AustAsia Finds Tough Going As Independent Dairy

Key Takeaways:

• AustAsia said it expects to report a loss of $50 million to $60 million for the first half of 2023, but added its gross margin improved in the second quarter compared with the first
• The company’s shares currently trade at a big discount to larger rivals, positioning it for a potential buyout bid from one of China’s major dairies

By Doug Young

It’s not easy being independent, especially in China’s fiercely competitive milk market.

AustAsia Group Ltd. (2425.HK) has been learning that lesson the hard way in the eight months since listing its shares in Hong Kong last December. The stock has lost more than 70% of its value since then, and could come under further pressure after the company issued a profit warning on Monday after the market closed.

The word “profit” in this instance seems a bit generous, since AustAsia disclosed it swung into the red in the first half of the year, hit by a double-whammy of falling milk prices and rising costs for the cattle feed that’s one of its main expenses. Both trends were already featured prominently in the company’s IPO prospectus last year, reflecting two of the broader industry’s biggest challenges.

AustAsia said it expects to record a consolidated net loss of between $40 million and $50 million for the first six months of this year, reversing a $30 million profit a year earlier. It noted that its average selling price for raw milk was down about 8% during the period from year-ago levels, even as its feed costs rose 7% over the same period.

The falling milk prices are the result of weak demand in China, which is probably related to the nation’s sputtering economy. Meantime, the high feed prices are related to the Russia-Ukraine war, since both countries are both major grain exporters, especially Ukraine.

The news wasn’t all bad, as AustAsia noted its feed costs began to go down in March. As a result, it said, its gross margin improved in the second quarter of the year from the first. But before anyone starts celebrating, we should note that trend could face potential headwinds in the months ahead after Russia abandoned a key deal allowing Ukraine to keep exporting its grain by sea last week. That development could cause prices to spike again.

Such is the life of a small dairy farmer like AustaAsia, which is subject not only to this kind of global geopolitics, but also a weaker position in its home market due to its status as a smaller, independent dairy. By comparison, most of China’s other smaller dairies have been purchased by the country’s two domestic giants, Yili Industrial Group (600887.SH) and Mengniu Dairy (2319.HK), in recent years.

AustAsia’s underdog status has scared off investors, who may now feel vindicated after seeing the dairy drop into the red in the first half of the year. The company sold its IPO shares for HK$6.40 last December, raising about HK$200 million ($26 million). But the stock has moved steadily downward since then, and last closed at just HK$1.82 on Monday before the latest profit warning.

Lowly Valued

AustAsia currently trades at a price-to-earnings (P/E) ratio of just 6, based on last year’s profit that looks set to evaporate this year. Yili and Mengniu both trade far higher at ratios of 19. And even smaller rivals like Youran (9858.HK) and Modern Dairy (1117.HK), which are owned by the larger companies, trade at much higher multiples of 14 and 10, respectively.

With so many milk stocks to choose from, it’s no wonder investors are shying away from an independent operator like AustAsia. The company is controlled by a group affiliated with Indonesia’s Japfa, and also counts Chinese dairy Meiji as a major stakeholder with 22% of its shares. Its customers include Mengniu, as well as Bright Dairy (600597.SH), another major national brand.

With so much milk swishing around the Chinese market, it’s quite possible AustAsia’s days as an independent company could be numbered if its Japfa shareholders decide to throw their lot in with Yili, Mengniu, or another major player with better resources. At the stock’s current level, the company certainly looks like a bargain for any potential buyer.

Despite its second-tier status, AustAsia is still a relatively sizable company in a Chinese dairy market that’s the world’s second largest, behind only the U.S. The company’s revenue rose 7.8% last year to $563 million, as it boosted its dairy cattle herd by 11% to 118,000 during the year. It derives the big majority of its revenue, nearly 90%, from dairy products, with most of the rest coming from its smaller beef cattle herd that totaled about 29,600 head at the end of last year.

Despite recording revenue growth last year, AustAsia’s gross profit actually fell 26% for the year to $131 million, while its net profit tumbled 78%. Part of that was due to the factors we’ve previously mentioned, but it’s also worth noting that Mengniu’s profit actually rose 5.5% for the year.

One of the most revealing figures in differentiating this herd of companies from each other is gross margin, which measures how much profit a company makes for each dollar of revenue it generates. AustAsia’s gross profit margin tumbled about 10 percentage points to 23.2% last year – far below the 35.3% gross margin for Mengniu, which was also down but by a milder 1.4 percentage points.

While the big names like Mengniu, Yili and Bright all sell dairy products under their own well-known brands, AustAsia is relegated to selling its products mostly to other dairies, as well as large buyers like coffee chains and bakeries, which partly explains its lower margins. But when prices sag and competition heats up, like we’re seeing in the current market, the company clearly comes under larger pressure than its bigger-name peers.

When all is said and done, there probably isn’t really a long-term place at the Chinese dairy table for smaller, independent dairies like AustAsia. We’ll need to see some more details on its latest financials, which the company will publish in its full interim report next month, before commenting on its situation. But the pressure is almost certainly growing on Japfa to join forces with a larger rival, and we wouldn’t be surprised to see this company quickly lose its independent status within the next year or two.