China Milk: Strong 3QFY09 raw milk revenue

Strong raw milk revenue contribution despite tainted industry. Raw milk production increased by 26% YoY to 13,187 tonnes in 3QFY09. This is a positive as many of the bigger players in China’s dairy industry have fallen into the pit. Raw milk revenue grew by 24% YoY to RMB42m. We firmly believe that China Milk will be able to sell a total of 54,000/tonnes of raw milk for FY09 which equates to RMB155.5m revenue.

Firm operating profit growth of 27% but weak net profit due to CB. All of China Milk’s core businesses saw strong revenue growth during 3QFY09. Operating profit grew by 27% to RMB150.4m during the same period. However, its convertible bond was the main culprit which caused its net profit to slump to a growth of 1.9% to RMB119.1m in 3QFY09. Due to its change in fair value of derivative financial instruments component in its income statement, the company saw a loss of RMB8.1m in 3QFY09 compared to a gain of RMB24.6m in 3QFY08. We are concerned that China Milk has not bought back these CBs in the open market. We believe that China Milk will continue to monitor these convertible bonds and buy-back when the right opportunity arises.

Strong cash position offsets concerns of CB. The company is sitting on nearly RMB2b worth in cash (US$292.2m) which exceeds its US$150m convertible bond (maturing in 2010). Long term outlook. We believe that the key to China Milk’s success will be going downstream. The commencement of its own proprietary brand, Yinluo is a major step forward. However, the next step for China Milk is sealing what has been a long period of negotiations with an OEM customer. The milk processing business offers China Milk the ability to capture a large market share in China’s dairy industry. We will continue to monitor these developments. Maintain BUY. Pending our earnings revision, we maintain our price target of S$0.67 based on 5.0x FY09 P/E. We have given China Milk a premium to the FSTC FY09 P/E of 3.9x.

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