Investment Summary

Short seller Blue Orca has recently published reports about Ausnutria Dairy. The main allegations include overstating import data of infant milk formula, revenue and profits; understating its labor and staff costs; misleading Chinese consumers in relation to the ingredients of Kabrita infant goat milk formula; the acquisition of the 40% equity interest in Nutriunion HK was a sham transaction to unjustly enrich insiders, and the independence of the company's distributors. Apart from releasing voluntary announcement clarification, the independent review committee has been established and engaged the independent consultant to conduct the independent review.

In responding to the allegation of overstating import data of infant milk formula, revenue and profits, Ausnutria denied and pointed out that all import data are supported by documents. The report only counts the number of shipments of import agents. The estimation was arrived after deducting the company's inventory level. such estimation did not take into account the overhead costs incurred and value-added processes conducted by the company after the imported infant milk products arriving the Changsha, and did not take into account of the purchase of imported base powder (mainly New Zealand) from local importers. The independent consultant also noted that the import volume of goat milk in 2017 as per the customs` records was 154% higher than the annualised import volume as estimated by the short seller reports.

We are still optimistic about Ausnutria's medium and long-term business. Although China is facing a problem of declining birth rate, consumption upgrade continues in the infant milk industry. In 1H of 2019, the overall infant milk industry recorded a mid-single digit growth, which was mainly driven by ASP growth, and the trend is expected to continue. Ausnutria has conducted market research consistently with targeted consumers to raise the awareness of goat milk products. In view of the decline in birth rate, goat milk formula for kids has been launched. The company plans to also launch goat milk formula for the whole family, targeting adults and elderly. In 1H of 2019, in the imported formula milk milk powder market, Kabrita's market share in China reached 64.4%, accounting for 61.7% of the total imported goat milk powder. It is still the market leader.

Its interim revenue increased by 21.9% y.o.y. to RMB565 million. The growth of its own-branded formula cow milk powder recorded a slowdown but still with a 20.7% increase, among which organic formula milk powder increased by 52.3%. The proportion of overall own-branded formula milk powder business increased by 6.3 ppt to 86.7%. Benefiting from the increase in the proportion of its own brands, the gross profit margin increased by 5.7 ppt y.o.y. to 52.1%. The ratio of sales and distribution expenses to revenue was basically maintained at 27.4% y.o.y.. We expect overall revenue growth in 2H of the year to be faster than 1H. The slowdown in the growth of its own-branded formula cow milk powder business in 1H was mainly due to the high base in the same period last year and the delay in the approval of registration.

As for the private label and other business, the y.o.y. decline in 1H was mainly due to the strategic reorientation. As the new plant was completed, it is expected to gradually ease the problem of production capacity shortage. Ausnutria plans to terminate its butter business in the second quarter, and inventory will be cleared in 2H. We maintain buy rating, target price-earnings ratio 25 times, with target price HKD15.7. (current price as of September 23, 2019)

Investment Thesis & Valuation

We give buy rating, target price-earnings ratio 25 times, with target price HKD15.7. Potential investment risks include policy change, market competition deterioration, and raw milk cost with huge volatility. (current price as of September 23, 2019)

Financials

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