Is China Feihe Ltd Going To Benefit From China’s Growing Infant Formula Market?

Infants-related products and services are big business due to parents’ willingness to provide the best for their children. 

One key sector is the infant formula industry, where parents splurge on branded milk powder that comes with all the DHAs and AHAs.

China Feihe Ltd (HKG: 6186) is one of the major infant formula producers in China that has benefited from parents’ rising spending on children. We shall take a closer look at its history, earnings, market position, and growth opportunities in this article.

Business Overview 

Feihe is the largest Chinese infant milk formula producer, according to the Frost & Sullivan IPO report commissioned by the group. Its brand ranked first among domestic and international companies with a 7.3% market share in 2018. Among domestic producers, the group ranked first with 15.6% of total retail sales value in 2018. 

Feihe prides itself as a local enterprise that knows Chinese babies well, hence the unique value proposition as being ‘More Suitable for Chinese Babies’. Its products are designed to closely match the composition of Chinese mothers’ breast milk through in-house research and development, supported by a breast milk database with over 1,500 milk samples from mothers of various physiques and diets across China. 

Feihe derives most of its revenue from the super-premium and premium infant milk formula with a retail price of RMB450 and between RMB350 to RMB449 per kilogram. The two segments accounted for 68% of total sales in 2018. 

Percentage of revenue contribution from product categories. Source: IPO Prospectus

Latest Results

For the financial year ended Dec 2019, the group’s total revenue increased 32% to RMB13.7 billion. Gross profit was up by 37% RMB9.6 billion, with broad-based growth across both the high-end and regular brands. 

Pre-tax earnings improved vastly from RMB3.2 billion to RMB5.7 billion, giving the group a high pre-tax margin of 41%.

The business generated a large amount of cash, as net cash from operating activities was RMB5.2 billion, compared to RMB2.1 billion in 2018. 

Historical Earnings

The group’s revenue and pre-tax earnings had been increasing steadily since 2015, with compounded annual growth of 40% and 73% respectively. 

Source: 2019 Annual Report

Gross profit margin increased from 55.3% in 2015 to 70% in 2019. This was achieved through higher retail prices due to strong brand value, and competitive sourcing of raw materials.  

The group also has a strong balance sheet. As of Dec 2019, it had a net cash position of RMB256 million and a gearing ratio of 0.43.

Favourable Market Trend

As China progresses into a consumption-driven economy, Chinese consumers would likely purchase more high-end products driven by higher disposable income and health awareness. This applies to the infant milk formula sector too. As seen from the chart below, the average retail price of high-end infant milk formulas had been growing much faster than the regular brand and is expected to continue to 2023. 

Source: IPO Prospectus

Feihe’s focus on the premium and super-premium segments have shown good results. Sales of high-end products expanded at a compounded rate of 84% per year from 2016 to 2019. Its share of total revenue was up from 42.6% to 68.6%. 

While China’s birth rate is expected to slow down, demand for infant milk formula would remain strong, underpinned by economic growth and increasing urbanisation that drive mothers to value convenience and quality over breastfeeding. In fact, the rate of infants fed exclusively on breast milk remained low at 29% in 2018. 

Response to Coronavirus Pandemic

Feihe took swift actions to organise its workforce and finetune its production line in response to the Covid-19 outbreak. In the first two months of 2020, the group increased production by 40%. It mobilised its sales force and logistic partners to ensure that the delivery of raw materials and finished goods are not affected. As a result, its delivery rate in February was an impressive 98%.  

Diversifying into Retail Healthcare Business

Feihe bought over the retail health care operations of Vitamin World in 2018. Vitamin World is a major seller of vitamins, herbs, and natural supplements with more than 120 speciality stores across the United States. While nutritional supplement products accounted for 4.2% of the group’s total revenue in 2019, it is of strategic importance to Feihe and its revenue is set to grow. 

Strengths and Opportunities

Feihe’s key strength is its marketing prowess. As a big enterprise, it has the financial resources to implement large-scale marketing activities, which is crucial in an industry with homogeneous products that require constant marketing to strengthen consumer mindshare. Feihe’s has one of China’s top celebrities, Ms Zhang Ziyi, as its brand ambassador. It also engages online influencers to share positive reviews of its products.  

Product reviews by online influencers. Source: Corporate website

This has enabled Feihe’s super-premium products to grow exponentially. For example, its star product Astrobaby registered compounded annual revenue growth of 168% from 2016 to 2018.  

The infant milk formula industry has high barriers of entry, such as scarcity of fresh milk supply, large funding required to set up production lines, and time needed to establish a wide distribution network. These would help protect the industry from new entrants, allowing Feihe to grow and expand its market share. 

Risks

The group faces considerable supply chain risk. Currently, Feihe sourced almost 90% of its fresh milk from YST Group, a major dairy farming company in terms of production volume. Unforeseen events such as earthquakes, the outbreak of dairy cow diseases, or pollution at YST farms would damage Feihe’s raw materials and product quality. 

Another risk is the negative publicity related to quality control lapses that can adversely impact Feihe’s brands. In 2015, the group faced negative media reports for recall of products by its then-subsidiary, Guanshan Dairy. Although the group managed to resolve the issue, it saw a material impact to its revenue and operations. 

Conclusion

To summarise, China Feihe is the leader in one of the world’s largest infant formula markets. Its premium brands ride on the coat tail of brand premiumisation. It also has strong margins and a history of growing revenue and earnings. 

It has a price-earnings ratio of 26 according to Bloomberg. 

This company may be suitable for investors who like established companies in a slow-growing industry with a high barrier of entry. While the nature of its business makes it less susceptible to negative surprises, do be aware of the risks and potentially huge damage that they can cause.

I view Feihe as a possible stock holding due to its strong fundamentals. However, as it is a Chinese company listed in Hong Kong, I would need deeper research and a much longer monitoring period before deciding on the next move.  

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