No matter how excellent a company is, performance cannot grow linearly forever, so there's no need to overreact to short-term fluctuations; otherwise, it's just technical analysis chasing short-term results disguised as fundamental analysis. However, if short-term performance reveals long-term factors like business attributes and competitive advantages, we must pay attention.
Yili released its interim report on August 31, with revenue of 39.943 billion yuan, up 19.26% year-on-year, and net profit of 3.469 billion yuan, up 3.00%. The market considered this report below expectations, and the stock price fell.
Yili's revenue growth was acceptable; the main issue was that profit growth fell short. In the first half, Yili's operating costs were 24.2 billion yuan, up 18%, in line with revenue; administrative expenses were 1.3 billion yuan, up 8%, lower than revenue growth; financial expenses were 36 million yuan, with little impact. Selling expenses were 10.17 billion yuan, up 33%. It's clear that the profit shortfall was mainly due to the high proportion and rapid growth of selling expenses.
Selling expenses being three times net profit is also astonishing. In recent years, Yili's selling expense ratio has consistently been above 20%, and in the first half of this year, it exceeded 25%. Yili's high expenses are nothing new; it's just that this year's interim report revealed the impact on profits. Yili explained: "Mainly due to increased advertising and marketing expenses from intense market competition, increased employee compensation, and increased loading and transportation costs driven by higher sales volume." Among these, advertising and marketing expenses increased by about 1.6 billion yuan, up 38.9% year-on-year; employee compensation increased by about 460 million yuan, up 37.6%; loading and transportation costs increased by about 350 million yuan, up 19.2%. The increase in loading and transportation costs matched the revenue increase; the extra increases were mainly in the first two items.
The intense competition is mainly due to Mengniu. Mengniu's first-half revenue was 34.47 billion yuan, up 17% year-on-year, with selling expenses of 9.98 billion yuan, up 39.6%. Its selling expense ratio was as high as 29%. Mengniu sponsored the World Cup, leading to a significant increase in selling expenses. Yili has also been increasing marketing expenses for the Winter Olympics and offline promotions. When the top two fight, the third player, Bright Dairy, saw both revenue and profit decline despite selling expenses of 2.4 billion yuan.
Yili's interim report reveals the business model of dairy companies. Undoubtedly, Yili is an excellent company. It has the best milk sources in China, huge scale and channel advantages, massive selling expenses, strong product innovation capabilities, and abundant free cash flow. As a leader in the food and beverage sector, long-term holding of Yili yields returns no less than Moutai. But Yili's business model is not as good as Moutai's. This is evident from the selling expense ratio.
Do Yili and Mengniu really need such high selling expenses? If a large portion of selling expenses, which account for 25% or even 30% of revenue and are two to three times net profit, were removed and passed on to consumers, wouldn't that be better? Why give it away to advertising media?
Xueqiu user leguy calculated the relationship between selling expenses and net profit for Yili and Mengniu over the past decade. The "net profit difference = Yili's net profit margin - Mengniu's net profit margin, selling expense ratio difference = Yili's selling expense ratio - Mengniu's selling expense ratio" showed that the two curves are opposite. When one company's selling expense ratio increased, it did not lead to an increase in profit margin but rather a decrease. So how to explain why Yili and Mengniu, despite consumer interests and even their own profits, continue an "arms race" in selling expenses?
Yili's high selling expenses are first related to the current competitive landscape.
China's current dairy market is a duopoly, with Yili and Mengniu as the true national brands. Other regional dairy companies have basically lost the opportunity to become national brands. New entrants are almost invisible. A duopoly market may form a stable structure and share profits, like Gree and Midea. Or it may remain unstable, with both sides continuing fierce competition in price, marketing, and products.
Although Yili is already the leader in dairy products, it has not yet established an absolute gap over Mengniu. If one side in a duopoly always wants to challenge the leader's position, and the other side desperately tries to maintain its position or even eliminate the second, competition will be bloody. If one day Mengniu completely declines for some reason, leaving Yili as the sole dominant player, Yili's selling expense ratio would definitely drop significantly, releasing more profits. But this assumption is currently unrealistic.
Yili and Mengniu's marketing expenses are necessary, also related to the need for extensive advertising and promotion to cultivate users when new products like Ambrosial were first launched. Even for mature brands, maintaining a certain level of exposure is necessary. But Yili and Mengniu's marketing expenses, which are often over 10 billion yuan, equivalent to two to three times net profit, are excessive, and it can even be said that most is wasted.
Consumers are not drinking "milk" but "advertising." If both companies reduced selling expenses to 2 billion yuan, perhaps revenue would be the same, and profits would increase significantly. After all, milk is a high-frequency repeat consumer product. Once consumers get used to a certain type of dairy product, they are likely to keep buying it. How many of us buy milk because of advertising, or don't buy milk because we haven't seen advertising?
The marketing "arms race" between Yili and Mengniu is more due to the "prisoner's dilemma." Neither dares to suddenly cut selling expenses significantly, otherwise it might be left further behind by the other. Yili and Mengniu are currently similar in scale. Yili cannot tolerate losing its top position, and Mengniu cannot tolerate being too far behind Yili. This is both a reputational and career risk for the management of both companies. Given the small gap between them, don't have high hopes for a reduction in selling expenses.
Yili's high selling expense ratio is deeply rooted in the fact that dairy products are almost homogeneous consumer goods. Whether it's Yili, Mengniu, or Bright's products, there is almost no difference for consumers.
In contrast, baijiu is a highly differentiated product. Not to mention the huge difference between Moutai and Erguotou, even Wuliangye and Moutai are very different. The taste and quality of baijiu do differ, but the social and emotional value embedded in the brand is even more important. Dairy products are functional products that satisfy protein and taste needs, without the added value of social and emotional value. Therefore, Moutai's profit margin (nearly 50%) is much higher than Yili's (nearly 10%), while its selling expense ratio is much lower. Moutai's selling expense ratio is only 5%.
Moutai and Wuliangye are both brand-driven companies, gaining varying degrees of pricing power due to differences in brand and quality compared to other baijiu brands, while Yili and Mengniu rely on external forces like advertising and channels. Moutai's brand pull is stronger than Wuliangye's, so its selling expense ratio is lower than Wuliangye's (around 10%). In his 1991 letter to shareholders, Buffett proposed the concept of "economic franchise": "An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by customers to have no close substitute; (3) is not subject to price regulation." If Moutai is a strong economic franchise, then Yili is a weaker one.
Consumers are not so desperate for Yili's milk (unlike Moutai's promotion in August this year when police had to fire warning shots to maintain order), nor does it have Moutai's addictive quality. When choosing milk products, consumers do consider brand factors; they prefer big brands like Yili, Mengniu, and Bright. But when these big brands are together, consumers don't care which one they choose. Brand loyalty is low; they almost pick whichever is cheaper, has a later production date, or is easier to reach. We see promotional staff for these milk brands every time we go to the supermarket.
So, although both are beverage companies, Yili and Moutai are vastly different. Yili is a functional, homogeneous product, relying on low profit margins and high turnover, requiring continuous product updates as a fast-moving consumer good. Yili's sales are not driven much by brand pull but more by marketing push.
From a development perspective, Yili's dairy products are still a healthy category, unlike unhealthy categories like Shuanghui's ham sausages, which are gradually declining. But the dairy industry as a whole is already in a mature stage. Kantar data shows that as of June 2018, Yili's market penetration for ambient liquid dairy products was 81.2%. China's per capita dairy consumption has caught up with South Korea and Japan, which have similar consumption habits. Among them, per capita consumption in first-tier cities is nearly saturated, while lower-tier cities and rural markets are still far below the national average, leaving some room for growth.
Yili's high-end products account for about 50% and still maintain a relatively fast growth rate. In the first half, revenue from key product lines such as "Jin Dian," "Ambrosial," "Chang Qing," and "Mei Yi Tian" increased by more than 30% year-on-year. These key high-end products are the main growth drivers for Yili.
Yili's market share is already relatively large (in 2017, Yili's ambient liquid milk accounted for 34% of sales, while Mengniu had 28%), with a little room for improvement. For example, in the first half, the company's retail value share of ambient liquid milk increased by 2.4 percentage points year-on-year, and the retail value share of low-temperature liquid milk and infant formula increased by 1 and 0.8 percentage points, respectively. As for Yili's milk powder business, due to the psychological shadow left by the "melamine" incident and the lack of price advantage for domestic milk powder, although Yili holds the largest share among domestic milk powder brands, it is difficult to challenge imported milk powder.
Yili's pricing power is also not very strong; it has even been cutting prices. We can feel that some of Yili's high-end products are already quite expensive, for example, Yili's 450g Chang Qing yogurt retails at 13 yuan per bottle. Yili's products have actually been cutting prices over the past two years, with overall price increases achieved more through product mix adjustments. In 2016, Yili's liquid milk revenue was 49.522 billion yuan, an increase of 2.371 billion yuan from the previous period, of which 1.139 billion yuan came from increased sales volume, 2.946 billion yuan from product mix adjustments, and a decrease of 1.714 billion yuan due to price changes. In 2017, Yili's liquid milk revenue was 55.766 billion yuan, an increase of 6.244 billion yuan from the previous period, of which 5.544 billion yuan came from increased sales volume, 1.061 billion yuan from product mix adjustments, and a decrease of 361 million yuan due to price changes.
In 2014, Yili upgraded its corporate vision to "Become the world's most trusted healthy food provider," aiming to benchmark against Danone and Nestlé and become a comprehensive food provider. In recent years, Yili has attempted some external acquisitions and launched cross-border new products such as plant protein drinks, functional drinks, and cheese. These are still relatively small in scale, face fierce competition, and have significant uncertainty about success.
As for the incident this year where Chairman Pan Gang was reported missing, it has been proven to be a rumor. The "cross-province arrest" is also completely different in nature from the Hongmao Pharmaceutical case. Yili is already a mature company; regardless of who is chairman, the impact is not significant. As for the "halal" logo that some people dislike, most consumers don't actually care, and it has not affected sales.
In summary, Yili is still an excellent company, but its business model is different from Moutai's, and its future growth should not be expected to be too high.
Source: Jingyi Investment (ID: jingyifund) -END-