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Morningstar | Yili’s Profit Growth In Line in 1Q19, Lower Margins Offsetting Strong Revenue Growth

Narrow-moat-rated Inner Mongolia Yili Industrial’s net profit of CNY 2.28 billion in the first quarter, up 8% year on year, was largely in line with our full-year 7% growth forecast, but details are different to what we expected. The core business revenue grew 18% from last year, higher than our 13% forecast, while the 11.9% operating margin, down 90 basis points, was worse than our expectation. Management’s strategies in driving sales growth successfully led its market shares to further increase, but higher selling costs deteriorated its profitability in the meantime.

We leave our assumptions unchanged but revise up our fair value estimate slightly to CNY 28 from CNY 27.50, owing to the time value of money. The shares are fairly valued at current levels.

The promising top-line growth in the first quarter was fueled by both the sales volume and product mix. Yili saw strong sales volume from lower-tier markets, on the back of rising milk consumption per capita, which was much lower than that of higher-tier markets. Meanwhile, the mix continued shifting toward higher-end products amid the premiumization trend, which increased the average selling prices. The flagship premium products, including Satine (UHT milk) and Ambrosial (UHT yoghurt) brand series, grew 25% and 20% year on year, respectively, outpacing the company’s aggregate sales growth.

Gross margin, increasing 115 basis points from last year to 40%, in the first quarter was better than we projected, thanks to a favorable mix and lower-than-expected increase in raw milk prices, which increased only 5%-6% from the year-ago quarter. We expect the raw milk prices will hike about 10%-15% because of tight supply that will increase the production costs going forward. However, we think Yili will have less impacts compared with its peers, due to its long-term contracts with its suppliers, meaning it will not be forced to pay higher prices when out of raw milk sources.

The 28.6% operating expenses to sales ratio, up 1.8 percentage points year on year, was much higher than our expectation and the main reason for dragging the profit growth. The higher costs mainly came from higher marketing and advertising investments for new product launches and sales channel penetration to lower-tier regions. Operating profit and net profit added 9.5% and 8.4% year on year, respectively. We expect the company’s aggressive promotion campaign will fade and operating expense ratio for the rest of the year will slightly improve compared with the first quarter.

Market shares for its room-temperature milk product and infant milk formula increased 3 and 0.5 percentage points, respectively, to 38.8% and 6.3%, while the chilled milk products lost 1.3 percentage points of market share to 15.7%.