In 2022, the company's milk price and feed cost performance were superior to the industry. Production capacity and yield increased rapidly. The company's revenue/return net profit for the whole year was +73.7%/-44.8% year-on-year to 12.30 billion dollars/560 million yuan. Among them, poor profit performance was mainly due to rising costs and falling milk prices. Management and financial expenses increased due to the company's acquisition of Ai Kei Cow and the expansion of production capacity, and the annual exchange loss of 380 million yuan dragged down performance. Looking ahead to 2023, we expect the company's feed costs to gradually drop, and the gradual recovery in demand for dairy products will drive the company's performance to improve.

The company's revenue/net profit attributable to the mother in 2022 was +73.7%/-44.8% year-on-year to 12.30 billion dollars/560 million yuan. Benefiting from the expansion of herd size, increased yield, and rapid development of the feed business after mergers and acquisitions in 2022, the company's revenue increased 73.7% to 12.30 billion yuan, of which H2 revenue increased 70.9%. In 2022, the company's net profit fell 44.8% to $560 million due to continued increases in feed prices, increased management and financial expenses due to mergers and acquisitions, exchange losses, and profit and loss on derivative financial instruments, of which H2's profit fell 89.4%. Excluding the impact of exchange gains and losses and gains and losses on derivative financial instruments, the company's adjusted net profit increased 2.7% to 950 million yuan throughout the year.

Gross margin declined due to feed cost pressure and changes in business structure, and rates increased year-on-year during the period. By business, the company's raw milk revenue in 2022 was +42.0% year-on-year to 9.95 billion yuan, accounting for 81%, mainly due to the expansion of the size of the herd and the increase in yield; feed revenue increased about 30 times to 2.35 billion yuan, accounting for 19%, mainly due to the acquisition of Ai Raising Cows and the expansion of downstream customers. The gross margin of the company's raw milk business fell 5.1 Pcts to 31.1% in 2022, mainly due to rising feed costs and falling milk prices; the gross margin of the feed business fell by 12.5 Pcts to 7.3%, mainly due to changes in the internal business structure. Under the combined influence, the company's gross margin in 2022 was -9.4 Pcts year-on-year to 26.6%, of which H2 gross margin was -10.9 Pcts year-on-year. In 2022, the company's sales/management/finance rates were +0.4pct/+0.6pct/+0.3pct to 3.0%/5.9%/3.1%, respectively. The increase in management fee rates was mainly due to the different periods of consolidated financial statements after mergers and acquisitions, the increase in personnel size, and the increase in salary incentive expenses. The increase in financial expense ratio was mainly due to the increase in debt scale brought about by mergers and acquisitions of Ai Raising Cattle. The company period rate was +1.3pcts to 12.0% year-on-year. In 2022, the company's exchange loss was 380 million yuan (profit for the same period last year was 80 million yuan) and biological asset impairment was 990 million yuan (mainly due to a decline in the share of adult dairy cows, compared to 960 million yuan in the same period last year), which dragged down profit performance.

Supply and demand in the raw milk industry have eased and feed costs have risen. The company's milk prices have also dropped by 3.2%, and the cost of a single kilogram of raw milk has increased 6.5%. Affected by the increase in the supply of raw milk in the industry and the demand for dairy products disrupted by the epidemic, the company's raw milk sales price fell 3.2% to 4.27 yuan/kg in 2022 (the price of raw milk in the industry fell 3.0% to 4.16 yuan/kg). Feed prices were at an all-time high in 2022. Soybean meal/alfalfa grass/cottonseed prices were +25%/+36%/+20% year on year, with a cumulative increase of 44%/51%/61% over the past three years. By strengthening and simplifying the procurement process, using a unified procurement platform, optimizing feed formulations, adjusting feed structure, continuously increasing yield and reducing operating costs, the company effectively calmed the impact of some feed cost increases. As a result, feed costs for single kilogram cows increased 11.0% to 2.33 yuan, and sales costs for single kilogram dairy cows increased 6.5% to 2.97 yuan, and the performance was superior to the industry average.

In 2022, the yield of dairy cows was +8% compared to the same period last year. The scale of adult dairy cows continued to expand, and the company's raw milk production and sales increased rapidly.

In 2022, driven by many factors such as effective herd management, genetic improvement of dairy cows, and more herds reaching peak lactation, the yield of the company's dairy cows was +8.0% to 12.2 tons compared to the same period last year, exceeding the expectations set in the guidelines at the beginning of the year. The size of the company's dairy cows continues to grow. As of the end of 2022, it had 405,000 cows, an increase of 52,000 over the end of 2021. Among them, adult cows/calves and young cows increased by 15,000/36,000 heads respectively. The increase in yield and the scale of adult dairy cows drove the company's annual raw milk production/sales volume to +46.6%/+46.7% year-on-year to 2,360 million tons/2,327 million tons.

2023 outlook: Milk prices continue to fall and feed prices fall from high levels, and the overall industry chain layout is expected to increase profitability.

Affected by the rapid increase in the supply of raw milk in the industry than the recovery in downstream demand for dairy products, the price of raw milk has continued to fall since 2023. Data from the Ministry of Agriculture shows that the price of raw milk in March was -4.8% year on year. We expect prices to drop per unit year over year. On the feed side, the high price of soybean meal has declined since 2023. Data from the Ministry of Agriculture shows that the price of soybean meal in March was -2.2% year on year. Looking ahead to the whole year, we think the cost of soybean meal will improve, and the cost of corn is expected to decline steadily. The company acquired 75% of Aiyangniu Technology's shares in June 2022, expanded its business to animal husbandry internet platform operation, and further strengthened the collaborative advantages of the entire industry chain. The company has achieved a full industry chain layout from raw milk business, feed sector, beef cattle industry, breeding business, digital intelligence platform to grassroots resources. In the future, it can provide digital technology, supply chain finance, breeding technology and other services upstream and downstream based on an ecological shared platform, which is expected to enhance profitability. The company has set the target of storing 500,000 heads and producing 3.6 million tons of milk in 2025, which is expected to be achieved steadily under the operation of the entire industry chain.

Risk factors: The price of raw milk fell more than expected, feed costs rose sharply, production capacity expansion fell short of expectations, risk of environmental policy changes, dairy cow disease and other natural risks.

Investment advice: Considering that the company's profit performance in 2022 fell short of expectations, we lowered the company's 2023/24 EPS forecast to 0.11/0.16 yuan (the original forecast was 0.16/0.19 yuan), and the new 2025 EPS forecast was 0.23 yuan. Referring to the comparable company Youran Animal Husbandry Dynamics PE 9x (Wind's unanimous expectations), considering the company's excellent ability to control costs and leading the industry in terms of herd size, we gave the company a target PE of 10 times for 2023, corresponding to the target price of HK$1.2, and maintained an “increase in holdings” rating.