Is CHINA FEIHE coming out of the trough?

This year, the consumer goods industry is in a state of widespread sorrow, with the dairy industry not performing any better than the liquor industry. Both Yili and Mengniu have hit new lows, with profits experiencing a significant drop for the first time in many years.

However, within the industry, Feihe, which started declining earlier than these two industry leaders and has a more pessimistic overall environment, has shown a completely different trend. Its stock price has been exceptionally strong this year, outperforming the Hang Seng Index, making it the strongest dairy stock.

Feihe mainly sells infant formula. In recent years, as the population has been declining, expectations have generally been pessimistic. No matter how high the market share of infant formula is, it cannot withstand the drastic decline in birth rates. Feihe's performance has also been poor for many years, but this year, Feihe has rarely become one of the few dairy companies with positive earnings growth. This has supported the rebound in its stock price. It seems that Feihe, which has the worst demand, is the first to emerge from the trough?

I. The Difficulty of Further Population Decline

First of all, this year, unexpectedly, the slope of the population data is likely to stabilize. On one hand, this year, the Year of the Dragon is the most popular zodiac year, coupled with the relaxation of the epidemic last year, birth data is expected to recover. According to data from various regions, the number of births in the first half of this year has increased by nearly 10% compared to the same period last year. Under this influence, the industry's search for the bottom should be nearing its end.

Currently, the expected number of births in 2024 is around 8-9 million. According to the life expectancy of 78 years, after a century of turnover, China's population will eventually be reduced to 660 million, equivalent to a halving of the population. Will the number of births continue to decline as the economy slows down, leading to a situation like South Korea where the population naturally becomes extinct after a certain number of years? The answer is most likely no.

With the decline in population, the per capita resources of all kinds will increase significantly, something that countries like South Korea and Japan cannot compare to. For example, if the existing area of real estate in China remains the same, with an average housing area of 70 square meters for a population of 660 million, China will be able to catch up with the United States, reaching the highest level globally, alongside the United States, Australia, Canada, and Russia, with vast land and abundant resources.

In this environment, the fertility rate can completely rebound.

Based on the current level of resource support and life expectancy, the current number of births is likely close to the bottom. In the long run, the logic of the impact of population decline on infant formula sales has gradually been completed, and there is also a lack of basis for continued industry sales decline in the future.

When considering the main consumer group of milk powder, children aged 0-3 years old, the data for 2023 is 28.5 million people. Based on a birth population of 8 million, this data will continue to decrease to around 24 million in the coming years. Therefore, in the next 1-2 years, sales will continue to decline, but after that, the industry's sales will basically enter a bottoming out phase. It can also be said that Feihe's continuous decline in performance over the past few years will face a turning point within these years, even now.

Previously, an analysis was made of the status of dairy giants Yili and Mengniu in the article "The Value of Bottoming Out in China's Dairy Industry". They have entered a state of declining revenue and profits this year (Yili's profit growth comes from non-recurring income), and they share the same underlying logic as Feihe, which is population.

However, Feihe focuses on the birth population, while Yili and Mengniu focus on the total population. Feihe's decline is more severe and came earlier, but after a rapid short-term decline, the bottom also arrived quickly. On the other hand, the total population undergoes changes over a century, with a small annual decline but lasting for a long time, making it difficult to grasp the bottom. It's basically a difference between a downward trend and a one-step drop.

The birth population leads the way in declining compared to various economic data, which now doesn't seem like a bad thing because the risk is released earlier.

Increasing market penetration + raising product ASP can offset the decline in volume and achieve growth in this market.

II. Increasing profits without increasing revenue

Specific problems require specific analysis. Looking at Feihe's interim report, the performance is not particularly good. Revenue increased by 3.7%, while profits increased by 18%, mainly driven by the increase in profit margin, with the industry still significantly affected by the contraction due to the sharp decline in population.

From the company's disclosed information, one major factor contributing to profit growth is the growth in high-end products, with ASP increasing. The revenue from the company's ultra-high-end products grew by 19% year-on-year, but the total sales volume is still in a declining trend. From the above population data, it can also be inferred that the continued decline in volume for the next 1-2 years is reasonable.

However, both gross profit margin and net profit margin have reached near-high levels in recent years, starting to gradually warm up, which is indeed surprising. In the current environment, where various consumer goods need to be discounted to promote sales, the fact that milk powder can raise prices is enough to illustrate the resilience of consumption.

As a consumer goods company, it is unlikely to return to the peak profit margin of 30%. At that time, it was also an unexpected achievement due to the combination of population and industry competition advantages. People also believed that Feihe's profit margin was too high at that time, and it has now returned to its original state in the past two years. However, the lower limit of the decline is now visible, with the profit margin rising from 16.75% to 18.8%.

The 16-18% range may be the bottom range of Feihe's profit margin, which is considered a reasonable level for consumer goods. Compared to other dairy companies, it still demonstrates competitiveness, which is a data point that reflects competitiveness

Three, Many Shortcomings

However, behind the financial reports, there are still some shortcomings. In terms of competition, the infant formula market in the first half of 2024 declined. Feihe's performance outperformed the industry, but compared to its competitor Yili, it is somewhat lacking.

According to data disclosed by Yili, both in terms of revenue growth rate and scale, Yili's infant formula business surpasses Feihe.

Although Yili's business category includes adult milk powder and dry dairy products such as cheese, when it comes to infant formula business, the growth rate will not be lower than 7.31%. Feihe may have increased market share, but Yili has increased more.

Both are now jointly replacing the original market of other brands. However, Feihe's market share growth rate has always been inferior to Yili's. In the long run, this is also a pessimistic point for Feihe's market share growth. Yili's market share is rapidly increasing, while Feihe's market share expansion is slowing down, which is synchronous.

However, considering that Feihe's profit margin is higher than Yili's, and neither of them currently have the intention to engage in price wars to seize the market, it appears that this market can still accommodate the growth of two giants. As long as the difference in growth rate is not too large, Feihe's foundation will not be shaken.

In terms of going global, Feihe has also encountered setbacks (other dairy companies are also struggling). In the first half of the year, revenue from the United States declined year-on-year. For any Chinese consumer brand, the biggest growth potential basically depends on globalization. Currently, there is no breakthrough in sight, so Feihe's future does not seem to have high growth potential.

Feihe also faces much controversy in terms of shareholder returns. On one hand, the company has had decent profits in the past and has accumulated a large amount of cash, but it has not distributed dividends, leaving them all in the account. There is 9.6 billion in cash and cash equivalents, as well as 9.4 billion in structured deposits

In theory, this can support a large-scale buyback or special dividend plan, injecting momentum when the stock price is low. However, the company does not have a strong attitude towards the decline in stock price.

The choice is to buy financial products. As of now, the company holds nearly 5.5 billion in financial products. Although the yield is higher than government bonds, it is much lower than the company's ROA and dividend yield. If used for share buybacks, the company's EPS could soar by 20% and further increase the dividend yield.

Regarding this phenomenon, there are doubts that the money the company earns will not be fully shared, which is basically equivalent to private use. This lack of trust in the company's long-term prospects is either due to the vested interests of targeted investment in financial products or lack of intelligence. Overall, the ability of Feihe to return value to shareholders has been criticized more than supported for a long time.

However, in terms of profit distribution this year, Feihe is better than most listed companies. In the first half of the year, the company distributed 1.35 billion, with a payout ratio of 72%. Combined with a low valuation, the current dividend yield has reached 7%, which is quite high in the consumer goods sector. The company has also committed to annual dividend growth of over 10% and a payout ratio of over 70% in the future.

Although historically the management's performance forecasts have not been very reliable, the cash volume supports such dividends. Even if Feihe's performance declines, it can still maintain the dividend amount. Therefore, in terms of shareholder returns, despite many past issues, it still far exceeds the passing line. If a large special dividend or buyback is achieved, it will basically be at the top level of shareholder returns in the Hong Kong stock market.

Therefore, the key issues to consider are the competitive situation with Yili, the lack of surprises in going global, and whether shareholder returns can proceed as promised.

Conclusion

Overall, Feihe's current dividend yield and performance support this year's stock price performance. It should not be seen as a growth stock, but rather as an alternative to various mainstream income stocks: resource stocks, bank stocks, and utility stocks. A 7% dividend yield is similar to these, and while the population may decrease slightly, it won't decrease significantly. Income may decline, but the company has the ability to maintain growth. Infant formula remains a relatively good category in the dairy industry.

Many of this year's hot income stocks do not provide commitments to distribution ratios and dividend growth. There are also few increases in income and profit.

Of course, do not consider Feihe as a high-return target. Both domestically and internationally, the company lacks the ability to achieve excess growth, and the fluctuation of performance is highly likely to depend on industry performance. Without high growth, the lack of a story, and being dividend investors, it is unlikely to become a high-return multiple stock in the long term. The higher the risk preference, the less advantageous the stock price elasticity of the company.

However, stocks with a 10% dividend yield that double to 5% are not uncommon this year. Long-term low returns do not mean short-term low returns, and realizing the future years' gains all at once now can also be attractive Such occurrences are rare but possible, stocks with high dividend yields (above 10%) may have the opportunity to experience such lottery-like gains. The rise of CHINA FEIHE may also be part of this process.

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