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China Mengniu Dairy Long-Term Expectation Prevails in Bull Market

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China Mengniu Dairy Long-Term Expectation Prevails in Bull Market Equity Research February 8, 2018 China Mengniu Dairy Long-term expectation prevails in bull market Results Preview Maintain BUY Near-term earnings could be a miss Ticker 02319.HK We expect Mengniu’s core earnings (Mengniu + Yashili) will shrink CICC investment rating BUY from Rmb1.48bn in 1H to Rmb1.15bn in 2H due to cost inflation and Last close HK$23.85 an increased SG&A/sales ratio HoH despite accelerated top line CICC target HK$25.92 growth and narrowed losses from Yashili (est. at Rmb34mn vs. 52wk price range HK$27.25–14.11 Rmb122mn in 1H) in 2H. CMD losses also trimmed in 2H but cannot Market cap (bn) HK$94 offset the decline of Mengniu’s accounting profit HoH. We thus Daily value (mn) HK$388.61 expect full year earnings may come in at Rmb2.1bn on the back of Shares outstanding (mn) 3,927 10% top line growth, 15.3% below market consensus and 12.8% Free float (%) 100 below our earlier expectation. Dividend payout ratio may stay at the Daily volume (mn sh) 15.37 guided range of 20–25% although free operating cash flow can Business sector Food & Beverages suggest a maximum of 70% to indicate possible M&A opportunities. 02319.HK HSCEI 188 Trends to watch 166 ► Earnings miss could be dragged by mild cost inflation, a resilient expense ratio and weaker-than-expected return from both 144 Yashili and CMD. 122 Relative Value (%) Value Relative 100 ► Long-term outlook remains unchanged as top line growth is 78 accelerating while a product-driven growth strategy has been Feb-2017 May-2017 Aug-2017 Nov-2017 Feb-2018 working effectively. ► Long-term expectations may prevail in the bull market despite a (Rmb mn) 2016A 2017E 2018E 2019E possible miss in near-term earnings. Revenue 53,779 59,366 64,644 70,536 (+/-) 9.7% 10.4% 8.9% 9.1% Valuation and recommendation Net profit -751 2,072 3,159 3,811 (+/-) -131.7% N.M. 52.5% 20.6% We cut our FY17 & FY18 earnings forecasts by 12.8% and 6.9% while lifting our sales expectations by 2.2% and 3.1% to reflect a stronger EPS -0.19 0.53 0.80 0.97 top line momentum vs. a slower pace of margin uptrend. We believe BPS 5.31 5.75 6.43 7.21 DPS 0.09 0.13 0.18 0.22 Mengniu’s product-driven strategy may still be able to maintain both top line rally and a margin uptrend in the long run. We thus raise the CPS 1.15 1.23 1.39 1.51 long-term growth expectation in our DCF model and raise our P/E N.M. 38.7 23.5 19.5 end-2018 TP from HK$20.24 to HK$25.92. Maintain BUY though we P/B 4.0 3.6 2.9 2.6 believe the earnings miss may cap share price performance in the EV/EBITDA 76.3 17.8 14.3 12.5 Dividend yield 0.4% 0.6% 1.0% 1.2% near term. ROAA -1.5% 4.0% 5.6% 6.3% ROAE -3.5% 9.5% 13.2% 14.2% Risks Margin recovery pace slower than expected. Source: Wind Info, Bloomberg, company data, CICC Research Paul Feiyang YUAN Analyst [email protected] SAC Reg. No.: S0080511030012 SFC CE Ref: AIZ727 Please read carefully the important disclosures at the end of this report CICC Research: February 8, 2018 Financial summary Financial statement (Rmb mn) 2016A 2017E 2018E 2019E Financial ratios 2016A 2017E 2018E 2019E Income statement Growth ability Revenue 53,779 59,366 64,644 70,536 Revenue 9.7% 10.4% 8.9% 9.1% COGS -36,144 -38,762 -42,018 -45,628 Operating profit -115.9% N.M. 15.6% 11.4% Selling expenses -13,435 -14,845 -16,033 -17,482 EBITDA -71.1% 321.4% 12.9% 9.9% Administrative expenses -2,471 -2,331 -2,607 -2,818 Net profit -131.7% N.M. 52.5% 20.6% Other ops income (expense) -2,851 -854 -705 -754 Profitability Operating profit -420 3,276 3,786 4,218 Gross margin 32.8% 34.7% 35.0% 35.3% Finance costs 184 150 312 559 Operating margin -0.8% 5.5% 5.9% 6.0% Other income (expense) 0 0 0 0 EBITDA margin 2.2% 8.4% 8.7% 8.8% Profit before income tax -461 2,868 4,164 4,952 Net margin -1.4% 3.5% 4.9% 5.4% Income tax -351 -571 -701 -808 Liquidity Minority interest 62 -226 -304 -334 Current ratio 1.30 1.60 1.78 1.96 Net profit -751 2,072 3,159 3,811 Quick ratio 1.08 1.27 1.44 1.62 EBITDA 1,181 4,979 5,624 6,183 Cash ratio 0.46 0.65 0.84 1.03 Recurrent net income -751 2,072 3,159 3,811 Liabilities / assets 48.1% 48.4% 46.5% 44.5% Balance sheet Net debt / equity 6.1% 11.7% 0.2% net cash Cash and bank balances 7,031 8,336 11,530 15,214 Return Trade and bill receivables 5,045 3,575 3,896 4,256 RoA -1.5% 4.0% 5.6% 6.3% Inventories 3,314 4,220 4,581 4,983 RoE -3.5% 9.5% 13.2% 14.2% Other current assets 4,447 4,447 4,447 4,447 Per-share data Total current assets 19,837 20,578 24,454 28,900 EPS (Rmb) -0.19 0.53 0.80 0.97 Fixed assets and CIP 13,970 14,322 14,541 14,634 BPS (Rmb) 5.31 5.75 6.43 7.21 Intangible assets and others 15,317 19,025 19,135 19,353 DPS (Rmb) 0.09 0.13 0.18 0.22 Total non-current assets 29,287 33,348 33,677 33,987 Cash flow per share (Rmb) 1.15 1.23 1.39 1.51 Total assets 49,124 53,926 58,131 62,887 Valuation Short-term borrowings 3,045 1,143 1,143 1,143 P/E N.M. 38.7 23.5 19.5 Trade and bill payables 11,917 11,308 12,275 13,356 P/B 4.0 3.6 2.9 2.6 Other current liabilities 341 442 358 260 EV/EBITDA 76.3 17.8 14.3 12.5 Total current liabilities 15,303 12,893 13,776 14,759 Dividend yield 0.4% 0.6% 1.0% 1.2% Long-term borrowings 5,542 10,455 10,455 10,455 Total non-current liabilities 8,318 13,231 13,231 13,231 Total liabilities 23,621 26,124 27,007 27,990 Share capital 357 357 357 357 Retained profit 20,488 22,210 24,878 27,968 Equity 20,845 22,567 25,236 28,325 Total liabilities & equity 49,124 53,926 58,131 62,887 Cash flow statement Pretax profit -461 2,868 4,164 4,952 Depreciation & amortization 1,602 1,703 1,837 1,965 Change in working capital 1,897 57 201 221 Others 1,476 186 -729 -1,193 Cash flow from operations 4,513 4,815 5,473 5,946 Capital expenditure -3,037 -2,706 -2,200 -2,200 Others -968 -3,114 763 1,011 Cash flow from investing -4,005 -5,819 -1,437 -1,189 Equity financing 0 0 0 0 Bank borrowings -2,970 3,448 0 0 Others -1,066 -1,138 -843 -1,073 Cash flow from financing -4,036 2,310 -843 -1,073 Foreign exchange gain (loss) 51 0 0 0 Net changes in cash -3,529 1,305 3,194 3,684 Source: Company data, CICC Research Company description China Mengniu Dairy Co., Ltd and its subsidiaries manufacture and distribute quality dairy products in China. It is one of China’s leading manufacturers of dairy products, with Mengniu being its core brand. The group’s diversified range of products includes liquid milk products, such as UHT milk, milk beverages and yogurt, as well as ice cream and other dairy products like milk powder. Mengniu’s market share has ranked among the top two in China over recent years. In 2013, Mengniu acquired controlling stakes in China Modern Dairy and Yashili, comprehensively upgrading its raw milk and products. Please read carefully the important disclosures at the end of this report 2 CICC Research: February 8, 2018 Earnings miss could be dragged by mild cost inflation, a resilient expense ratio and weaker-than-expected return from both Yashili and CMD. Dairy demand warm-up in 2H has driven up raw milk prices for both the industry and the company itself. An increase in packaging goods prices (mainly paper cartons) also added to the mild cost inflation in both 2H17 and possibly FY18. We expect the selling expense ratio to move up both HoH and YoY in 2H17 and in the near term given more new product launches, ongoing channel cultivation to penetrate lower tier cities, and World Cup promotions in FY18. The G&A expense ratio may also go up in 2H17 as the first batch of options and selective share fees are booked, especially as there is a seasonal pattern of G&A expenses going up HoH almost every year. Foreign exchange loss was an extra amid RMB appreciation, and estimated at Rmb200mn for the current year. This risk could be largely removed this year since the company bought futures contracts to hedge at the end of last year.
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