Is China Mengniu Dairy’s Competitive Position in Danger?

Is China Mengniu Dairy Co Ltd’s (SEHK: 2319) dominance of the dairy part of Hong Kong’s stock market over? – Milk China dairy stocks

It was recently reported that China ZhongDi Dairy Holdings Company Ltd (SEHK: 1492) has attracted an investment from one of the Chinese dairy giants, Inner Mongolia Yili Industrial Group Co Ltd (SHA: 600887).

As a result of the investment, the share price of ZhongDi more than doubled the next day.

In this article, I will take a look at the reason driving this investment and the implications to Yili’s major competitor, Hong Kong-listed China Mengniu Dairy Co Ltd (SEHK: 2319).

Overview of ZhongDi

ZhongDi is a mid-sized dairy farm operator in China. It currently operates around eight modern dairy farms all over China’s prime zones of milk sources.

The company has been listed in Hong Kong since 2015 but its share price has been under pressure due to industry headwinds.

Prior to the announcement of Yili’s investment, its share price has dropped by almost 60% since its listing.

ZhongDi’s major business is in dairy farming. This includes the production and sales of premium raw milk and the feeding, breeding and sales of dairy cows, etc. This accounted for more than 99% of the group’s total revenue in 2019.

Land grab competition

The inventory of dairy cows in China reached its peak in 2014. It has been decreasing since 2014, causing a shortage in recent years.

As such, the two Chinese dairy giants, Yili and Mengniu, have been lately engaging in a competition of “land grabs” by buying and investing in major dairy farms in China in order to secure their supply of raw milk.

Mengniu now controls China Shengmu Organic Milk Ltd (SEHK: 1432), Yashili International Holdings Ltd (SEHK: 1230), and China Modern Dairy Holdings Ltd (SEHK: 1117). All these companies help Mengniu secure its upstream supply chain.

Yili’s investment in ZhongDi is, no doubt, targeting its dairy farming business to fight against the influence of Mengniu.

Yili vs. Mengniu

Mengniu was once a legend in the Chinese dairy market whose revenue managed to surpass the traditional heavyweight player, Yili.

However, in 2012, Yili managed to catch up with Mengniu and retook the leading position. And that lead has only been extended since then.

While both companies’ gross profit margins have been in line with each other over the past few years, Yili has been winning and leading in the area of net profit margin, due to its better channel mix.

The difference is also reflected in their share price movements. Since the beginning of 2012, Yili’s share price has gained more than 400% while Mengniu’s has only increased by slightly more than 200%.

As investors may well have noticed, traditionally Mengniu has dominated the dairy-focused part of the equity market in Hong Kong as it controls and invests in other Hong Kong-listed Chinese dairy companies.

While Yili traditionally focuses more on the onshore A-share market, its investment in Hong Kong-listed ZhongDi could mark its foray into the H-share market to challenge the dominance of Mengniu.

Foolish takeaway

Yili’s investment in ZhongDi, strategically, is to secure the supply of raw milk. But it could also signal its intention to challenge Mengiu’s dominance in the stock market in Hong Kong.

Mengniu will have to improve its revenue growth and margin in order to catch up with Yili.

Otherwise, with Yili’s better fundamentals, intelligent investors will know which cup of milk to drink from if a choice is given.

More reading

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Alec Tseung doesn’t own shares in any companies mentioned.

The Motley Fool Hong Kong Limited( 2020

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