EUR 850.00 For Business Accounts Only

Morningstar | Yili’s 4Q Profits Ahead of Our Forecasts on Margin Improvement; Raising Our FVE to CNY 27.50

China’s largest dairy producer, narrow-moat Inner Mongolia Yili Industrial, or Yili, posted solid fourth-quarter results that surpassed our forecasts, with underlying revenue and operating profit up 18% and 33% year on year, respectively, driven by product upgrades and strong sales volume growth from lower-tier regions. Yili’s leading market position was further strengthened, with its market share of room-temperature and low-temperature liquid milk segments expanding 2.3 and 0.5 percentage points from last year, respectively, to 36.8% and 16.6%. Meanwhile, reported operating margin was above our projection and was up 104 basis points year on year, thanks to better product mix, despite higher raw milk prices and administrative expenses.

We increase our fair value estimate for Yili to CNY 27.50 per share from CNY 25.50, as we roll over our model. We expect the company continue to outstrip the market growth on the back of its strong premium product portfolios amid ongoing premiumization trend as well as sales channel penetration to lower-tier markets where the dairy products consumption per capita remains low. We forecast revenue to grow at a CAGR of 9.7% in the next five years, with liquid milk, milk powder, and ice cream segments to grow at CAGRs of 9.8%, 10.5%, and 7.8%, respectively. On the negative side, we expect the rising raw milk prices and high advertising and marketing costs will weigh on its profitability in the near term. That said, we project operating profit to grow at a CAGR of 13% through 2023, with operating margin averaging at 8.7%, versus 8.1% in 2018, bolstered by product mix improvement, while the operating expense ratio will gradually decline. We maintain our narrow moat and stable trend ratings. The shares are trading at price/earnings ratio of 25 times, and we view them as fairly valued at current levels.

While the Chinese dairy industry had a solid year in 2018, with overall sales growing 11% from 2017, Yili continued to outgrow the industry and delivered a strong revenue growth. Its 2018 full-year underlying revenue finished stronger than we anticipated, rising 17% year on year to CNY 79 billion, slightly above our 15% growth forecast. The upbeat top-line growth was attributable to 11% volume increase and 6% average selling price increase (price hikes and product mix upgrades). The liquid milk business, accounting for 83% of total sales, saw a 18% sales growth, driven by strong sales growth from flagship premium products, such as Satine and Ambrosial, up 20% and 30% respectively.

The milk powder business had another great performance in 2018, with sales increasing 25% year on year, thanks to the implementation of the new infant formula registration policy that allowed Yili to aggressive seize market share in the lower-tier markets, while other small players were forced to exit the market. Its market share in the infant milk formula segment was up 60 basis points from prior year to 5.8%, the largest among domestic competitors.

2018 full-year operating profit of CNY 6.42 billion was 5% higher than our CNY 6.12 billion forecast, implying an 8% year-on-year growth. Operating margin was down 50 basis points from last year to 8.1%, owing to higher advertising and marketing expenses. However, profitability was better than our previous 7.9% forecast, mainly due to improving gross margins on the back of product mix upgrades, up 2.1 percentage points in the fourth quarter versus down 0.8 percentage points in the first three quarters, despite rising raw milk prices. Net profit added 7% year on year to CNY 6.44 billion, with earnings per share of CNY 1.06. Dividend per share is CNY 0.70, implying a 66% payout ratio, which is in line with our expectation.