Mengniu (2319, $26.95) 12M Target $33.82 Trading BUY
In 3Q07, raw milk price of Mengniu rose 15% yoy due to higher animal feed price. Further increase is expected in 4Q07. For 1% raw milk price increase, we estimate net profit of Mengniu would drop by over 5%. Market concerned about earnings would drop sharply, that has led to a 17% drop in share price last week. However, market’s overreaction creates a good buying opportunity in our view.
In 1H07, with shift of product mix and efficient cost control, Mengniu maintained retail prices of dairy products with gross margin grew to 24.5% from 22.9% in 2006. Meanwhile, raw milk price rose only 6-7%, reflecting the company possesses higher execution capabilities than competitors.
In July 2007, leading dairy companies reduced promotion expense (such as 1-for-5 gift). This has helped Mengniu increase average selling price by 2% indirectly.
We estimate a 0.4% increase in average selling price could offset 1% increase in raw milk price. Mengniu has already raised retail price in major cities, and management planned to increase selling price as much as 8% by year-end of 2007.
Raw milk price increase is likely to ease in 2008, since the government is going to provide subsidies and discounted loans to support cow-farmers.
Negative impact of higher raw milk price on earnings is manageable since Mengniu is improving its product mix, increasing average selling price as controlling cost efficiently. We therefore maintain BUY with target price of $33.82. |
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