1H23 strengthens channel control in an unfavorable environment; payout rates are expected to increase
Although the infant formula industry faces insufficient demand, increased competition, and a short-term registration system that accelerates industry inventory removal, Feihe continues to strengthen its product power and channel control. When introducing new products, it has carried out digital ecosystem reforms from May to August, covering 40,000 terminal outlets, effectively reducing channel inventory and controlling smuggling and price management. We believe Feihe will precede the recovery of the industry and continue to expand its market share. In June of this year, the company's offline/online infant formula market share increased by 1.4/0.7 pp to 23.1/ 13.1%, respectively, over the same period last year. 1H23 Feihe has a dividend of 0.12 yuan per share, a dividend rate of 66%, and will increase its dividend level in the future (2022:45%).
Considering that short-term demand in the industry is still insufficient and competition is fierce, we lowered the basic EPS of 23E-25E by 15/9/ 6% to 0.52/0.61/0.68 yuan. Based on 10.3 times dynamic PE (average historical PE reduced by 0.5SD due to intense competition) and dynamic EPS of $0.58, we lowered our target price by 12% to HK$6.5. Buy it in.
Channel inventory health will support a rebound in 2H23's revenue growth rate; Sanzhuo products became the focus of revenue growth, and Feihe 1H23 milk powder business revenue declined by about 2% year on year. Among them, the ultra-high-end, high-end, and regular series were +6/-13/ -21% year on year, respectively. Through digital store transformation in the first half of the year, Feihe actively removed Star Flying Sail's inventory of 2.5 billion dollars. Currently, the inventory of the digital ecosystem store Starfly has been completely removed. The inventory of the national dealer channel Starfly is only 0.7 times that of sales. Channel inventory health will support a rebound in 2H23's revenue growth rate. In terms of new products, the company launched a new national standard version of Lamb Miao Ke in March, Starfly Premium Care (focusing on lactoferrin +10 times probiotics) on 1Q23, Starfly Premium Care's Wonderful Can (digital ecology store exclusive) in July, and will soon launch Zhuo Rui A2 (organic A2 milk source) and Lamb Miao Ke's digital ecological store exclusive products in September.
Management expects the total revenue of Zhuorui/ AdvantageCare/ Zhuoyao products to reach $6-7 billion in 23 years.
The short-term cost ratio of building a digital ecosystem will strengthen the company's channel advantage 1H23, and the gross margin will shrink by 2.3 pp year-on-year, mainly due to the decline in the share of classic Star Flying Sailing products with a gross margin of about 73%. The 1H23 sales expense ratio increased by 3.1 pp to 35.5% year on year, mainly due to the creation of digital ecosystem platforms and the increase in offline activity expenses. The digital ecosystem platform can achieve full-process coverage and data tracking for consumers, terminal stores, dealers, and star mom's preferred applets. The consumer places an order on the Xing Mom Preferred Mini Program, and the dealer ships it directly. We expect the cost of building a digital ecosystem platform to be reduced month-on-month in the second half of the year. 1H23 Feihe hosted about 480,000 offline events, received over 1 million new visitors, and had a conversion rate of 30% for the Mom's Love Campaign. At the same time, the number of Star Mom Club members exceeded 63 million, and the number of members participating in online events exceeded 31.64 million.
Lower target price to HK$6.5; maintain “buy” rating
Feihe's current stock price corresponds to 7.4 times the 12-month forward PE, which is 44% off from the historical PE average (13.2 times). The company's stock price has fallen 32% since the beginning of the year, reflecting investors' expectations of insufficient demand and pressure on performance. We expect Feihe to lead the recovery of the industry with the support of healthy channel inventories and digital ecosystem platforms. Maintain the “buy”.
Risk warning: Downside risks: 1) the number of newborns in China continues to decline; 2) increased competition in the goat milk powder market; 3) unfavorable changes in the foreign exchange rate ratio; 4) food safety issues. Upside risks: 1) Consumer demand for terminal milk powder is improving; 2) The recovery of the milk powder business is accelerating.