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The cold winter is not without vitality. High-quality companies and excellent management can always lead the companies through the fog.

Text/Daily Financial Report Zhong Ning

The concentrated release of production capacity and the slower-than-expected recovery in consumption have led to overcapacity, which has become the biggest problem for the domestic dairy industry. Due to the differences in business models and links in the industrial chain, the impact of this set of contradictions on dairy companies has been very different during this long period of record-breaking decline in raw material prices. Although the macro-economic situation has led to weak expectations for consumption recovery, the dawn of hope for individual dairy companies can serve as valuable experience for getting through the cold winter.

Imbalance between supply and demand, consumption differentiation

According to the monthly report on the supply and demand of fresh agricultural products in May 2024 released by the Ministry of Agriculture of China, the purchase price of domestic fresh milk has recorded a year-on-year decline for 27 consecutive months. In May this year, the purchase price of fresh milk in the main producing provinces of China fell by 12.4% year-on-year and 2% month-on-month to 3.39 yuan/kg, and fell again to 3.3 yuan/kg in the second week of May.

According to Euromonitor data, between 2019 and 2023, domestic milk production will increase from 32.01 million tons to 41.97 million tons, with a compound annual growth rate of 7.01%; while during the same period, the domestic dairy market size will increase from 587.2 billion yuan to 659.8 billion yuan, with a compound annual growth rate of 2.96%.

Significantly, in recent years, the rate of increase in milk production has been much higher than the growth rate of the dairy market size, causing the entire dairy industry to enter a stage of serious supply and demand imbalance, which in turn led to a continuous decline in the price of raw milk.

From the perspective of sub-categories, the dairy industry shows a situation of consumer differentiation: the core ambient temperature white milk still maintains steady growth, with a CAGR of 5.28% from 2019 to 2023; fresh milk is relatively resilient as consumers' health awareness increases; infant formula has declined for two consecutive years due to the slowdown in fertility rates; the overall performance of the yogurt market size is poor, especially low-temperature yogurt has been declining for four consecutive years; consumption downgrades have also caused the most promising cheese market to cool in 2023, with its size declining by 19.56% year-on-year to 11.1 billion yuan.

The internal logic of performance growth

The imbalanced supply and demand in the industry is fully reflected in the business operations: the 2023 financial report shows that among the 15 A-share dairy-related companies, only five companies, including Sanyuan Foods, Manor Farm, Meike Landou and Western Animal Husbandry, recorded a year-on-year decline in revenue. In the first quarter of 2024, against the backdrop of continued sluggish demand, only New Dairy, Tianrun Dairy, Beingmate and Yiming Food recorded year-on-year revenue growth, and the performance distribution showed a "green fat, red thin" pattern.

However, from the perspective of gross profit margin,Although dairy companies' revenue declined across the board in the first quarter of 2024, the gross profit margins of 10 of them rebounded compared with the whole year of 2023.Although they are in the same industrial chain, due to different scale factors, business distribution, product areas and industrial chain depth, they show huge differences under the influence of cycles. The internal logic is:

(1) The upstream livestock industry is affected by high feeding costs, and the concentrated release of industry production capacity has led to an increase in the supply side, while the lack of downstream consumer willingness has suppressed the demand side. The spiral interaction has led to a continuous decline in the price of raw milk.In the absence of significant improvement in short-term demand, it is urgent to reform the supply side and reduce production capacity in order to stop the price decline from the supply side (because downstream demand is not in recession, it is just growing slower than supply).

For example, the two major raw milk suppliers, China Shengmu and Youran Dairy, although their operating income increased by 6.55% and 3.56% year-on-year respectively in 2023, they also faced the situation of "increased revenue and reduced profits". China Shengmu's net profit attributable to shareholders decreased by 79.33% year-on-year to 86 million yuan, while the larger Youran Dairy turned from a profit of 415 million yuan to a loss of 1.05 billion yuan year-on-year.

(2) For dairy companies with deep integration of the industrial chain, what is more important is the matching degree between production capacity and their dairy products, product matrix and terminal performance capabilities.For example, New Dairy’s operating income in 2023 and the first quarter of 2024 increased by 9.8% and 3.66% year-on-year respectively, and its gross profit margin continued to increase from 24.04% in 2022 to 29.38% in the first quarter of 2024; on the other hand, Manor Ranch’s revenue in the same period decreased by 8.95% and 9.96% year-on-year respectively, and its gross profit margin also continued to decline from 19.04% in 2022 to 8.78% in the first quarter of 2024.

(3) Dairy product manufacturers that rely on external milk sources will enjoy the cost benefits brought about by the current round of decline in raw milk prices.For example, Panda Dairy's gross profit margin increased from 19.27% ​​in 2022 to 23.13% in 2023, and further increased to 28.86% in the first quarter of 2024; Meiji Landou's gross profit margin in the first quarter of 2024 recovered by 3.85 percentage points from 2023 to 33.09%, and its gross profit in the first quarter surged 4.26 times year-on-year to 31 million yuan.

Some inspirations for surviving the cold winter

The 2024 interim report season is approaching, and Tianrun Dairy, Manor Ranch and Royal Group have successively released forecasts. Among them, Tianrun Dairy's net profit attributable to shareholders after deducting non-recurring items is approximately RMB 22 million to RMB 26 million, a year-on-year decrease of 77.78% to 81.2%; Manor Ranch's net profit attributable to shareholders after deducting non-recurring items is approximately RMB -97 million to RMB -72 million, and the year-on-year loss increased by 200 to 304.17%; Royal Group's net profit attributable to shareholders after deducting non-recurring items is approximately RMB -19 million, turning from a slight loss to a profit year-on-year.

The sluggish terminal consumption and the continued decline in raw milk prices have already given early warning to the interim reports of most dairy companies, but the cold winter is not without hope. High-quality companies and excellent management teams can always lead the companies through the fog and gain some inspiration from it.

As the fifth largest vertically integrated dairy company in the world and the largest in Asia, Yili has demonstrated its robustness and resilience in this round of industry reshuffle: relying on the advantages of vertical integration, brand potential and channel reuse, Yili has maintained steady growth in performance from 2019 to 2023, with a compound annual growth rate of 12.46% in net profit attributable to shareholders after deducting non-recurring items, 3.71 percentage points higher than the compound annual growth rate of revenue in the same period. Although revenue fell by 2.58% in the first quarter of 2024, the substantial increase in gross profit margin drove the net profit margin after deducting non-recurring items in the first quarter to a record high of 11.44%.

As a leader, Yili has learned that despite the industry's cold situation, it has not engaged in too many price wars, but has digested excess raw milk through powder spraying storage; it has focused on channel inventory digestion and product price stability in the case of slow recovery of downstream consumption; and it has continued to increase investment in research and development for innovation and iteration, enriching the product matrix while also broadening the product price range to cover a wider range of consumers. In 2023, Yili accelerated its layout of the "big health" industry, and its breakthrough innovations brought new products including "Jindian" A2β-casein organic pure milk, "Anmuxi" active probiotic yogurt, "Shuhua" Antangjian lactose-free milk, "Jinlingguan" new generation infant formula milk powder, "Xu Jinhuan" low GI series ice cream, "Changqing" protein time series flavored yogurt, etc., accounting for 16.8% of revenue. While stabilizing the domestic base, it continues to optimize the production capacity of overseas bases and actively develop overseas markets. In 2023, overseas business revenue increased by 10.08% year-on-year.

In addition, as a leading domestic regional dairy company, Xinruyi focuses on its "Fresh Cube Strategy", taking low-temperature products as the main focus, and engaging in differentiated competition with its peers with the brand positioning of "fresh, trendy, and new technology". Its performance in this round of dairy industry winter is remarkable: from 2019 to 2023, operating income and net profit continued to set new highs. Xinruyi, whose main products are low-temperature products and flavored yogurt, can still record excellent results in Q1 2024, with revenue and profit increasing by 3.66% and 33.75% year-on-year respectively.

The revelation given by New Dairy is that it is difficult for local dairy companies to compete with national leaders in ordinary products. The way to survive is to take advantage of the limited delivery radius of low-temperature fresh milk to conduct differentiated operations. Focusing on the core goal, they should continuously strengthen the brand belonging of the consumer group, provide high-end products (such as its "24 hours") through supply chain empowerment, and constantly innovate in the field of low-temperature flavored milk to lead new consumption trends.

In short, from the perspective of the industry's value chain transmission, the restoration of the upstream animal husbandry industry will most likely require a round of "supply-side reform", and dairy companies should find their own position and play their own differences in the environment of sluggish terminal consumption. In addition, for midstream companies that have been highly dependent on external milk sources in the past, proper performance during the profit center dividend period may be able to accumulate capital for vertical integration.

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