Profit warning: 1H23 net profit fell 57-61% compared with the same period last year; profit margin in the second half of the year is expected to improve

Hyundai Dairy issued a profit warning that 1H23 net profit would fall 57-61 per cent year-on-year to 2-220 million due to falling raw milk prices, high feed costs and widening losses on the fair value of biological assets (up 1.8-240 million year-on-year). We expect that weak terminal consumer demand may lead to continued pressure on 2H23 raw milk prices, while feed costs are expected to improve month-on-month (mainly due to price locking and higher yield per unit area), leading to a month-on-month recovery of gross profit margin. We expect industry profit margins to be squeezed by falling milk prices and high costs, driving the exit of small and medium-sized farms, coupled with a slowdown in the expansion of large farms, supply and demand are expected to improve gradually next year. We downgrade the 23-25e basic EPS forecast of 32.5 EPS 17.0 to 0.08 PE 0.12 to 0.15, and the target price to 22% to HK $0.94, corresponding to 12-month dynamic basic PE 0.10 yuan and 8.4 times 12-month dynamic PE (average since 2019). Maintain "buy".

Continuous improvement of raw milk management index

We expect 1H23 revenue to grow by 18% to 6.6 billion yuan. Among them, raw milk business revenue increased by about 4 per cent, driven by a year-on-year decline in the price of raw milk in low and medium units (the average domestic raw milk price fell 5.6 per cent in the same period) and a year-on-year increase in raw milk sales in high units, while feed business revenue grew by more than 100 per cent to 1.6 billion. As of June 30, the stock of modern animal husbandry cows increased 9 per cent to 420000 head compared with the same period last year, and the annualized yield of adult cows increased by 2 per cent to 12.6 tons in the first half of the year. We expect raw milk business revenue to grow 5 per cent to 10.5 billion year-on-year for the whole year, of which raw milk prices are down about 4 per cent and sales are up 9 per cent.

Profit margins are squeezed by weak milk prices and high feed costs

1H23 raw milk gross profit margin fell 4pp to about 28% year-on-year, mainly due to falling raw milk prices and rising feed costs. According to Wind,1H23, the domestic average price of jade rice / soybean meal increased by 4.8% compared with the same period last year, while modern animal husbandry needs to give priority to the relatively high-priced inventory at the end of last year; at the same time, the company partly hedged the pressure of rising raw material costs by locking prices and increasing per unit yield. Taking into account the rapid increase in revenue from the feed business with low gross margin, we expect the gross profit margin of the 1H23 Group to shrink by about 5.8pp to 23.6%. Group cash EBITDA fell 10-15% year-on-year to 12.3-1.3 billion. Due to the decline in the sale price of 1H23 beef cattle, the fair value loss of biological assets increased by 1.8-240 million year-on-year (1H22: loss of 338 million), resulting in a 57-61% decline in net profit to 2-220 million. We expect 1H23's net profit margin to be about 3.2 per cent.

Reduce the net profit of 2023E-25E to 6.0amp, 9.6pm, 1.22 billion.

We lowered the net profit of 2023E-25E by 32.5 amp 17.0 pm 14.2% to 6.0 pm 9.6 pm 1.22 billion to reflect that full-year milk prices may maintain a downward trend under weak demand, as well as an increase in fair value loss of biological assets. We expect the net interest rate of modern animal husbandry to be 4.4 per cent, 6.3 per cent, 7.3 per cent over the same period. Hyundai shares correspond to 7.1x 12-month dynamic PE, a 16% discount to the average PE valuation since 2019.

Risk tips: 1) raw milk prices are lower than we expected; 2) feed costs rise sharply; 3) capital expenditure is higher than we expected; and 4) implement higher-cost external financing programs.