1H22 adjusted net profit slightly better than market expectation
China Modern Dairy’s (CMD) 1H22 revenue rose 77.1% YoY to Rmb5.63bn, attributable net profit grew 2.2% YoY to Rmb508mn, and adjusted net profit (excluding loss and gains from foreign exchanges and derivative financial instruments) increased 48.9% YoY to Rmb729mn. Net profit was largely in line with market expectation, while adjusted net profit slightly beat market expectation thanks to a milder than expected decline in gross margin on the back of improving yields.
Trends to watch
Yields rise significantly in 1H22; high increase in reported sales volume drives swift revenue growth. Thanks to gene modification and technological improvement, yields of the firm’s cows rose 11% YoY to 12.3t in 1H22. Its herd grew from 354,000 head at end-2021 to 383,000 head at end-1H22 (vs. 252,000 head at end-1H21), partly driven by M&A. Thanks to rising yields and a growing herd, we estimate the firm’s organic output grew by at least high double-digits. Considering the contribution from M&A, the firm’s 1H22 reported output of raw milk reached 1.15mnt and its output and sales volume both increased by about 57% YoY. As COVID-19 control measures weighed on demand, domestic prices of raw milk dipped 1.7% YoY in 1H22, and the firm’s ASP fell by 1.2%, narrower than the sector. Thanks to rising sales volume, the firm’s raw milk revenue rose by 53% YoY and its new feedstuff business also boosted overall revenue growth.
Rising cost weigh on 1H22 profit margin; outperforms sector thanks to high internal efficiency. The firm’s 1H22 gross margin of raw milk fell 5ppt to 32.2% due to cost pressure and mild declines in milk prices. Its 1H22 net profit margin declined 6.6ppt YoY to 9.0%, due to the falling gross margin, a mild rise in expense ratio and a higher contribution from the feedstuff business. The firm’s procurement prices for feedstuff rose 10.9% YoY in 1H22 due to an 18–30% YoY increase in prices of soymeal, alfalfa, and cottonseed, among others. However, thanks to a rapid increase in yields, the firm’s per-kg feedstuff cost only rose Rmb0.17 (or 8.1% YoY), significantly outperforming the sector (Rmb0.3–0.4) thanks to internal efficiency.
Full-year profit to steadily grow thanks to cost reduction, efficiency enhancement, and financial consolidation. Data from the Ministry of Agriculture shows milk prices declined 4–5% YoY in July–August, due to relatively weak demand, a marginal increase in supply, and seasonality. Considering the improving supply and demand balance, we think milk prices may decline mildly in 2H22. Thanks to herd growth in 1H22 and a better-than-expected improvement in yields, the firm expects full-year yields to grow in the high single digits and sales volume to rise by 40–45% YoY to about 2.3mnt. The firm thinks feedstuff prices will stay elevated in 2H22, as soymeal and alfalfa are mainly imported and overseas supply is relatively tight. Considering cost reduction and efficiency enhancement, we think 2H22 gross margin pressure will be controllable. Thanks to the significant increase in sales volume, we expect reported profit to grow steadily in 2022.
Financials and valuation
The stock is trading at 6.5x and 5.7x 2022e and 2023e P/E. We largely maintain our 2022 and 2023 earnings forecasts. Considering falling overall market valuations, we trim our target price 16% to HK$1.35 (8.4x and 7.3x 2022e and 2023e P/E with 29% upside). Maintain OUTPERFORM.
Risks
Falling milk prices; rising cost of feedstuff; uncertainty from COVID-19.