Profit warning: 1H22 net profit is expected to fall by 75-82%

Youran Animal Husbandry issued a profit warning that 1H22 net profit is expected to fall 75-82 per cent year-on-year to 168 million-234 million yuan, mainly due to the loss of the fair value of biological assets of no less than 900 million yuan, lower gross profit margins caused by rising feed costs and financial costs rising with the expansion of capital expenditure. Excluding changes in the fair value of biological assets, we expect 1H22-adjusted net profit to grow by 27-35 per cent year-on-year.

Taking into account the softening of raw milk prices and the rapid rise in raw material prices, we have lowered our diluted EPS forecast for 2022-24 by 46x23 per cent to RMB 0.27per cent and target price by 29 per cent to HK $4.60, based on 9.9x (the average historical PE since 2019 for modern farming) and 12-month dynamic dilution of EPS of RMB0.39. Maintain "buy".

Raw milk price weakens, feed cost rises, eroding gross profit margin

We expect 1H22 gross margin to contract by 2.6% year-on-year to 28.0%, mainly due to expected contraction in raw milk business, while gross margin in ruminant farming systematic solutions (CRFS) business is expected to remain stable. According to Wande information, the average price of raw milk in 1H22 fell 1.7% year on year, while the average domestic soybean price rose 10.7% year on year, and the average domestic corn price was basically the same as the same period last year.

Given that the price of raw milk in the second half of the year is usually higher than that in the first half and the increase in feed costs is expected to slow, we expect 2H22 gross profit margin to rise month-on-month.

The fair value loss of biological assets is expected to narrow in the second half of the year.

The change of fair value of biological assets of dairy farming enterprises is determined by a variety of operating factors, mainly concentrated in raw milk price, feed cost, per unit yield, herd structure and dairy cow market sales price. The fair value loss of 1H22 biological assets is not less than RMB900 million, which is significantly higher than that in previous years (RMB 414 million / 407 million in 202021), which we believe is mainly due to the decline in raw milk prices and the increase in overall feed costs. Assuming a decline in feed costs, we expect the fair value loss to narrow in 2H22.

Adjust the profit forecast and lower the target price to HK $4.6

We left our sales forecast for 2022-24 basically unchanged, reducing our gross margin forecast by 1.9% to 2.0%, mainly reflecting the rapid rise in raw material prices. Youran aims to increase the herd size from 416000 in 2021 to 800000 in 2026, with a CAGR of 39 per cent. Rapid expansion involves a large amount of capital investment, so we raise the assumption of financial expenses. To sum up, we have lowered our net profit forecast by 57x39 pounds by 38% to RMB 1 billion / 1.8 billion / 2.2 billion. We have downgraded our diluted EPS forecast by 46% to RMB 0.27, 0.48, which is less than the net profit adjustment, mainly due to the fact that convertible notes are treated as bonds when the share price is below the conversion price of approximately HK $3.50 (US $0.44605). Youran's current stock price corresponds to 6.7x 12-month dynamic PE. Maintain "buy".

Risk tips: 1) the price of raw milk is lower than expected; 2) feed costs rise rapidly; 3) the fair value loss of convertible notes is higher than expected.