China Mengniu Dairy has long attracted its fair share of headlines - mostly of the kind that the management and shareholders would rather wish away. But events of the past week have underscored a change in fortunes for the former industry leader on the mainland that some market watchers think may gain momentum.
Last week, Mengniu received a vote of confidence when French food giant Danone spent HK$5.15 billion to raise its stake in the company. The icing on the cake came the same day it was named as a new constituent stock of the Hang Seng Index.
Danone's top-up of its Mengniu holding will inject a much-needed dose of optimism in a sector - valued by Mengniu at US$40.6 billion last year - that has grappled with safety scandals and punishing competition over the past five years.
Investors rushed to give their appraisal on the Danone deal, pushing its shares to fresh highs at HK$39.50, while some analysts upgraded their target prices for the stock.
Still, the jury is out on whether Mengniu can recoup its lost ground as the mainland's No1 dairy firm by revenue after ceding the title to Shanghai-listed Inner Mongolia Yili in 2011.
"As long as Mengniu keeps its products from any safety scandals and the appetite for dairy products continues to increase, the company's future growth will be stable," Guotai Junan International analyst Sunny Kwok said. "The central government's decision to allow families to have two children instead of just one will fuel consumption."
Kwok upgraded Mengniu's target stock price to HK$41 in the next 12 to 18 months from HK$35.
BOC International also rerated the stock, to HK$43 from HK$37.95.
The stock yesterday closed 0.91 per cent firmer at HK$39.
In October 2007, the stock was trading at a high of HK$35.80 before it plunged to HK$6.03 a year later following the scandal over melamine-laced milk products which caused the death of at least six children and made 300,000 ill. Mengniu was among 22 dairy firms that sold contaminated products.
In 2011, some milk products from a Mengniu dairy farm in Sichuan were found to contain excessive levels of a potentially cancer-causing agent.
A period of management instability further clouded the outlook for the company.
In its road to recovery, Mengniu has bought into two rivals: in May last year, it paid HK$3.17 billion for 28 per cent of Modern China Dairy to secure a stable supply of raw milk; in June, it offered to take over milk formula maker Yashili International for HK$11.4 billion, the biggest acquisition in the dairy industry in the country. It now owns 76.58 per cent of Yashili.
The deal with Danone last week more than doubled the French firm's stake in Mengniu to 9.9 per cent from 4 per cent. Danone paid a premium of 15.3 per cent for 121 million new shares at HK$42.50 each.
Danone's stake increase came as part of a complex reorganisation of holdings held by the French company and other core shareholders including Cofco Hong Kong, the mainland state-owned food supplier, and Arla Foods, the biggest dairy firm in Scandinavia.
The three companies consolidated their holdings into a single vehicle - Cofco Dairy Investments - which in turn holds 31.5 per cent of Mengniu. This effectively leaves Cofco Hong Kong with a 16.3 per cent stake, Danone 9.9 per cent and Arla 5.3 per cent.
Although Danone was the only investor funnelling additional cash into Mengniu in the reorganisation, Nomura Global Markets Research analyst Emma Liu quoted Mengniu's management as saying Danone had no intention to interfere in the mainland firm's daily operations.
Liu said Danone's co-operation with Mengniu would focus on their existing joint venture, which makes chilled dairy products. "Danone may be more committed to the joint venture now that it has a bigger stake in the company," she said.
A Mengniu spokesman, in response to inquiries from the South China Morning Post, said the two companies would "deepen their co-operation" in chilled dairy products.
Some analysts said Danone's increased exposure to Mengniu and the mainland's dairy market could help dilute the legacy of the company's tainted history. "The market is too large to ignore despite its blemished safety record," Kwok said.
Credit rating agency Moody's vice-president and senior analyst Lina Choi said Mengniu would benefit from Danone's technological know-how in boosting the scale of its yogurt business on the mainland.
"While Danone's increased investment enhances Mengniu's liquidity, any increase in scale, product diversity and geographical coverage will take longer to materialise," she said.
A recent Fitch Ratings report said consolidation of the mainland's dairy sector was in the pipeline and that this would result in three top players - Mengniu, Yili and Shanghai Bright Dairy & Food.
In terms of revenue, Yili was likely to keep its top position last year, Kwok said.
Research firm Mintel said China's rapid growth in dairy consumption - at 8.2 per cent annually in the five years to 2017 - would surpass that of raw milk supply. An easing in the mainland's one-child policy was not factored into this forecast.
However, Liu said the tight supply of raw milk and the resulting higher prices would choke growth at dairy producers.
Danone misses forecast
Danone yesterday reported adjusted earnings per share fell 7.6 per cent to ¤2.78 (HK$29.60) last year, its first annual earnings decline in more than a decade after a botulism scare hurt baby-food sales in Asia.
Analysts had forecast earnings of 2.84 per share on average.
Trading operating profit fell 5 per cent to ¤2.81 billion.
Like-for-like sales rose 2.9 per cent in the fourth quarter and were up 4.8 per cent for the year.
Milk price was on average 10 per cent higher than in 2012.
Danone said it expected like-for-like revenue to rise 4.5 to 5.5 per cent this year. Free cash flow would be about ¤1.5 billion, excluding one-time items. Bloomberg