Yili:3Q17earnings beat;reiterating Buy on continued sales re
Strong sales growth on recovering sector growth and market sharegains. We estimate the industry retail growth recovered from low singledigit in 3Q16 to high single digit in 3Q17, helped by less price discounton more balanced supply. Meanwhile, Yili's market share in Ambient/chilled products/IMF expanded from 31%/15%/5.7% to 34%/16%/6%respectively (Figure 1).
Industry recovery and market share gains through high-end products.We expect the liquid milk industry to grow by 6% in 3Q17(vs. 7% in 1H17)and Yili's market share in liquid milk to increase from 33.6% in June to34% in September. High-end products, including UHT yoghurt, high-endyoghurt and pro biotic drinks, are the key sales drivers. Meanwhile, weexpect the lower tier region and special channel to deliver higher salesgrowth helped by Yili's increasing penetrations.
Selling expense/sales ratio declined 100bps yoy to 21.9%, helped byeasing of competition within a more balanced supply environment.
Our recent channel check indicates that its sales growth remainsstrong in 3Q. The Shanghai distributor indicated that its room temperateproducts grew at 8% in both 1H17and 3Q; the Shenzhen distributorindicated its sales grew at higher than 10% YTD. Meanwhile, we find thatMengniu and Yili are revising up ex-factory price and retail price from July,implying that industry competition continues to ease down.
G&A expense declined 150bps yoy to 6.2% from a high base, as Yiliincurred incremental G&A for some one-off event (i.e. internal propertymaintenance).
90bps yoy expansion of recurring EBIT margin. Our recent channelcheck indicates the price competition is stabilizing. We believe themore balanced supply/demand in upstream should also lead to a stablecompetition environment. Accordingly, we forecast a yoy flattish sellingexpense/sales ratio in 3Q17. The yoy EBIT margin expansion is mainlyhelped by lower G&A/sales from a high base in 3Q16, while partly offsetby lower gross margin on rising packaging cost and milk powder price.
SG&A expense savings was partly offset by 102bps yoy decline in grossmargin, due to rising raw milk and packaging prices.
Sales growth to accelerate in 2017-19
Improving inventory turnover indicates that 4Q growth to remain strong.
Liquid milk growth is recovering from low single digits in 2016to high single digitsin 2017. Firstly, we think this is mainly helped by more balanced supply from2017, and we expect raw milk cycle to turn from over-supply in 2014-16to undersupplyin 2018-19. Secondly, the recovery is also helped by trading up demandfrom low-end milk beverage to pure milk and yoghurt. Thirdly, this is helped byYili's increasing penetration in lower tier regions and special channels. We believethese drivers are sustainable. We forecast Yili's sales CAGR to improve from 8%in 2014-16to 11% in 2017-18E.
Inventory days improved from 31.9 days in 3Q16 to 30 days in 3Q17. Given theproduction date is an important decision factor when consumers choose brandsin retail ends, the shorten inventory days indicate improving fresh level of theproducts, which should help to drive its sales growth in 4Q17. The improvinginventory days also indicate a more balanced supply and demand market.
We expect the recovery trend to continue with an under supply environment.
We believe Yili's growth recovery from 2Q is mainly driven by more balancedsupply from 2017. After three years capacity reductions for upstream dairy farmsfrom 2014, raw milk supply is becoming more balanced with demand from 2017.
During the over supply environment, smaller dairy players could source raw milkat a heavy discount compared with large brands, but during the under supply environment from 2017, smaller players need to pay a premium instead. This helpslarge players such as Yili and Mengniu to gain market share.
We are revising up our earnings forecast by 2-4% in 2017-19E, mainly to factorin higher-than-expected sales driven by Yili's market share gains. We revise upour TP by 13% to Rmb31.6 based on a DCF approach, factoring in a 9.5% WACC(3.9% RFR, 5.6% ERP, 1.0 beta, debt-free structure) and 2% terminal growth. Wereiterate Yili as our top pick among our A share coverage. Downside risks: higherthan-expected raw material price increase, food safety incidents and worse-thanexpectedcompetition.
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