The 1H23 performance was in line with the forecast; gross margin was squeezed by weak milk prices and high feed costs, Youran Animal Husbandry announced its 1H23 net profit loss of 990 million yuan (1H22: profit of 220 million), in line with the company's previous profit warning of a loss of 9.5 to 1.03 billion dollars, mainly due to falling raw milk prices, high feed costs, and a sharp increase in the fair value of biological assets (1H23:2.26 billion; 1H22:850 million). We expect that weak terminal consumer demand may cause the price of 2H23 raw milk to continue to be pressured, the cost of superimposed feed is still high, and 2H23 gross margin is expected to continue to shrink. We lowered our 2023E-25E diluted EPS forecast to -0.33/+0.26/+0.43 yuan to reflect the trend of continued weakness in milk prices due to weak demand, higher financial expenses, and a sharp increase in the fair value loss of biological assets. We lowered our target price by 21% to HK$1.9, based on 24E diluted EPS of $0.26 and 6.7 times dynamic PE (modern animal husbandry's historical average PE has been reduced by 0.5SD over 19 years to reflect high feed costs). Maintain buys.
Revenue from the raw milk business continued to grow rapidly; herd storage continued to expand rapidly, 1H23, and revenue increased 4.2%. Among them, the raw milk/ruminant breeding systematic solution (CRFS) business was +18.0/ -16.3% year-on-year, respectively, accounting for 68/ 32% of total revenue. Revenue growth in the raw milk business was mainly driven by a 24.4% increase in sales volume, while the average selling price fell 5.1% year over year. In the first half of the year, the total herd/adult cows increased by 8.0/ 9.5% month-on-month to 539,400/253,633 heads, with adult cows accounting for 47% (2022:
46%), yield increased 7% year over year to 12.2 tons. The price of specialty milk is still maintaining a relatively stable trend, with little decline compared to the industry. The cost of feed per superimposed unit increased by 2.5%, the GPM of the 1H23 raw milk business contracted 3.9 pp to 28.3% year on year, while the share of the CRFS business with low GPM declined, and the Group's GPM fell by only 1.0 pp to 23.1% year on year.
High financial costs; significant loss of fair value of biological assets
The ratio of Youran 1H23 operating expenses to sales was roughly stable at 7.3% (1H22:7.0%); financial expenses increased to 560 million dollars (1H22:5.1 billion), mainly due to the increase in interest expenses due to the increase in the size of debt. Youran's net debt rose from $19.9 billion at the end of 2022 to $25.3 billion at 1H23, and the net debt ratio rose from 135% to 191% to support the expansion of its inventory size. In the first half of the year, under the influence of falling raw milk prices, rising feed costs, falling beef prices, and a relatively high share of reserve cattle, the fair value loss of biological assets reached 2.26 billion dollars, significantly higher than in previous years (4/16 billion for the full year 2022/2021). We expect these factors to continue in the second half of the year, and the loss of fair value of biological assets is expected to reach 3.5 billion dollars for the whole year.
Adjust the profit forecast and lower the target price to HK$1.9
The stock price of Youran Animal Husbandry corresponds to 5.4 times PE in 2024, a 36% discount compared to Hyundai Animal Husbandry's historical average PE value since 2019 (8.4 times). Youran's stock price has fallen by 31% since the beginning of the year, which may reflect investors' expectations of weak demand. Considering that a gradual recovery in milk prices next year will help repair the company's performance, we remain “buying.”
Risk warning: 1) The price of raw milk is lower than our expectations; 2) the cost of feed is rising rapidly; 3) the loss of fair value of convertible notes is increasing.