"Struggling" to reduce dairy inventory, YILI's winter survival strategy

Facing weak consumer demand, even leading dairy companies find it difficult to go against the trend.

YILI (6008867.SH)'s 2024 interim report shows that in the first half of the year, revenue fell by 9.49% year-on-year to 59.915 billion yuan, marking the largest decline in nearly 20 years for the same period.

Net profit attributable to shareholders increased by 19.44% year-on-year to 7.531 billion yuan. However, excluding the impact of inventory provision reversal and other factors, the non-GAAP net profit attributable to shareholders decreased by 12.81% year-on-year to 5.324 billion yuan.

Looking at the second quarter alone, YILI's revenue and non-GAAP net profit both fell significantly by 16.54% and 35.61% year-on-year, respectively, showing a much faster decline compared to the first quarter.

Similarly, the day before releasing its interim results, Mengniu Dairy (2319.HK) also reported a decline in both revenue and net profit in the first half of the year, with decreases of 12.74% and 19.03% year-on-year, respectively. Mengniu also announced a HKD 2 billion share buyback plan, leading to a more than 9% increase in its stock price on the day following the financial report release.

The demand in the dairy industry has not yet bottomed out.

In the first 7 months of this year, the main raw material for dairy products, whole milk powder, saw a decrease in both import volume and price. A total of 446,200 tons were imported, down 20.4% year-on-year, with an average price of $3,533 per ton, down 7.3% year-on-year.

Reflected in YILI's performance, although revenue has dropped significantly, due to a year-on-year decrease of 11.73% in operating costs, the gross profit margin increased by 1.63 percentage points to 34.78%, but still lags behind the around 37% in the same period of 2021.

Only marginal improvement in profit performance may not be enough to convince secondary market investors, and YILI needs to work harder to find growth opportunities.

On August 30, YILI's stock opened low and closed higher, falling by 1.05% to 22.63 yuan per share, making it 1 out of 302 declining companies on the Shanghai Stock Exchange in the context of a general market rise, with a year-to-date decline of 12.03%.

Control the Pace, Reduce Inventory

As a "reserve material" for supplementing protein during the epidemic, the demand elasticity of dairy products may be increasing.

In terms of channels, there is not much difference in performance between YILI's distribution channels and direct sales channels, with revenue contributions of 57.454 billion yuan and 95.89% from distribution channels.

In terms of products, YILI's largest business, liquid milk, contributed revenue of 36.887 billion yuan, a decrease of 19.61% year-on-year.

An executive at YILI attributed the decline in revenue from the core product, liquid milk, to adjustments in terminal inventory.

"We had already seen some pressure in the liquid milk channel at the beginning of the year. Therefore, after the Spring Festival, we adjusted the freshness of terminal products in the second quarter. By reasonably controlling the pace of shipments, we helped distributors 'digest' some of the overstocked products. Now, most products in the channel are within three months, and the freshness of the products has been significantly improved," the executive explained.

In other words, in the first half of the year, YILI temporarily delayed shipments to help distributors clear excess inventory, but also incurred higher cost. The selling expense ratio increased by 1.9 percentage points year-on-year to 19.41% From the perspective of contract liabilities, it may take time for YILI's distributors to regain confidence. In the first half of the year, contract liabilities decreased by 8.56% year-on-year to 4.43 billion yuan.

The second largest business - infant formula and dairy products became one of YILI's few highlights in the first half of the year, contributing revenue of 14.509 billion yuan, a year-on-year increase of 7.31%.

According to Nielsen and Star Map's third-party zero research data, YILI's retail market share, including Aoyou, increased by 1.7 percentage points year-on-year to 16.9%.

Securities business personnel at YILI mentioned that the infant formula under the YILI brand achieved double-digit growth in the second quarter, and the gross profit margin of infant formula and dairy products increased by 2.7-2.8 percentage points, mainly due to the optimization of product structure. It is expected that by 2027, domestic brands will account for over 70% of the domestic infant formula market share.

Beverage products contributed revenue of 7.322 billion yuan, a year-on-year decrease of 20.04%, and even experienced a significant 44.27% year-on-year decline in sales during the peak sales season in the second quarter. It is worth noting that YILI originally planned for a mid-to-high single-digit growth target for beverage products for the full year.

Regarding the decline in performance of beverage products, securities business personnel at YILI believe it is due to relatively weak consumer purchasing power and confidence, as well as slow sales due to excessive rainfall.

However, they emphasized that YILI's beverage products have performed better than the industry in terminal sales and continue to increase market share.

Unsold inventory and raw materials led YILI to make provisions for impairment of 492 million yuan in the first half of the year, further dragging down profit performance.

During the same period, YILI also recorded a credit impairment of 454 million yuan, turning from positive to negative year-on-year. This was attributed to "increased provision for factoring risk and losses on small loans" by YILI.

YILI's factoring and small loans are mainly aimed at companies in its supply chain, including distributors and suppliers. Its wholly-owned subsidiary, "Huishang Commercial Factoring Co., Ltd.," provides factoring services to distributors and suppliers, forming receivables.

Another wholly-owned subsidiary, Inner Mongolia Huishang Internet Small Loan Co., Ltd., provides short-term small loans to distributors.

Behind the phenomenon, there may be more difficult days ahead for distributors with increasing inventory backlog.

How to Find Incremental Growth

Both YILI and Mengniu, two dairy industry giants, have expressed optimism about industry trends.

The above-mentioned YILI executives stated that YILI will definitely perform better in the second half of the year than in the first half. "We will adhere to the principle of reducing costs and increasing efficiency, continuously improve the efficiency of cost utilization, and make every effort to ensure the company's profit level."

Another Mengniu executive's statement at the performance meeting was even more optimistic, expecting an increase in revenue in the second half of the year and maintaining this trend next year.

However, for the secondary market, YILI's proactive inventory control does not meet expectations for continuous expansion of market share by giants.

YILI has three directions to find growth.

First, expand product categories.

Taking the infant formula business as an example, the above-mentioned YILI securities business personnel stated at the performance meeting that the growth rate of high-end functional products in adult milk powder exceeded 30% in the first half of the year, far exceeding the market average.

They mentioned that in the long term, YILI is optimistic about the development space of nutritional products under the aging trend, and has already separated the adult powder business unit last year and established cooperation with Tongrentang. In the future, they will explore more cross-border cooperation At the same time, YILI is further expanding its beverage business. In the first half of the year, it launched a probiotic drink called "Changyi 100% Milk Beer". Earlier, YILI had entered the bottled water business, introducing products such as "inikin Yike Spring" mineral water and cold-brewed tea products.

However, these new products still account for a small proportion, contributing revenue of 406 million yuan in the first half of the year, a year-on-year decrease of 26.5%, accounting for less than 1%.

Secondly, expanding channels.

In addition to YILI's strong retail channels, YILI is now focusing on more B-end catering customers such as Naixue Tea and Saliya, who have larger and more stable dairy consumption capacity compared to individual distributors.

This is also one of Mengniu's expansion directions.

The above-mentioned Mengniu executives stated at the performance meeting that the demand for B-end business has already started in China. Coffee chains, bakeries, and tea shops have all driven indirect consumption of dairy products.

"Although consumption has declined, this trend is irreversible. We need to meet the demand to generate income."

YILI officials told TradeWind01 that currently, YILI's cold drink collaborations mainly include brands such as Naixue Tea, Shanghai Auntie, Guming, COCO, and Saliya.

The above-mentioned YILI securities personnel also stated that YILI's B-end business saw very rapid growth in the first half of the year. With the current industry's surplus raw milk production capacity, the value of processed raw milk (supplied to B-end customers) is at least twice that of ordinary raw milk.

The individual mentioned that the development of these products will significantly enhance the overall value of dairy products, bringing more business opportunities to YILI.

Thirdly, going global.

The above-mentioned YILI officials told TradeWind01 that currently, the Southeast Asian market accounts for a large proportion. In addition, YILI has officially started sales in Africa and the Americas, but specific data is not disclosed at the moment.

The Southeast Asian market is also a key focus for Mengniu, which considers it a "key region". The above-mentioned Mengniu executives stated, "We believe this market has huge potential and plan to invest more resources in its expansion in the future."

With domestic dairy consumption cooling down, the two major players are bound to continue competing in emerging markets such as Southeast Asia and jointly explore incremental opportunities