1H22 performance meets forecast; 2H22 gross profit margin continues to be under pressure

Youran Animal Husbandry (Youran) released its semi-annual report on August 29: net profit fell sharply by 76.5% year-on-year to 219 million yuan, in line with the profit warning issued by the company on July 22. The decline was mainly due to higher unit feed costs (1H22: 14.6 per cent year-on-year) and significant losses on the fair value of biological assets (852 million yuan). We believe that, as the largest dairy farming enterprise in China, Youran, like the same industry, will continue to be adversely affected by the tight balance of raw milk supply in the future, which may put pressure on the gross profit margin of the pasture. Therefore, we downgrade the diluted EPS forecast for 2022-24 by 24.9% PE 22.1% to 0.20 scarp 0.37 prime 0.46, and the target price by 26% to HK $3.40, based on the average diluted EPS forecast of modern animal husbandry since 2019 and Youran's 12-month trend (August 2023). Maintain "buy".

Sales drive revenue growth, average selling price is weak

1H22 revenue rose 19.4 per cent year-on-year, mainly due to a 19.9 per cent year-on-year increase in raw milk / ruminant farming systematic solutions (CRFS) business, with both accounting for 60 per cent of total revenue.

Sales growth in the raw milk business was mainly driven by 21.5 per cent year-on-year sales growth, partly offset by a 1.3 per cent year-on-year decline in average selling prices. The decline in the average price of raw milk is mainly due to the decline in the price of high-quality milk in the company (the change is similar to the 1.7% drop in the average raw milk price in the domestic industry compared with the same period last year), while the price of characteristic milk remains stable. Due to a 14.6% year-on-year increase in unit feed cost, the gross profit margin of 1H22 shrank by 5.2 percentage points year-on-year to 24.1%. Given the weak price of raw milk and the continuing trend of high feed costs, we expect 2H22 gross profit margin to shrink by 4.9% year-on-year to 26.9%.

The substantial loss of fair value of biological assets and high financial costs further reduced the net interest rate. However, the ratio of operating expenses to sales of 1H22 decreased by 1.4 percentage points compared with the same period last year, mainly due to effective cost control and operating leverage. The increase in the financial cost of 1H22 to RMB 512 million (1H21: RMB 298 million) is mainly due to an increase in actual interest expense on convertible notes. The fair value of 1H22 biological assets recorded a substantial loss of 852 million yuan (1H21: income of 97.63 million yuan), which also led to the consolidated loss of Secco Star (1H22 net profit of 103 million yuan, preferably holding 58% of its shares) and minority shareholders' equity contribution of 19.21 million yuan. Taken together, 1H22 net interest rates plunged 10.3 percentage points year-on-year to 2.5 per cent.

Lower profit forecast, low valuation

We will reduce the gross margin forecast of 2022Universe 2023Universe by 2.6 percentage points to 25.5%, 25.6%, 25.7%, to reflect unfavorable raw milk prices and high feed prices. Superimposing a higher financial expense forecast, we cut our net profit forecast by 24.9%, 22.2% and 21.1% to 800 million / 1.4 billion / 1.8 billion yuan. Youran's current share price corresponds to 6.8x 12-month dynamic PE, a 28% discount to our benchmark PE valuation. We believe that the current valuation is not high and maintain the "buy" rating.

Risk tips: 1) the price of raw milk is lower than expected; 2) the feed cost is rising rapidly; 3) the improvement of milk yield is weaker than expected.