EUR 850.00 For Business Accounts Only

Morningstar | We Expect Strong 4Q Sales Growth From Yili, but Operating Margin Pressured; CNY 25.50 FVE Intact

We've tweaked narrow-moat Inner Mongolia Yili Industrial’s growth forecasts slightly, but our fair value estimate is unchanged at CNY 25.50 per share. The shares look fairly valued at current levels. Yili’s evolved business strategy has achieved good results with top-line growth and market share expansion, and we expect the full-year 2018 organic revenue growth will finish strong at 15% year on year. However, higher raw milk costs and a sharp increase in selling (marketing and promotional) expenses for driving sales growth will weigh on profitability, as operating profit is projected to grow merely 2.6% from last year, pointing to an operating margin that is 90 basis points lower.

In the long term, we believe Yili will continue to lead the Chinese dairy market and gain further market share on the back of its strong cost advantages and entrenched distribution network. While we forecast a 10% operating profit compound annual growth rate through 2022, we are concerned that the intensifying competition between Yili and its major rival, China Mengniu Dairy, will damp its profit growth amid slowing economic growth.

Management seems to be confident that it can drive sales growth for the next three years through product upgrades, sales channel penetration, and new business in the soy milk and bottled water segments. Yili believes the advancing market share will help it to dominate the market and profitability will eventually increase in the long run. Indeed, the company’s aggressive plan has reaccelerated its revenue growth but has yet to translate into strong bottom-line growth. We think this will be quite challenging for Yili, as Mengniu also has an aggressive strategy to boost its revenue, which is likely to damage margins, and we see substantial costs for getting a seat in other beverage segments, given that the market is already too crowded and the company has no advantages versus other competitors in other beverages.