We hosted investors meeting with management recently. Key interested topics are sales recovery pace, margin trend, channel inventory level and 2H outlook. Excluding Junlebao and Bellamy’s, MN saw flat revenue growth in 1Q20 and positive revenue growth in Apr. We think its 1H20E organic revenue growth could beat guidance of slight YoY decline. MN would benefit from continuing sector consolidation. Going forward, we expect MN to deliver OPM expansion thanks to continuing momentum of high-margin products (Milk Deluxe and Just Yoghurt) and improvement of non-A&P selling expenses ratio. Maintain BUY.
- Sales recovery ahead of expectation. Organic revenue growth was flat in 1Q20 (vs -11% of Yili (600887 CH)) and turned positive in Apr. By category, UHT milk sales did not see decline in 1Q20 but milk beverage, UHT yoghurt and Yashili were relatively weaker. Management attributed the recovery to rapid and effective responses to COVID-19 impact such as promoting sales by keeping sales promoters in KA channel during CNY holidays, allocating more inventory to e-commerce channel and setting up >70,000 wechat groups for group purchases.
- Channel inventory notably improved. After clearing channel inventories manufactured last year and Jan 2020, both channel inventory and price levels notably improved from end of 1Q20 to end of Apr 2020, which is in line with our channel checks.
- 2H20E guidance maintained. NP would drop in 1H20E due to (1) weakened sales; (2) selling expenses spent for channel inventory destocking especially in Feb and Mar; (3) donation and expenses for epidemic prevention; (4) converting unused raw milk into milk powder would increase production cost of beverage, adult milk powder and ice-cream because such conversion cost is higher than import price of milk powder. That said, as both revenue growth and promotion discount improve QoQ in 2Q20E, we expect 2Q20E NPM would notably improve QoQ. Management maintained its 2H20E guidance of low-teens organic revenue growth and 30-50bps OPM expansion YoY.
- Maintain Buy. Our TP of HK$34.20 represents 28.0x average FY20E and FY21E EPS. Catalysts: better-than-expected revenue and margins; Risks: slower-than-expected recovery and food safety issues.
