Results hit by raw material prices and the pandemic

■ UPC reported 1Q22 net profit of Rmb329m, dropping by 12% yoy, below our
expectation, because of raw material price hikes.
■ Market sentiment is negative for raw material price increases in FY22F; UPC chose to
cut promotions to mitigate the raw material price pressure.
■ Although UPC has a satisfactory number of transportation permits, it may still face some
barriers entering towns and counties in lower-tier markets because of different local
pandemic control measures. Management said instant noodle sales were solid in Apr,
but sales of beverages were negatively impacted by the Omicron situation.
■ Reiterate Add with a lower DCF-based TP of HK$7.8.

Raw material price hikes dragged down 1Q22 results

1Q22 revenue increased by high-single digits with double-digit growth in the beverage
segment, driven by juice and tea products, and high-single digit growth in the food
segment, driven by both ASP and volume yoy growth and double-digit sales growth for
noodle products with a retail price of over Rmb5 (accounting 40.9% of segment sales).
UPC’s POS almost doubled yoy in 1Q22 vs. that in FY19 with more POS opened in lower-tier markets. Its 1Q22 gross margin dropped by single-digit ppt because of raw material
price hikes, especially for palm oil, flour and PET, but this was partially offset by single-digit improvement in production utilization. Its selling and marketing expenses ratio
decreased yoy in 1Q22, driving a yoy decline in the overall operating expenses ratio, as
UPC focused on precise advertising investment and cut promotions in the quarter. The
12% yoy net profit drop was attributable mainly to the food segment, as the 1Q22 palm oil
price increased by 43% yoy. But its high-end product Kai Xiao Zao maintained high yoy
pre-tax profit growth in the double digits. 1Q22 net profit for the beverage segment rose by
single digits yoy despite a 20% yoy increase in the PET price.

Cutting promotions to mitigate raw material price pressure

Because of the uncertain international environment and pandemic situation, market
sentiment is negative regarding raw material prices in FY22F. Instead of directly increasing
its ex-factory price, UPC chose to cut promotions to mitigate the raw material price
pressure. UPC implemented some promotion cuts in 1Q22, and depending on market
conditions, expects there to still be room for further cuts in both revenue deductions (e.g.:
buy 100 get 16 free for distributors) and channel promotion expenses. UPC will continue
to work on product mix upgrades, as the main margin drag is its Rmb4 and below instant
noodle products. UPC noted that the price structure in the market is becoming healthier.
UPC also expects to improve the utilization rate to stabilize margins.

Pandemic affecting primarily beverage demand and logistics

Beverage demand and logistics have been more affected by the lockdown policy. UPC has
a food production facility in Jinshan, Shanghai, whose production was not interrupted by
the Shanghai lockdown policy, as it implemented a closed-loop production process. The
major concern lies in logistics. Although UPC has a satisfactory number of transportation
permits, it may still face some barriers entering towns and counties in lower-tier markets,
given the different local pandemic control measures.

Reiterate Add with a lower DCF-based TP of HK$7.8

We reiterate our Add rating for UPC, since its noodle and beverage sales will benefit from
its famous brand name and the continued mix upgrade trend. UPC is trading at 17.36x
FY22F and 14.96x FY23F P/E, at the low end of its 5-year P/E range. Positive catalysts
include: 1) better-than-expected sales, and 2) better control of expenses. Risks include: 1)
intensifying market competition, and 2) higher-than-expected raw material prices.