In 2022, the company's revenue/net net profit was +17.6%/-56.4% year-on-year, of which 22H2 revenue/net net profit was +16%/-49.7% year-on-year, respectively. The year-on-year decline in milk prices and feed costs were under pressure, compounded by the impact of loss of 1.62 billion yuan due to the adjustment of the fair value of biological assets. The company's annual profit was under pressure, but management and control capabilities continued to be excellent. The company plans to continue to build new ranches to keep herds growing, while starting technological transformation is expected to improve profits. Considering the company's market position as the largest ranch in China, as well as a clear plan to increase production and excellent control capabilities, we gave the company 2023 PE 10x, corresponding to the target price of HK$2.6, maintaining the “increase in holdings” rating.

Steady income growth, rising costs & falling milk prices & adjustments to the fair value of biological assets dragged down net profits. In 2022, the company achieved revenue/net non-net profit of 18.05/890 million yuan, +17.6%/-56.4%, respectively, of which H2's revenue/net non-net profit was 9.34/45 billion yuan, +16.0%/-49.7% year-on-year. By business, revenue from the raw milk/ruminant farming systematic solution business in 2022 was 10885/7.20 billion yuan respectively, +13.8%/+23.9%, respectively, of which H2 was +8.7%/+29.3% year on year. The company's gross margin in 2022 was -7.2 Pcts to 23.4% year on year, mainly due to a sharp increase in raw material prices and a decline in raw milk sales prices. The company's expense management continues to be excellent. The sales/management expenses ratio in 2022 was -0.3 Pct/-1.4 Pcts to 3.3%/4.0%, respectively. Affected by the increase in interest on convertible stock notes and bank loans, the financial expense ratio was +1.3 Pcts to 6.1% over the same period last year.

The fair value adjustment of the company's biological assets in 2022 resulted in a loss of 1.62 billion yuan (loss of 4.1 billion yuan in the same period last year), which dragged down the company's net profit.

The increase in the price & cost of raw milk was superior to that of the industry. The annual milk price was -4.8% to 4.66 yuan/kg, and the cost of raw milk was +11.4% to 4.69 yuan/kg compared to the same period last year. The supply and demand for raw milk eased in 2022, and the company's annual milk price was -4.8% year over year to 4.66 yuan/kg (industry milk price was 4.16 yuan/kg), of which H2 milk price was -7.8% year-on-year to 4.69 yuan/kg.

On the cost side, feed prices such as corn and soybean meal have risen markedly. The annual price of soybean/alfalfa grass/corn was +25%/+36%/+2% (wind, China Customs, Ministry of Agriculture), and the company's total annual cost per kilogram was +11.4% to 3.2 yuan (22H2 +10.9%). The company took advantage of large-scale procurement advantages, promoted technological innovation, optimized feed formulations, and used low-cost raw material alternatives to cope with feed cost pressure and better control the cost increase. The cost increase exceeded the increase in milk prices, and the company effectively controlled the decline in raw milk gross margin by optimizing the product structure. The annual gross margin of the raw milk business was -10.Pcts to 31.4% year on year (22H2 year-on-year - 11.7 Pcs), and overall profitability is still at the leading level in the industry. The gross margin of the company's ruminant farming systematic solutions business in 2022 was -1.5 Pcts to 11.3% year on year (22H2 -1.8 Pcs year-on-year), mainly dragged down by rising raw material prices.

Cows expanded their herds and increased yield, and raw milk production and sales increased rapidly. Driven by the acquisition of 2.16% of the shares in Wholesome Harvest and the cooperative investment and expansion of the ranch operation with Nissin, the company kept +20% of its dairy cows in 2022 to 499,000 heads compared to the same period last year. The share of the company's adult dairy cows ranged from -2.8 Pcts to 46.4% year-on-year, mainly affected by the youthfulness of the herd structure of newly built ranches. Through fine control of TPM, utilization of advanced technology and feed optimization, the company's own dairy cow yield in 2022 (excluding Fonterra China Ranch and SECOSTAR) was +2.6% to 11.7 tons compared to the same period last year, maintaining the trend of increasing yield. Empowered by the company's excellent ranch management experience, the yield of Fonterra China Ranch and Seco Star Ranch, which were previously acquired, increased rapidly in 2022 to +11.7%/+3.8%, respectively, to 11.5 tons/10.9 tons, respectively. With the expansion of dairy cows and the increase in yield, the company's annual raw milk production reached 2.38 million tons by +19.5% year on year, and sales reached 2.33 million tons by +19.6% year on year.

2023 outlook: Feed costs are expected to improve, and the company has initiated technological transformation to drive profit improvement. 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. The company is expected to maintain a relatively rapid increase in revenue in 2023, driven by the accelerated release of production capacity and the launch of feed mills. On the cost side, the pressure on feed costs is expected to ease. Data from the Ministry of Agriculture and Rural Affairs shows that soybean meal/corn prices in March were -2.2%/+2.3% compared to the same number of units. We expect the price of soybean meal to fall in units throughout the year, and the cost of corn is expected to fall steadily. In 2023, under the planning goal of “building an excellent animal husbandry in five years”, the company plans to continue to build new ranches to support the rapid growth of herds. At the same time, the company fully launched a technology transformation strategy to comprehensively promote the strategic goal of technological empowerment and upgrading. In 2023, the company set up a digital center to digitally empower various businesses, while leveraging the advantages of the entire industry chain to continue to expand high-value-added businesses such as breeding technology, breeding technology, feed nutrition, etc., and profitability is expected to increase.

Risk factors: The price of raw milk fell more than expected; feed costs rose sharply; the company's capacity expansion fell short of expectations; environmental policy changes; dairy cow diseases and other natural disasters.

Investment advice: Considering that the profit performance in 2022 fell short of expectations and the downward pressure on raw milk prices in 2023, we lowered the company's 2023/24 EPS forecast to 0.21/0.25 yuan (the original forecast was 0.42/0.50 yuan), and the new 2025 EPS forecast was 0.28 yuan. Referring to the comparable company Hyundai Animal Husbandry's 2023 PE 8x valuation (Wind's consistent expectations), considering the company's market position as the largest ranch in China, a clear plan to increase production and excellent control capabilities, it was given 10 times PE in 2023, corresponding to the target price of HK$2.6, maintaining an “increase in holdings” rating.