Milk a Substitute for Cola in China?

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HEARD IN ASIA: China's Growing Taste for Milk Lifts Mengniu, Other Dairy Firms

• Summary: China's dairy sector is reportedly generating 60 billion yuan (US$7.5 billion) in annual sales and is expected to grow by 20%-25% this year. Dairy firms and their investors are clearly optimistic despite a historically lactose-intolerant nation. The largest player, China Mengniu Dairy, controls almost 1/3 of the market and twice as much as its largest two rivals, Inner Mongolia Yili Industrial Group and Bright Dairy & Food. Mengniu's H1 profits surged 39% to US$43.2 million, while its shares listed in Hong Kong have more than doubled. Mengniu is a master of marketing. It must be, since it contracts from about 3,000 milk suppliers, not owning any farms directly. The head of China research at BNP Paribas commented on Mengniu's consumer buzz generating capability in which, "... milk beverages [are (seen as)] a substitute for cola drinks, seen as something sexy and trendy." Mengniu is expanding both its scale and scope economies, now offering more premium milk beverages and introducing related products such as ice cream and milk tablets. Its biggest risk is its supply chain, followed by renewed interest in China among foreign companies such as Groupe Danone of France which has increased its stake in Bright Dairy to 11.55%.
• Comment on related stocks/ETFs: Mengniu is listed on the Hong Kong exchange under code: 2319. It also has an extremely thinly traded listing on the OTC in the U.S. (CIADF.PK) -- see also Pinksheets.com. Whenever trading low-volume stocks or when the bid/ask spread is wide, it is a good idea to use limit orders. Among other companies mentioned in the article, Danone (DA) trades in the U.S, and both Mongolia Yili and Bright Dairy are listed on the Shanghai exchange with Class A shares. BNP Paribas, Citigroup, and Merrill Lynch have a "buy" rating on Mengniu. A quick check of Morningstar.com shows that Mengniu is not a top-25 holding of any of the China funds traded in the U.S. The BNP Paribas analyst's comment calling milk essentially a substitute for cola may be a cause of concern for Coca-Cola (KO) and Pepsi (PEP). Per Coke's Q1 conference call in 2005, the company's China strategy is focused on three areas: carbonated soft drinks, non-carbonated beverages such as tea (think Nestea), and value-added hydration (think POWERade). For more information on Mengniu, visit its web site.

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Comments

[Doug Roberts]

Hi -
Two other Chinese dairy ADRs that I have traded this year - both were doubles for me - are Synutra (SYUT) and American Dairy (ADY). Synutra just continues to go up, but both companies have great earnings growth. ADY has been added to the Russell Microcap index. Both have targeted parents of children.

Doug Roberts