1HFY20 net profit rose 18% YoY, 6%/4% above consensus/our estimates, due to stronger-than-expected GPM. The Company will adopt multi-brand strategy and channel diversification to drive growth and improve GPM. We raised FY20E net profit estimates by 3% and TP from HK$7.50 to HK$7.70. Maintain BUY.
- 1HFY20 results beat. Revenue rose 1% YoY to RMB9.3bn, 3% above consensus. Except popsicle sales fell by double-digit due to unfavorable weather, core brands (85% of revenue) achieved mid-single-digit growth. New products accounted for 9% of revenue (vs 7% in FY19). GPM widened by 4.4ppt YoY to 48.9%, 1.9ppt above consensus, which was 50%/25%/25% driven by VAT cut /product mix enhancement /drop of raw materials costs. SG&A expenses ratio rose 0.9ppt to 28.5%, driven by 1.0ppt increase of R&D expenses ratio on new products development.
- Multi-brand strategy and product upgrade to improve growth and GPM. The Company had initiated multi-brand strategy to target different age groups (from babies, children, youngsters to elderly) and differentiated needs (keep fit, OL snacks) of consumers. New products (such as “Tian She Mi Shao”, Pocket Jelly etc) and product upgrade (healthy and nutrition products such as low-sugar and trans-fatty acid free rice crackers, Hot-Kid pure milk etc) are brought in with high margins, while sales of low-margin sub-brands were reduced. New product sales mix increased to 9% in 1HFY20 from 7% in FY19.
- Channel diversification to drive growth. Sales mix from emerging channels increased from 5% in 1HFY19 to mid-to-high single-digit in 1HFY20, driven by rapid growth in e-commerce, maternity stores and themed stores channels. Management revealed GPM of emerging channels are generally higher than traditional channel because sales mainly come from new products. However, OPM of emerging channels is similar or slightly lower than traditional channel due to higher operating expenses ratio. We think OPM could improve in future when sales grow.
- 2HFY20E outlook. The Company will continue to improve revenue growth and GPM through multi-brand strategy, product upgrade and channel diversification. That said, due to prices rebound of milk powder and sugar, we expect raw materials prices will be higher in 2HFY20E. GPM is estimated to expand 0.7ppt YoY to 46.8% in 2HFY20E, at a slower pace than 1HFY20. Management targets A&P expenses ratio would remain at historical ranges despite multi-brand strategy and launch of new products. R&D expense would stay at around 1.5% for 1-2 years to develop new products.
- Lift TP to HK$7.70. We raised our FY20 net profit estimates by 3% mainly to reflect higher GPM assumption. Our TP is revised from HK$7.50 to HK$7.70, still based on 21.7x FY20E P/E (at historical average). Catalysts: (1) revenue growth accelerates; (2) better-than-expected margins. Risks: (1) keen competition; (2) food safety issues; (3) unfavorable raw materials prices.
