Broker's View

Yili’s share placement dilutes its near-term earnings but enhances long-term growth, say analysts

Taking a controlling 37 per cent stake in organic milk producer Shengmu strengthens Yili’s position as China’s largest dairy producer by retail sales

PUBLISHED : Tuesday, 25 October, 2016, 1:12pm
UPDATED : Tuesday, 25 October, 2016, 10:32pm

The planned 9 billion yuan in private placement of shares by dairy giant Inner Mongolia Yili Industrial Group, will dilute its earnings by share (EPS), according to a fresh note Deutsche Bank, but enhance its long-term growth,

Yili unveiled the carefully structured 4.6 billion yuan takeover of Hong Kong-traded China Shengmu Organic Milk, China’s largest producer of organic milk, on Monday and issued new stock to create a so-called poison pill to ward off any potential hostile takeover from its third-largest shareholder, Sunshine Insurance Group.

Yili said it would issue 9 billion yuan worth of new shares to acquire four new investments, including the 37-per cent controlling stake in Shengmu at HK$2.25 per share.

The issuance will dilute the stake held by Yili’s third-largest shareholder Sunshine to less than 5 per cent, which should fend off any possible move by the company.

The 9 billion yuan will be raised by issuing 587 million shares to five investors at 15.33 yuan per share, according to a statement to the Shanghai Stock Exchange: Hohhot City Asset Investment, Inner Mongolia Transportation Investment, Jinshi Haorui Investment, Ping An Asset Management, and Jinmeihua Investment.

According to Euromonitor International, Yili is the largest dairy producer by retail sales with 22.3 per cent market share, followed by China Mengniu Dairy (17.3 per cent) and Hebei Yangyuan Zhihui Beverage (5.2 per cent) while Shengmu has a 0.7 per cent share.

The Chinese market for products such as drinking milk, cheese, yogurt and sour milk drinks is worth 350 billion yuan.

“We expect the placement to dilute its 2017-2018 EPS by 3-4 per cent due to expanding share

numbers, diluting the EPS by 9.68 per cent and the acquisition of Shengmu to increase its EPS by 6 per cent,” analysts at Deutsche Bank, including Mark Yuan and Charlie Chen, wrote after the finer details of the deal were revealed.

“We are concerned that the share placement could dilute Yili’s EPS in the near term and reduce its return on equity (ROE), given it currently has enough owned cash for acquisition, even without a share placement,” Yuan added.

The new placement will increase its net cash from an already-high level of 10 billion yuan in June to 19 billion yuan and expand Yili’s outstandingshares by 9.68 per cent.

Yili’s purchase of Shengmu is mainly to enhance its organic milk business, a string income stream for Shengmu. Demand for organic milk in China is increasing and becoming one of the most promising sub-sectors of the dairy industry, as wealthier Chinese consumers seek healthier food options.

Wang Jiahui, a senior analyst at Industrial Securities, says the purchase of Shengmu is a clever move by Yili.

“The leading dairy producers who have already developed organic milk business have gained an edge,” Wang added.

The leading dairy producers who have already developed organic milk business have gained an edge
Wang Jiahui, a senior analyst at Industrial Securities

The two sides are actually well suited, in a “synergistic” way with the widespread distribution channels and brand power of Yili able to boost Shengmu’s sales, while the Hong Kong-listed Shengmu could serve as a platform to ease Yili’s overseas financing demands.

Deutsche’s Mark Yuan added: “We expect synergies from acquiring Shengmu, helped by Yili’s strong distribution network and Shengmu’s niche product positioning.”

Besides the Shengmu deal, 2.5 billion yuan of the proceeds will be used to fund the development of high-end products domestically, and expand the company’s ability to produce ultra-high temperature (UHT) yoghurts, chilled yoghurts, soya, pasteurised milk and plant-based milk, which are all now major driver in the dairy sector.

“With the acquisition and investment into high-end products, we expect Yili’s sales growth to accelerate, making the transactions EPS incremental long-term,” said Yuan.

Another 538 million yuan will be spent in a dairy production line in New Zealand.

For Yili, Deutsche Bank maintains “Buy” rating.

“We get comfort from its planned use of the proceeds, as we believe it is investing in the right categories and products, which should enhance its long-term growth,” said Yuan.

Wang suggests “ investors should keep an eye on Shengmu”, but she does not give any rating for the dairy producer.

“Food safety issues” is also one of potential downside risks for Shengmu, said Wang in her report.