Slowing Demand To Weigh On Valuations In The Near Term
We turn conservative on dairy companies’ top-line growth guidance for 2024, as we expect consumption to slow down in the discretionary segment while distributors are lacking enthusiasm in placing orders. We expect modest gross margin expansion, while companies may still achieve net profit margin expansion from disciplined investment and targeted marketing in 2024. Downgrade the dairy sector to MARKET WEIGHT. We switch our top pick to Yili.
WHAT’S NEW
- Yili and Mengniu guided down revenue for 2023. Inner Mongolia Yili Industrial Group (Yili) guided revenue to grow 3-4% yoy for 2023, vs its previous guidance of mid-single digit yoy in Oct 23. By category, Satine (up double-digit yoy) grew faster than basic UHT milk (up single-digit yoy), Ambroisal revenue was down by double digits yoy, while low temperature yoghurt growth turned positive in 2023. Yili’s infant milk powder business improved sequentially in 4Q23, as other smaller brands completed inventory clearance by Oct 23. Revenues of domestic frozen dairy and 2B cheese segments rose by double digits yoy. Similarly, China Mengniu Dairy (Mengniu) reiterated challenges in achieving its organic revenue growth target of mid-single digit yoy. By factoring in Milkground’s consolidation, Mengniu’s revenue growth is likely to reach mid-to-high single digits yoy in 2023, in our view.
- Modest product mix upgrade in 2024. In 2024, both Yili and Mengniu expect revenue to grow faster than in 2023. Specifically, Mengniu aims to focus on both high-end Milk Deluxe and mid-range UHT milk Selected Ranch. Meanwhile, Yili does not expect an aggressive product mix upgrade in 2024. The company’s revenue growth will be mainly driven by higher shipments growth via penetration into lower-tier cities, while the later Chinese New Year gifting season this year (in Feb 24) could help enhance its product structure mix.
- Margin guidance remains unchanged. Yili maintained its organic net profit margin expansion of 30bp for 2023. Meanwhile, Mengniu maintained its 50bp operating profit margin expansion, while also noting that net profit margin will be dragged by one-off impairment loss from associates in 2023. We think companies may still achieve net profit margin expansion in 2024 thanks to: a) a gradual improvement in milk demand, b) slight gross margin expansion, and c) enhanced marketing efficiency – Mengniu expects its sales & marketing expense ratio to either stay flattish or reduce slightly, and Yili aims to lower sales & marketing expense ratio in 2024.
ACTION
- We downgrade the dairy sector to MARKET WEIGHT from OVERWEIGHT. There is a lack of catalysts for the sector and valuation re-rating could be delayed, given the weak liquid milk sales growth and the slower-than-expected turnaround in other categories such as yoghurt, infant milk powder, and cheese. Thus, we downgrade the sector from OVERWEIGHT to MARKET WEIGHT. Nevertheless, companies’ valuations are rather cheap now. Yili currently trades at 13.2x 12-month forward PE, 1.5SD below its historical mean and near to historical low of 12.5x, while Mengniu currently trades at historical low of 10.2x 12-month forward PE, vs its historical mean of 23.4x PE. We switch our top pick to Yili given its: a) high dividend payout ratio, b) lower price points which suit the consumption downtrend, and c) no impairment loss from Ausnutria is expected for 2023.
- Inner Mongolia Yili Industrial Group (600887 CH/BUY/Target: Rmb34.50). Yili’s overall revenue growth acceleration in 2024 will be driven by shipment growth in lower-tier cities and increasing self-drinking consumption scenarios. We expect Yili’s revenue growth to be further bolstered by product innovation, as well as expansion into new consumption scenarios and channels. We stay relatively conservative on its infant milk powder business as we only expect a gradual improvement in the country’s birth rates in 2024. We keep our earnings for 2023 largely unchanged, and cut our 2024 earnings by 2% as we tweak gross margin assumption. We revise our WACC from 11.8% to 12.1%, and we roll over our target price to 2024. Our new target price of Rmb34.50 (vs previous target price of Rmb35.40) implies 20.9x 2024F PE.
- China Mengniu Dairy (2319 HK/BUY/Target: HK$24.10). There could be earnings downward revision for 2024 on additional withholding tax being incurred from a likely higher dividend payment, which is still in discussions by management. Furthermore, we believe investors are concerned on Mengniu’s premiumisation momentum given the signs of consumption downtrading. We cut our 2023 and 2024 earnings by 9% and 5% respectively on lower revenue growth assumption. We revise our WACC from 10.2% to 12.1%, and we roll over our target price to 2024. Our new target price of HK$24.10 (vs previous target price of HK$39.30) implies 15.3x 2024F PE.
- China Feihe (6186 HK/HOLD/Target: HK$4.21) will continue to face a slowdown in revenue as we only expect a gradual rise in birth rates in 2024. We cut our 2023 and 2024 earnings by 6% and 12% respectively as we cut revenue growth assumptions. We revise our WACC from 12.6% to 14.3%, and we roll over our target price to 2024. Our new target price of HK$4.21 (previous target price of HK$5.18) implies 7.2x 2024F PE.
