EUR 850.00 For Business Accounts Only

Morningstar | Mengniu Agreed to Sell Its Junlebao Shares for CNY 4 Billion in Cash; FVE Remains at HKD 20.50. See Updated Analyst Note from 03 Jul 2019

No-moat China Mengniu Dairy agreed to sell all of its 51% holdings in its subsidiary Shijiazhuang Junlebao Dairy, or Junlebao, to two Hebei provincial government-background companies Penghai PE and Junqian Management for CNY 4.01 billion in cash, as it seeks to concentrate on developing its core brands and enhance financial stability with sufficient cash for working capital and to facilitate future investment opportunities. Junlebao specializes in the yoghurt and infant formula categories, and is the largest dairy product manufacturer in Hebei province. We believe Mengniu received a good price for the deal, with the selling price of 40 times 2018 earnings and about 10 times what Mengniu paid for its investment in November 2010. Management expects the deal to be approved by the  authorities by the end of the third quarter.

We think the disposal is in line with the company’s strategic plan, focusing on developing premium brands, given that Junlebao concentrates on low- to mid-end products and has limited synergy between them. Meanwhile, we expect the disposal to be accretive to Mengniu’s margins, considering that Junlebao has lower profitability (2.5% in 2017 and 3.2% in 2018 versus Mengniu’s 3.4% and 4.4% aggregately). The company’s debt to equity ratio will decrease from 58% to 50% after the disposal, according to management. Junlebao’s 2018 revenue and net profits were nearly CNY 9.6 billion and 3.1 billion, respectively, which accounted for 14% and 10% of Mengniu’s total numbers. The effect is minimal for 2019 and we have lowered our top-line estimate by 3.3 percentage points, as Junlebao remains consolidated until the end of third quarter-2019. We expect Mengniu to grow only at low-single-digit rates year on year in 2020, as the contributions from Junelebao will be fully divided.

Our fair value estimate remains unchanged at HKD 20.50 per share on Mengniu, because we expect the company will accelerate its growth by strengthening investments in its premium products to offset the significant negative effects of stripping out Junlebao’s contribution to Mengniu’s financial figures over the short term. We also believe the company’s gross margin will further progress as the mix from higher-end products, including premium liquid milk, infant formula, and cheese, will continue to increase. However, we think the shares are overvalued at current levels, trading at a 50% premium to our fair value.

There will not be a special dividend payout distribution to Mengniu’s shareholders for this transaction. The excess cash will be used for future investment in premium flagship products and merger and acquisition opportunities.