Room temperature milk increased 10-15% year-on-year in the fourth quarter of '21

Our recent channel research shows that Mengniu's room-temperature milk retail sales increased 10%-15% year-on-year in the fourth quarter of '21, while we forecast Mengniu's revenue to increase 10.8% year-on-year in the second half of '21. Dealers say Mengniu's growth rate exceeds Erie, mainly because Erie had a higher base last year. Overall, distributors confirm our view that Mengniu and Erie continue to seize market share from smaller brands. Mengniu and Erie have set a target for the distributor to grow by more than 10% year over year. There may be a round of price increases in the first half of '22. It is expected that future retail sales growth will come from consumption upgrades (especially in unpenetrated rural areas), an increase in the share of sales of high-end products, and direct price increases. Mengniu raised prices in June 2021 (mainly white milk products), increasing factory prices and retail prices by 3%-5%. Mengniu also cut promotional subsidies to distributors and raised factory prices in disguise. The distributor has yet to be notified of further price increases, but it is expected that there may be another round of price increases in the first half of '22. Cheese is expected to continue to grow rapidly. Distributors expect sales of leading cheese industry companies to increase by more than 50% year over year. So far, Myocorando (600882 CH, unrated) has grown faster than its peers, and is also the first company to enter the room temperature cheese market. Its new products were just launched in November and December. The dilution effect of HK$4.9 billion convertible bonds Limited Mengniu issued HK$4.9 billion 5-year convertible bonds (initial conversion price of HK$34.73) as employee incentives. Currently, it is planned to convert shares 5 times in 2022-2026, convert 10% of shares in the first year, and increase the share conversion ratio by 5% every year thereafter. After full conversion, the new shares will account for 4.2% of the current share capital and 3.4% of the expanded share capital. Proceeds will be used for: 1) 55% for raw milk supply, 2) 30% for raw materials, 3) 10% for wages and salaries, and 4) 5% for taxes.

Maintaining the purchase rating and target price of HK$53.9

We lowered our revenue forecast for FY21/22/23 by 1.6%, 2.1%, and 2.1% to reflect more conservative sales assumptions. As a result of the issuance of convertible bonds, we reduced our diluted earnings per share for FY21/22/23 by 0.8%, 3.4%, and 4.3%, respectively. Based on a price-earnings ratio of 28.9 times FY22 (previously 28.9 times), we reduced our target price to HK$53.9. Maintain buy-in ratings.

Catalyst: Significant growth in sales of high-end products; profit margin expansion greater than expectations; M&A opportunities;

Risk: The impact of rising raw milk costs is higher than expected.