Mengniu Dairy - Long-term potential intact

StockFanatic

Publish date: Thu, 05 Jan 2012, 10:45 AM

Mengniu Dairy's sales have been affected since test results on 24 December found excessive levels of Aflatoxin M1 in one batch of the company's pure milk products. Given the disruption in sales, we revise down our earnings estimates by 9% and 2% for 2012 and 2013, respectively. However, we reckon the negative impact will be temporary and believe Mengniu's long-term fundamentals remain unchanged. We lower our target price to HK$22.50 and reiterate BUY.

Key Factors for Rating

According to local media, company sales have been affected most in tier 1-2 cities while those in lower-tier cities have only seen mild impacts. We note that the sales of pure milk have been affected the most, while those of premium UHT, milk beverage and yogurt products have been affected the least.
We believe the dent in sales will last into 1Q12, but the impact should be much smaller than that following the melamine scandal, as the tainted products were destroyed in the factory and were never available to the public. The product most affected is pure milk, which carries a low margin. In addition, there will be limited inventory write-off expenses.
We have cut our 2012-13E earnings by 9.3% and 2.2%, respectively. This is based on: (i) cuts in turnover of 3.5% and 3.8%, assuming sales return to normal in 2Q12; (ii) additional promotions for pure milk products in 2012; (iii) additional A&P expenses in 2012; and (iv) no additional inventory write-offs.
COFCO has not been involved in the daily operations of Mengniu, but we believe it will play a more important role going forward.

Key Risks to Rating

Further food safety issues.
Poor crisis management.
Higher-than-expected input costs and SG&A cost ratio.

Valuation

The company will post an 18% earnings CAGR during 2011-14E. We believe Mengniu should trade at a discount to leading F&B players given the larger systemic risk. Pegged at 18x 2012 P/E (a 25% discount to the peer group), we lower our target price from HK$30.20 to HK$22.50. We reaffirm our BUY rating. (Read full report)

Read also (Research Reports Archives)

JP Morgan : Another food safety scare - ALERT
JP Morgan : Maintain Overweight, lower TP to HK$33 from HK$35
Core Pacific -Yamaichi : An accident or crisis?
Core Pacific - Yamaichi : Excessive AFT found in UHT milk products
ICBC : Undervalued market leader
SWS : Consumer Sector Monthly July 2011; we recommend Mengniu Dairy
SWS : Upgrade to buy with far-better-than-expected raw milk supply
Nomura : Expecting strong 1H11, Product mix upgrades and market-share gains drive upward forecast, TP revisions

Source : Bank Of China International

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