China Mengniu Profit Gains as Foreign Tie-ups Boost Sales

China Mengniu Dairy Co. (2319), the country’s largest dairy producer, increased first-half earnings 16 percent as tie-ups with foreign milk producers helped reassure customers its products were safe. Shares surged.

Mengniu turned to France’s Danone SA and Denmark’s Arla Foods amba to win back confidence from Chinese consumers after a series of food safety scandals hammered sales of domestic dairy products. Mengniu also made deals to strengthen control of its supply chain and expand its infant formula business. The company agreed to buy a stake in raw-milk producer China Modern Dairy Holdings Ltd. in May to gain greater control of milk supplies.

“The overall industry is seeing decent growth in volumes,” Emma Liu, a Hong Kong-based analyst at Nomura Holdings Inc., said before the earnings announcement. “As consumers grow increasingly aware of food safety, they will stick to the big brands.”

The Hohhot, Inner Mongolia-based producer said in a filing to the Hong Kong stock exchange late yesterday that first-half net income climbed to 749.5 million yuan ($122 million) from 644.7 million yuan a year earlier. That compared with the 753.6 million yuan average of seven analyst estimates compiled by Bloomberg. Sales increased 13 percent to 20.67 billion yuan from 18.24 billion yuan.

Mengniu shares jumped as much as 7.9 percent to HK$32.20 in Hong Kong today, headed for the biggest gain since May 20. The stock traded 7.5 percent higher at HK$32.10 at 2:50 p.m. local time. The company’s stock has gained 46 percent this year, compared with a 4.5 percent decline in the benchmark Hang Seng Index.

Danone Deal

The company’s introduction of new and more expensive products this year, and improvement of existing ones helped boost consumer confidence and sales, Sun Yiping, Mengniu’s chief executive officer said in a briefing in Hong Kong today. A shortage and resulting rise in the cost of raw milk led to higher costs in the first six months of the year, she said.

Mengniu announced three major deals in two months, including a tie-up with Paris-based Danone SA (BN) and an investment in baby milk company Yashili International Holdings Ltd. (1230), amid a government push to improve product standards and consolidate the industry.

Danone, the French owner of Activia yogurt and Evian water, said in May it would spend 325 million euros ($434.6 million) to form a joint venture with Mengniu and invest in the company. The Chinese producer, which sells dairy products ranging from yogurt to liquid milk under its namesake brand on the mainland, already has a tie-up with Danish producer Arla Foods amba from 2012.

Mengniu will have more room to grow as China’s per capita consumption of dairy remains low, said Liu, who has a buy rating on the stock.

Supply Chain

In 2011, the company said moldy cattle feed led to excessive toxin levels in its milk. Mengniu was among 22 dairy companies found to have sold products containing the chemical melamine in 2008, when tainted powder killed six infants in China.

Mengniu also made deals to strengthen control of its supply chain and expand its infant formula business. The company agreed to buy a 26.9 percent stake in raw-milk producer China Modern Dairy Holdings (1117) in May for HK$3.18 billion ($410 million) in a deal that would give it preferential purchase rights to Modern Dairy’s milk supply.

The dairy product maker also offered to buy 75 percent of Yashili in a deal valued at about HK$12.5 billion in June.

Yashili ranked seventh in China’s infant-formula market last year with a 4.7 percent share, according to market researcher Euromonitor International. The investment will give Mengniu “an immediate and strong presence” in the smaller Chinese cities beyond Beijing, Shanghai and Guangzhou, Jacqueline Ko, a Hong Kong-based analyst at Kim Eng Securities, wrote in a report this month.

Food Quality

Mengniu will also benefit from China’s push to consolidate its dairy industry as authorities may implement policies favorable to local companies while seeking to improve food quality standards, said Ko, who has a buy rating on the stock.

Of the 30 analysts covering Mengniu, 22 have a buy rating, six have a hold call and two have a sell recommendation, according data compiled by Bloomberg,

China is seeking to groom as many as five large domestic infant-formula companies as part of the government’s move to raise product standards by 2018, the China Securities Journal reported Aug 16.

The plan, which will be put in place in stages starting this year, envisions the creation of up to five firms with more than 5 billion yuan of annual sales by the end of 2018, the newspaper said, citing people it didn’t identify.

Mengniu has the biggest share in China’s drinking milk market, with about 34 percent in 2012, according to Euromonitor.

To contact Bloomberg News staff for this story: Liza Lin in Shanghai at llin15@bloomberg.net

To contact the editor responsible for this story: Stephanie Wong at swong139@bloomberg.net

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