Earnings Call: H2 2016

Mar 30, 2017

Investors, good morning. On behalf of China Mengniu Dairy Company Limited and Yashili International Holdings Limited, welcome to our 2016 annual results announcement. I believe that you have already obtained information on the company. Let me introduce to you our management on the stage. First, Mr. Lu Minfang, Mengniu Chief Executive Officer and Executive Director. Mr. Bai Ying, Chief Operation Officer and Executive Director. Ms. Wu Wenting, Mengniu Vice President and Executive Director. Mr. Zhang Ping, CFO. Mr. Liu Shengli, Vice President. Mr. Gao Fei, Vice President. Mr. Shi Dongwei, Vice President. Mr. Chris Kwok, Financial Controller and Company Secretary. Then we have Mr. Zhang Ping, Yashili Chief Officer and Executive Officer. Mr. Hua Li, Yashili Chief Operation Officer and Executive Director. Ms. Wen Jieping, CFO. As usual, this presentation will be divided into two parts. First, Mr. Lu and Mr. Zhang will go through last year's results, and the second part will be Q&A. Over to you please, Mr. Lu. Distinguished guests, friends of media, good morning. Today, I am very happy to lead my team together with you and share with you our 2016 results. More importantly, I will share with you my plan since I have taken up this position 6 months ago. I guess you are looking forward to listening to what our plans are for the future. I will first report to you our results for 2016. Our financial highlights. In 2016, our revenue was very good. Our results were very good. Revenue grew 9.7%, almost a double-digit growth. This growth comes from volume growth as well as structure improvement. This is much higher than the industry average. You may know that in 2016, for the whole industry, there is only 3%-4% growth, but we achieved 9.7% growth. This is really not easy. This is really a highlight in terms of our revenue. At the same time, we have improved our efficiency and product structure, product mix. Our raw milk price was at a low point, so our GP margin was up by 1.4%. Of course, there is goodwill impairment of a subsidiary company, so there is a loss of CNY 75 million. This is a big decline comparing with last year. Because this includes goodwill impairment, now I would like to go through with you, if this one-off item is excluded, what will be our results? In 2016, there is quite a big impact on our profits. First, Yashili's goodwill impairment, and secondly, the one-off disposal of big packets of milk powder, and this was completed in 2016. If we exclude these two factors mentioned above, then now I am going to share with you the results after excluding these items. Revenue was up 9.2%, not much change. GP margin after excluding the sale of milk powder, bringing a loss of around CNY 600 million, our GP margin was up by 2.6%, from 31.4% to 34%. Now, if those two factors are excluded, then our net profit is almost CNY 2.04 billion. This profit as compared to last year has declined because we have two other companies within our group, and looking at their 2015 performance, at first, they made profit in 2015 and then they incurred loss after that. So there is an impact of around CNY 400 million. Operating profit was still at a good level. Now, let's take a look at this strong revenue growth. Where does it come from? First, our liquid milk. Liquid milk is the main source of growth, up 11%. This is much higher than the industry's, the market's revenue growth. Next, ice cream. Ice cream is that at the end of 2015, we changed that into independent operation, and there was decline for three years. In 2016, this is the first time we see a growth of 1.8%. The trend of ice cream is quite good. For milk formula, the results of Yashili will be presented by Mr. Zhang, and he will talk about the reasons behind the decline and also future strategies. There is a decline of 2.4%, but we have also Junlebao's business in milk formula. Then there are others. There is a growth of 4.8%, including some new businesses. This is quite good because we have achieved a structural improvement. Our revenue growth was 9.7% as a result. About market share, for liquid milk, there is an increase from 27.3% to 27.7%. For UHT products, we rose from 27% to 27.9%. For chilled products, in 2006, that was not satisfactory performance of Yoyi C, and so there is decline. For chilled yogurt, we did quite well. There is 31.4% market share. Again, this is an absolutely leading position. Then if you look at various categories. Under liquid milk, if you look at the growth of different categories, for example, UHT yogurt, there is quick growth of over 70%. For 2016, premium UHT, 17.7% growth, faster than previous year. For chilled yogurt, 16.1%. Our backbone UHT performed very well in 2016, from negative growth to positive growth. If you compare that with retail growth in the industry, you can see that we are higher now. Chilled yogurt, 43.9%. Premium UHT, 12.6%. Basic UHT declined. If you do a comparison, our results are really very good. Then if you look at our product mix, it is improving. When I presented the gross profit margin, I said that there is good change in our product mix. For our premium products with high GP margin, they are on the rise. Star brands plus opportunity brands account for 44.8% of the total. This is a high percentage. Improvement of the product mix is an important contributor to our results. Then cash flow. In 2016, cash flow improved significantly. In 2015, CNY 1.9 billion. In 2016, it's CNY 4.5 billion. Of course, they include the one-off sale of milk powder, resulting in a recovery of cash. Our operating cash flow is strong, CNY 4.5 billion. For CapEx, basically it's stable. If we exclude equity investment of CNY 480 million, in the past two years, there's not much increase. CapEx is at a normal level. S&D expenses rose mainly because in face of market competition and also our expectation on sale, was high. In the market, we made more investment. We invested more online in order to build our brand. S&D expenses increased. For G&A expenses, there's also an increase. Some was because of investment, improvement in our new investment, and there is also Social Security expenses. G&A expenses increased. Then let's take a look at our inventory. It is improving. 47 days to around 39 days. The inventory efficiency was higher. This is very related to the improvement in sales. Receivables turnover was low. Payables turnover, stable. 52 days, 51 days, basically not much change. The operating efficiency index is very healthy. Okay? Just now, I basically gave you an idea of our 2016 results. Now I would like to spend more time to talk about how we are going to develop our future business. To conclude for 2016, since I have arrived at the company, some of the actions that we have taken, actually, looking at it for the whole year, those are the three main directions. The first one is what we have mentioned. We need to focus on our product mix and our strategies. We need to improve qualities and as well as optimize our product structures. Our structure is changing. We're focusing more on our star brands. Actually, our three star brands have contributed to 80% of the growth. This has reflected the benefit of the strategy. In the meantime, we are also promoting brand internationalization, which is gaining momentum. in 2016, we have seen good results. Actually, when I talked about the sales growth, number one, our sales is helping us to make sure that we can lay a more solid foundation for the route to market. So route to market is something that we continue to work on, including the CBUs. We are also working hard on expanding this area, and we have increased our staff, or added more over 1,000 staff into this team. By end of December, working with our strategy committee, we have reached a good consensus on the future development. Two parts. The first one is that we have increased shareholding of China Modern Dairy, which strengthens our ties with the upstream partners, which has solved our problem in the past, which we were not really quite with the upstream or with the downstream, and this is helping us going forward. Second, we are working with one of our main shareholders, Danone. We have deepened our cooperation with them and made clear of the development direction of milk formula business. Today, we also have Yashili's management team present, and we'll also be listening in to their strategies going forward. So those are the three main actions that we have taken in 2016. Looking forward for 2017, you will also have expectations, what we should be looking at. We have challenges and opportunities. I believe opportunities are more than challenges. First, let's talk about opportunities. For the milk market, there is still quite a lot of room for improvement. For 2016, if we do a summary, if you look at the dairy consumption in China, it's still only 20%-25% of developed countries. Comparing it with Japan and Asia, we are still below their consumption. Second, product mix. This is an upgrade because of the industry growth. Thirdly, the raw milk supply and demand tends to be balanced, which means that there will no longer be the volatility in terms of the milk price. For the mid-end market, when the supply and demand is balanced and towards the end terminal, we will not see the volatility in price. Fourthly, the milk source deployment, especially for Mengniu, we have roughly completed our strategies, which is very healthy for the development going forward. Challenges are very clear. In the beginning of the year, investors have been asking me, the first one is cost is still going up. This is a pressure. For example, in the beginning of this year, we have the packaging and sugar commodity price rising. Second, for dairy products, its growth at the moment is still at its bottom, about 3%-4%. Compared to a few years ago, that has changed. Thirdly, in terms of the milk formula registration system in the market, it is still quite messy. In 2018, this will be formally completed, and we are still waiting for more regulation to come through. A lot of strategists and friends from the media, one question that I get the most is that since you have joined, does that mean that we are changing directions going forward? I would like to go over Mengniu 2020 strategies with you again. This is something that has not changed. We hope that we can focus on health, on nutrition. We are very clear about our vision, which is consumer-centric, to become a century-old, innovation-led health and nutrition food company. Our goal has not changed. We still want to grow into the most dynamic and internationalized Chinese company with tens of billions revenue scale. I believe this is still the target that we would like to strive to achieve, and I hope that you can see in terms of our strategic goals, there has not been any change. In terms of the implementation of our strategy, we hope that 2017 could be even clearer. There are five themes. I have done a summary. We need to do these five things to support us to realize our strategic goals. The first one, we all know, we have also announced this, we are going to take organization. We are going to build the new competitiveness of the business, by establishing our different business divisions. The new business division reform, we have completed by end of February. In January and February, our sales have done well. This has been a good start to us. This is number one, our business division, and the business division system is clearer now. Second, we need to improve our operational efficiency. You can see that for 2016, our sales are very good, but our profit is not as satisfactory. Therefore, we are looking at improving efficiency and profitability. Thirdly, we will deploy upstream resources at home and abroad, to really become a highly efficient and integrated company. It is not necessarily that we need to own the upstream completely, but we would like to build a through-channel with the upstream. Actually, I have just come back from New Zealand three days ago, and we have established a strategy with them. Fourthly, focus on star brands. Some of the star brands growth, because we have focused resources, because we have seen the right direction, and because we have done well in the quality, therefore, our sales growth really comes from these star brands. We also need to promote some of the other brands which have not become the star brands, and to upgrade them. Fifth, which is the last one, this is also something that in the future, in the next 2-3 years, that we continue need to work on this, which is our route to market initiative. These are the five key themes of implementation in 2017. Now, I will take some time to talk to you through about the details. Number one, business division. People say, "Are you going back to 10 years ago's design?" Well, since we have decided on this path, for us to go back, we must have learned our lessons and experience. First, we have changed the function-based system to a new division-based system. Under the new divisions, it's very clear, we have UHT, chilled product, ice cream, milk formula, and others. The others, we are working hard on it. You know that we have a plant-based business. Second part is cheese. I can say this, yesterday, we have officially established a cheese JV with Arla, which is a leading European cheese company, and we have already started our work in the cheese business in China. In the past few years, Chinese cheese industry is growing at 19%-20%, so this is a great area of business. For the whole of our division-based system, we are very clear. I believe that with this new layout of our business, this is very healthy, and in terms of our layout and the speeding up, this is very good for a solid foundation. There are a few points. For some of the power that we need to delegate, we will delegate, and for some of the power that we need to take control, we will take control. In the future, in terms of R&D, consumer insight, brand building, quality, regulatory monitoring, public affairs and administration, and talent training, those are the teams that we are building to support the group level. This is also a big change, and my team have all been on board with this new change. This is number one, to have a very clear division-based system. Second, in terms of efficiency and profitability. First of all, for the group, now we have become the division system. How do we concentrate all the purchasing, starting from the milk source to all the other main material that we need for the group? This could help us to offset the commodity price rise in 2017, and I'm very happy that we have made this decision. Actually, we have started doing this, made this decision back in end of 2016, and this was a very smart decision for the group. Second, for the supply chain to improve quality and efficiency, because currently all our divisions are connected. We have realized that this has been a good opportunity for us to improve our efficiency. Second, benchmarking. How do we benchmark? We benchmark ourselves with the best dairy companies in the world to improve the fundamental efficiencies in some of our basic infrastructures in our business. I believe that this will contribute greatly to the performance of 2017. Thirdly, to improve our merchandising efficiency, marketing efficiency. Right now, after our divisions are all connected, we have seen great efficiency improvement in terms of marketing, merchandising. Whether it is white milk or flavored milk, et cetera, we have seen great improvement in these areas. With these three steps, I believe that our profitability for 2017 has been laid a solid foundation, which is very beneficial for the development. Thirdly, it is also very important, we have always talked about how to deploy and lay out our upstream and downstream resources. Here we have a few points that we have already said. The first one is to establish milk sourcing division. Right now, we run the milk sourcing as a division, and how do we do that? For all the raw milk and milk powder, we put the control to the milk sourcing division for them to manage the cost and procurement, which help us to manage our supply and demand overall. Second, to control the premium raw milk sourcing in domestic China. We have a very clear strategy with China Modern Dairy. We are also very clear about how to utilize the material of Modern Dairy. At the moment, they have about 1 million tons of resources, and we would like to combine our advantages, to combine that with our high-end UHT product and our high-end low temperature chilled product. We have already completed the layout for the milk sources that will support the development of high-end UHT and chilled product. In terms of overseas, we have Europe, Australia, and New Zealand. These are our three upstream. We have recently just signed with Pengxin in New Zealand, and they have a very good farm, and we will be using that for our Telunsu product. The environment and the conditions there, they are all very good. In the meantime, some of our product in Australia, in Burra, we also have our plant there, which is a good guarantee of good milk source, especially these high-quality milk source to support the development of our business. Number 4. Focus on the star brands to promote full upgrade across all categories. First one is the promotion of the brands. You may have seen that last week, we have obtained the only exclusive partner of dairy products for Universal Studios Beijing. This is very rare that for a domestic company to obtain such world-class brand partnerships. We have Disney and Universal Studios, and this is a great opportunity for us to improve our quality, and this is also a test to see, to reflect our quality. I believe that those two brands will bring better connection or interaction with our young consumers and improve the brand image. Second, increase investment in brand building and enhance long-term brand influence. We hope that our Telunsu, Chunzhen, Zhenguoli, et cetera, will have all gained good results in this background. Second, to do brand building, we need to have good product. R&D and innovation, highly important. Currently, in terms of R&D, we have some good actions. You may have seen in terms of chilled LC-37, this is a new product, a functional product. We call it the small blue bottle. Perhaps the advertisement will be broadcast on TV very shortly. We also have a Telunsu super high-end product that will also be launched. We also have some other innovations of other brand. We are in the final stage of development. I believe that in the next 2 to 3 years, you will see some great new product launches from us, and we are working hard on the high-value added products and the next generation of Telunsu. We have also entered into the final stage, and Chunzhen as well. I believe R&D and innovation, this is something that we need to work hard on with Arla and Danone. We have, in terms of upgrading, we have obtained the best resources. R&D and innovation, we must do it well. Finally, on the product screening. When we talk about focusing of the brand, we need to have very clear product screening. About 10% of our SKU contributes to 90% of our revenue. Continuing to upgrading our product, we want to further maximize and optimize our product. When the division system is implemented, I believe that the innovation and the R&D is all being reflected. Finally, every year we talk about this. 2017, we continue to adhere to route to market initiative. Maybe this is very boring to keep talking about this every year, but this is a long-term work for our CBU, and companies, and balances of roles, et cetera, and our distributors. We have also done a clearing out of our CBUs lately. How do we further expand our business in the third and fourth-tier cities and improve our key account management? Continue to build advantages over special channels. Perhaps some of the channels that we can monitor, they're all traditional ones, but in some special channels we are growing very well. For example, in bakeries or in convenience stores, et cetera. Convenience store sales is also improving our overall performance in terms of our WeChat sales and more sophisticated online sales. These are all contributing and doing well. For 2017, these are our five themes, and for each five theme, we have a very clear implementation step. I believe that for 2016, it was a mixed year. Our sales have done well, but profit, not very good. Two subsidiaries, the losses that they've made in 2016, I believe that that will be turned around in 2017. This is number 1. We need to make sure the growth of our company, and in the meantime, we need to improve our profit by improving the efficiency. In the meantime, some of the loss-making subsidiaries, we have very clear steps going forward. We look forward to 2017. We hope 2017, we could implement fully these five themes to maintain the good growth momentum and improve our profitability, and we hope that we can give you a good result for 2017. Thank you.