By Meng Nan, reporter for Investment Times Despite similar asset scales, comparable revenues, and close market shares, since the melamine incident, the market value gap between Mengniu and Yili has been as large as one Mengniu, with profits only one-third of Yili's. This is closely related to frequent management changes and industrial layout adjustments at Mengniu. The public announcement of Lu Han and Guan Xiaotong's relationship once crashed Weibo, and the mobile phone brands they endorse became the biggest beneficiaries of this viral love declaration. However, Inner Mongolia Yili Industrial Group Co., Ltd. (hereinafter "Yili") and China Mengniu Dairy Company Limited (hereinafter "Mengniu"), regular advertisers on variety shows, did not gain any advertising effect from this hot event. Despite having signed half of the Running Man cast members, they missed the chance to partner with the newly "single" duo, perhaps now regretting it. Nevertheless, from Super Girl to Running Man, Yili and Mengniu have always been the biggest beneficiaries of variety show dividends. In recent years, with the explosive popularity of variety shows, their revenues and market shares have increased year by year, leading to the nickname "running milk" in the industry. But this has also driven up advertising costs. Their annual marketing expenses exceeding ten billion yuan have led consumers to lament, "I'm not drinking milk; I'm drinking advertisements." Ambrosial or Puregen? Future Star or QQ Star? Most people probably can't tell which brand belongs to Mengniu and which to Yili. In fact, whichever product becomes a hit through advertising, or whose spokesperson generates more fan effect, that product captures the market. For consumers, whether it's Mengniu or Yili may not matter. But for Yili and Mengniu, it's quite the opposite. After all, with their industry positions alternating, their 18-year "grudges and entanglements" mean "WE ARE NOT FAMILY"! Even though the dairy industry experienced explosive growth overall in 2017, it hasn't stopped their competition. Recent Bloomberg reports indicate that both Mengniu and Yili appear on the bidding list for Murray Goulburn, Australia's largest dairy company, valued at over 5 billion yuan. In recent years, against the backdrop of food consumption upgrades and the gradual emergence of the "second child" business opportunity, with the batch-by-batch implementation of the registration system, favorable policies have brought a recovery dawn to the dairy industry, which was once mired in negative news. Investment Times reporters noted that in the first half of 2017, Wind Information industry data showed that the overall revenue of listed companies in China's dairy industry grew by about 10.6% year-on-year, with net profit growing by about 3.1%. Is it a rebirth from the ashes? Or an industry reshuffle? Or a joint defense against "foreign monks"? Only time will tell. These favorable factors are particularly significant for Mengniu, which suffered its first loss in eight years in 2016. On August 30, 2017, Mengniu released its 2017 interim report in Hong Kong. The report showed that the company achieved revenue of 29.466 billion yuan in the first half, up 8.10% year-on-year; net profit was 1.115 billion yuan, up 4.7%. However, is the reality as rosy as the interim report suggests? Investment Times reporters learned that while the gap with Yili widened, Mengniu's long-held position as the market share leader in liquid milk was also taken over by Yili. Moreover, the goodwill impairment test conducted at year-end is not reflected in the interim report, significantly reducing the quality of Mengniu's results. Still a Mengniu Behind Yili The 2008 melamine incident plunged China's dairy industry into crisis. After barely surviving the "bet" challenge, Mengniu welcomed COFCO as its major shareholder in July 2009. However, with founder Niu Gensheng resigning as chairman of the board in 2011, Mengniu also gave up the top spot in the dairy industry. Even though Niu returned in September 2016 as a member of the "Strategy and Development Committee" and non-independent director, during this period, Mengniu's management, marketing system, and strategic layout underwent a series of changes, and things had changed drastically. Yili, on the other hand, leveraged its advantages to firmly hold the industry's top position. Now, the gap between the two has further widened. Investment Times reporters learned that as of now, Yili's total market value is 171.8 billion yuan, while Mengniu's is only 72 billion yuan, the latter being merely 41.90% of the former. The stock price gains since the beginning of the year also reflect this: Yili's stock price has risen 65.88%, while Mengniu's has only risen 47.18%. Moreover, there are differences in their interim performance. Yili's interim report shows that in the first half of 2017, it achieved revenue of 33.494 billion yuan, up 11.32% year-on-year; net profit was 3.368 billion yuan, up 4.75%. All its metrics are better than Mengniu's, with net profit more than three times that of Mengniu, and net profit margin at 10.11%, far higher than Mengniu's 2.50%. However, despite Yili's advantage over Mengniu, the risks they both face should not be underestimated, especially as the growth dividends from industry positives have not led to comprehensive growth in their financials. Increases in selling expenses and operating costs have caused both net profit margins to decline. Yili's net profit margin fell slightly by 6.13%, but its operating costs and selling expenses increased by 12.68% and 8.08%, respectively; Mengniu's net profit margin fell by as much as 54.50%, with operating costs and selling expenses increasing by 4.93% and 10.78%, respectively. It is not hard to see that the performance growth of the two giants is more based on a "money-burning" effect. With stricter regulation of variety shows, increased risk of celebrity image collapse, and a new round of packaging cost increases, relying on advertising bombardment strategies may not be as effective in the future, and cost pressures are bound to intensify. More importantly, there is the short-board problem in China's dairy industry. With the rapid rise of e-commerce, cross-border trade, and overseas purchasing agents, and burdened by past industry misconduct, consumers tend to prefer original imported products, causing the share of domestic brands to drop from over 50% to below 40%. Industry insiders told Investment Times reporters that with the relaxation of the second-child policy and the implementation of new registration rules, the milk powder industry has adjusted to the bottom and is about to rebound. Judging from the progress of the infant formula registration system, domestic leading companies have a first-mover advantage; moreover, some small and medium-sized enterprises are significantly behind schedule, and it is expected that 12-20 billion yuan of market space will be freed up in the future. Despite a positive outlook, the first urgent issue is to heal the "Sanlu" scar in consumers' minds. Regarding the handling of the melamine problem, Mengniu's crisis solution is also one of the reasons for the widening gap with Yili, especially the statement, "Our products sold to Hong Kong are of the same quality as those exported, and are guaranteed to be better and safer than those sold on the mainland," which has long been deeply ingrained in people's minds. The Pain of Mergers and Expansion While dairy giants are racing to expand, Mengniu's expansion path has been particularly high-profile and aggressive, which cost it its first loss in eight years. Despite a significant increase in Mengniu's stock price, its 2016 performance was disappointing. Its 2016 annual report shows that the company achieved operating revenue of 53.779 billion yuan, up 9.69% year-on-year; gross profit was 17.635 billion yuan, up 14.7%. Although revenue and gross profit grew steadily, it turned from profit to loss during the year, with a net loss of 751 million yuan. Mengniu stated that the main reasons for the loss were: first, Yashili recorded a loss during the year and the group made a goodwill impairment provision of 2.254 billion yuan; second, excess raw milk powder inventory was sold at market prices to optimize inventory; third, a joint venture company recorded a significant loss during the year, and the group's EBITDA fell by 77.4%. However, even excluding Yashili and goodwill impairment, Mengniu's 2016 net profit was only 1.687 billion yuan, still down 27.6% year-on-year. Mengniu, which lags far behind Yili in the milk powder business, had hoped to make up for its shortcomings by acquiring Yashili for 10 billion yuan and entering the first tier of China's milk powder sector. However, Yashili's mediocre performance has instead become a "drag" on Mengniu. Investment Times reporters learned that from 2013 to 2016, Yashili's revenue fell from 3.89 billion yuan to 2.2 billion yuan, including sales revenue from Mengniu's original milk powder brands. Among them, Yashili's 2016 revenue fell by more than 20.2% year-on-year, with Dumex alone incurring a loss of 55.905 million yuan. Moreover, the Dumex brand had previously been affected by the Fonterra botulism false alarm, which significantly damaged its brand awareness and led to declining sales. Yashili's internal adjustments and personnel changes, as well as the lingering shadow of the "melamine" incident, have left Mengniu's milk powder business facing internal and external troubles, despite Yashili securing 21 of the 192 infant formula registration slots. Yashili continued to incur losses in the first half of 2017. The report shows that the company achieved revenue of 967 million yuan in the first half, down 15.7% year-on-year; net loss was 121 million yuan, a year-on-year decline of 907.3%. In addition, in recent years, the increasing volume and falling prices of imported fresh milk have continuously impacted China's animal husbandry, causing great distress. Industry insiders say that on one hand, the impact of large quantities of low-priced imported milk powder and uncontrollable feed costs have made China's animal husbandry costs generally higher than international levels; on the other hand, price wars among dairy giants and consumer discounts on e-commerce platforms have squeezed upstream profits year by year. Mengniu's subsidiary Modern Farming is also in a difficult position, causing continued losses for Mengniu. In March 2017, after completing the tender offer, Mengniu held 61.3% of Modern Farming's shares. However, on August 6, Mengniu announced that it planned to sell 0.49% of Modern Farming's shares at HK$1.38 per share (about 70% of the tender offer price), totaling HK$41.4 million, to repay some existing debts. Why sell so soon after completing the acquisition? Modern Farming's performance explains it all. The interim report shows that in the first half of 2017, the company's revenue increased 5.2% year-on-year to 2.344 billion yuan, but it incurred a loss of 666 million yuan, with the loss expanding 17.78% year-on-year. This is the third consecutive year of declining performance for Modern Farming. Although Mengniu has repeatedly announced that Yashili and Modern Farming will see a turnaround in the second half of 2017, if the performance of the acquired segments remains sluggish at year-end, Mengniu will still need to make goodwill impairment provisions for the acquired companies, which will only subtract from Mengniu's own growth performance. After all, whether bitter or sweet, it's the fruit of one's own planting, and one must swallow it! Source: Investment Times (ID: touzishibao) 2017 (3rd) FMCG + Internet Conference will be held in Chongqing in November 2017. The conference will closely focus on the theme "New Forces, New Ecology" and invite 1,000+ distributors, 500+ brand owners, 200+ B2B platform founders, and 100+ investment and financing institutions to jointly explore a new chapter of cross-border integration! Click the link below to review the highlights of the first and second FMCG + Internet conferences: 2016 "FMCG + Internet" Summit Forum -END-