Four measures to offset raw milk pressure

　　伊利股份(600887)

　　3Q20 NP +24% YoY to RMB2,289mn, 9% above consensus due to RMB94mn/82mn YoY increase of fair value gain/other income. The 10% share price drop last Friday was partly because share price already ran ahead of 3Q20 results release. Share price jumped 9% from 23 to 29 Oct (vs MN’s 1% drop). We think Yili will implement four measures to offset raw milk pressure, and therefore we kept FY21/22E NP estimates unchanged. We expect Yili would continue to benefit from industry consolidation. Maintain Buy.

　　3Q20 NP beat but GPM missed. Revenue rose 11% YoY in 3Q20, which is in line with consensus and our expectation, led by 19%/10%/1% growth of milk powder/liquid milk/ice-cream segments. GPM fell 1.3ppt to 34.7% because of 6-7% raw milk price growth (RMB4.5kg in 3Q20 vs China ModernDairy’s ASP ~RMB4.2/kg) and dilution by Westland. That said, selling expenses ratio fell 1.4ppt to 20.5%, offsetting the impact of GPM decline.

　　Four measures to offset raw milk pressure. Management expects raw milk price to grow by high single-digit in 2H20E and increase further in FY21E. (1) Reduce discount promotion: Our sources of channel check found retail prices of Satine rose to RMB65 in second half of Oct (highest level since Feb)and so did MN’s Milk Deluxe (Figure 4 & 5). Management expects the sector would be more disciplined in promotions. (2) Control raw milk source: Yili became the largest shareholder of Zhongdi (1492 HK) in Sep and its associate company, Youran, bought two farms from Fonterra China in Oct. (3) Product innovation: For example, Ambrosial launched a high-end 5G protein in Aug and Satine will launch a high-end 4.0g UHT milk in 1Q21. The retail price/gramof 5G protein is more than double of Ambrosial original favour (Figure 6 & 7). (4) Improve efficiency of selling expenses: Selling expenses ratio fell 0.9ppt to 22.7% in 9M20 through more precise marketing such as online advertising. It’s 12.3% A&P exp. ratio in FY19 was higher than many major consumer names(Figure 9). As dairy sector leader, we think Yili has room to improve efficiency. Management expects slight drop of selling expenses ratio in FY21E.

　　To become global top three dairy company in 2025. The Company targets to become global top 3 dairy players in 2025 and the largest player in 2030. In the 14th five year period, Yili will strengthen its leadership and growth in dairy sector, while sales contribution by non-dairy products and overseas market will not be significant. At a 10% sales CAGR in 2019-25, we believe Yili could reach top 3 in 2025 (Figure 8).

　　Maintain Buy. We lifted FY20E NP by 4% to reflect strong 3Q20 results and maintain our NP estimates in FY21/22E. Our TP is kept at RMB45.90, still based on 32x FY21E P/E. Catalysts: better-than-expected revenue and margins. Risks: Raw milk cost pressure, food safety issues.