stimulated by imported commodities. UPC had some raw material inventory to partially mitigate the impact in 1H21. But the situation worsened in 3Q21, with an overall price hike in commodities that hurt UPC’s gross margin. Palm oil and PET prices increased by 60.0% and 26.5%, respectively, yoy in 3Q21. We now expect UPC to continue to make a loss in 4Q21F and raw material costs to continue to rise in the coming quarters.

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Possible selling prices increase

UPC is considering whether to increase its selling prices. It plans to lower promotion levels for mass market products and is considering increasing the selling prices of its more popular products, such as Kai Xiao Zao and Assam Milk Tea. We need to watch the sales performance and market feedback after the price increases, given the weak macroeconomic situation.

New product pipeline

In 3Q21, UPC launched KNIFE-CHI Daoxiao Noodles, with an ASP of Rmb7, in the food category, and Uni Sugar-free Ice Tea, with an ASP of Rmb3, and Classmate Xiaoming – Mingjituo, with an ASP of Rmb5, in the beverage category. UPC also has carbonated drinks and soda water products in its pipeline.

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Reiterate Hold with a new DCF-based TP of HK$6.7

We cut our forecast by 5.5%, 2.6% and 0.6% for FY21–23, respectively, since we expect the impact of the raw material price hikes to persist in the coming quarters, and we are conservative about the sales performance after the price increases, given the weak macroeconomic situation. Risks include: 1) intensifying market competition, and 2) higher-than expected raw material prices.