6186.HK
Feihe's profit and revenue declined last year

The premium infant formula maker is taking a hit from China’s low birth rate, but investors may like its dividends and transition to other dairy products

Key Takeaways:

  • China Feihe posted declines in both profits and sales last year, as it is heavily exposed to the country’s falling birth rate
  • The company, which gets 91% of its revenue from infant milk formula, may remain attractive to investors due to its pledge to pay much of its profits as dividends

  

By Edith Terry

China Feihe Ltd.’s (6186.HK) 2023 year-end results, announced last week, were dismal enough to leave investors crying over plenty of spilled milk. The infant formula maker’s annual revenue sank 8.3% year-on-year to 19.5 billion yuan ($2.69 billion), and its profit fell by an even larger 33.5% to 3.3 billion yuan. But rather than cry, investors applauded the results with a rise of over 9% in the company’s stock. So, what do they see in this homegrown infant powder star?

One answer is the healthy dividends it is spinning off. It paid an interim dividend amounting to 1.1 billion yuan last September, equal to 30% of profits. And in its latest results announcement, it promised to return another 40% of its profit in a dividend whose amount will be determined and approved at its annual meeting.

Such dividend payments are a popular strategy for attracting investors by consumer stocks like Feihe, which tend to soak up plenty of revenue but whose slower growth stories tend to be less attractive than sexier companies from sectors like tech and new energy.

Dividends aside, Feihe’s latest results offer clues that the company may be working hard to diversify beyond its core infant formula into powdered milk for children and adults, as well as new milk products with better growth potential. And it has 10.5 billion yuan in cash to cushion it through any transition. While its sales of infant milk formula products fell 10.3% to 17.8 billion last year, sales of its “other dairy products” actually rose by 23.4%.

Infant milk formula makes up 91.5% of Feihe’s revenue, with “other” dairy products, such as adult milk powder, liquid milk and rice powder supplements, accounting for a far smaller but faster-growing 7.3%. The shift to those other groups looks like a positive trend in the face of demographic inevitability with China’s plunging birth rate.

A total of 9.02 million babies were born in the country last year, the lowest number since the founding of the People’s Republic in 1949 and the second year of sharp declines. In addition to falling birth rates, companies like Feihe are also facing the challenge of recently overhauled government regulations on infant milk powder quality that some are calling the toughest in the world.

The objective is to set standards as close as possible to breast milk. The toughness is also partly in response to a 2008 scandal where six infants died and another 300,000 fell ill after drinking infant formula spiked with melamine, a toxic chemical that some producers used to boost their scores in milk protein tests.

Many of the 400 brands in the market before the new regulations have now left, and remaining players have had to re-certify their products. The market turbulence forced at least one major international player, Nestlé (NESN.SW), to close a baby milk factory in Ireland last October that produced milk solely for the Chinese market.

Falling margins

Other metrics for China Feihe’s 2023 fiscal year were equally dismal as its top- and bottom-line numbers. Its gross profit margin fell to 64.8% from 65.5% in 2022. And 2022’s results were nothing to get excited about either, with revenue and profit down 6.4% and 28.4% from 2021 levels, respectively.

The company’s 2021 annual report, whose cover featured a gold star and a can of milk powder, included the last time revenue increased, rising 22.5% to 22.7 billion yuan. But even in the peak year of 2021, profit was down by 7%.

The year 2021 was also when China officially adopted its “three-child” policy, raising the permissible number of children to three from the previous two. In 2016 the government abandoned its decades-old “one child” policy that imposed fines and other restrictions on couples who went beyond the limit. Feihe’s shares were hitting record highs around that time, rising to more than three times their IPO price of HK$7.50 from 2019, as investors bet it could become a big beneficiary of the government’s call for people to have more children.

But the policy changes have failed to have the desired effects of improving birth rates, with many people citing the high cost of raising children as a major deterrent. Feihe’s shares sagged as its revenue began contracting with the falling birth rates, and its current share price is now about half its IPO price.

Feihe’s stock certainly isn’t alone in feeling the shrinking pains of China’s declining fertility rates. Shares of leading dairy Yili Industrial (600887.SS) also peaked in 2021 before falling. But unlike Feihe, Yili’s top and bottom lines have both been rising since 2020. The same is true for Mengniu Dairy (2319.HK), whose shares also peaked in 2021, but whose revenue and profit continue to rise. Mengniu subsidiary China Modern Dairy (1117.HK) has similar stock trends, but has recorded falling profits despite growing revenue.

Those differences might imply that the regulatory change has favored older players like Mengniu and Yili with closer state ties, at the expense of newer companies like Feihei and Modern Dairy. Feihe’s heavy reliance on infant formula is also working against it, while its peers have more diverse product lines. Its recent diversification moves are aimed at weaning it from overreliance on the infant market, but the transition is taking time.

All those differences show up in Feihe’s price-to-earnings (P/E) ratio, which is markedly lower than the other three companies. Its stock currently trades at a ratio of 7.4, compared with 13 and 17 for Mengniu and Yili, respectively. China Modern Dairy trades at the highest ratio of 33.

The strong market reaction to Feihe’s latest earnings could partly reflect the stock’s current low valuation as well as enthusiasm about the company’s dividend policy. Investors may also like Feihe for its position in the relatively recession-proof consumer space, which should help to stabilize its revenue even as people cut back on spending in more discretionary areas in the current climate of economic uncertainty.

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