Key Takeaways:
- AustAsia has tweaked the wording of its profile in the new IPO prospectus, dropping the phrase “largest independent” dairy producer from its description
- With milk production costs rising and prices falling, the company is projecting a drop in annual profit
By Emily Chan
In a lengthy IPO prospectus, just a few words can say a lot about a business.
Such is the case of AustAsia Group Pte. Ltd., a milk and beef producer that recently refreshed its application to go public on the Hong Kong stock market, a month after its first IPO attempt lapsed.
Eagle-eyed investors might notice a change in the way the company describes itself in the latest bid to list on the Hong Kong Stock Exchange. It has gone from being the “largest independent dairy farm operator in China” in the original prospectus to “one of the top five dairy farm operators in China” in the second IPO pitch.
So, what’s the story behind the revised wording, and what does it say about the dynamics of China’s dairy industry?
The company’s main business is producing milk and raising beef cattle, with ranches in Shandong and Inner Mongolia provinces. Its parent company, the agri-food business Japfa Group, started out in Indonesia in 1997 and entered the Chinese cattle production market in 2009. It has built large-scale cattle ranches and sells raw milk to downstream makers of dairy products. The company has also been expanding its reach in recent years, selling its own-label “Greenfields” dairy products to big coffee shops, bakeries and dim sum chains.
At the end of June, AustAsia owned 10 ranches in China with 111,424 cattle, including 57,383 cows, according to its preliminary prospectus. Between 2019 and 2021, the company raised its annual raw milk production from 565,400 tons to 638,800 tons, putting it among the top five cattle farm operators in China, although with only a 1.7% market share.
Many other dairy producers, such as Youran Dairy Group (9858.HK), Shengmu Organic Milk (1432.HK) and Modern Dairy (1117.HK), have been acquired by the two giants of the Chinese dairy sector, Yili Industrial Group (600887.SH) or Mengniu Dairy (2319.HK), to serve as stable suppliers of milk for them.
AustAsia had opted for another model in which it supplies national or regional dairy brands such as Mengniu Dairy, Bright Dairy & Food (600597.SH), Meiji Dairies, Jun Le Bao, New Hope Dairy, Jiabao Dairy and Classy Kiss Dairy. It has also partnered with emerging brands such as Genki Forest and Jianai.
A quarter stake for Meiji
AustAsia described itself as the largest independent dairy farm operator in China in its initial IPO application. But the independent label has come unstuck after the company invited in several downstream clients as shareholders. And market research data show that AustAsia ranks third, fourth or fifth in the industry in terms of sales volume and value or raw milk production, with the No.1 spot looking out of reach for now. Thus, in the latest application, it merely refers to itself as one of China’s top five dairy farm operators.
Parent company Japfa still holds a 62.5% stake in AustAsia, according to the prospectus, but downstream companies have bought a big chunk of the business. Meiji holds 25% of its shares, while Genki Forest and New Hope Dairy both have 5% and Honest Dairy has 2.5%. Meiji bought its stake for $254 million in 2020 and the other three came on board last September with the possible intention of securing milk sources before the company goes public.
In the first half of the year, the company’s raw milk business generated $242 million in revenues, around 87% of the total, while beef cattle production brought in $25 million, a 9% share of company income. Revenue from continuing operations grew from $352 million in 2019 to $522 million in 2021, a compound annual growth rate of nearly 22%. During the same period, profit grew from $74.63 million to $105 million, marking a compound annual growth rate of around 18%.
Investors should take note, however, that the milk producer’s profit performance has somewhat soured. Last year, operating revenue rose by almost 29% year on year, but the company’s net profit came off the boil, rising just over 7% to $118 million. The performance deteriorated again in the first half when revenue grew by around 15% to $278 million while net profit fell nearly 63% to $29.84 million.
A sour taste: rising costs and falling prices
Many factors are at play, including the rising costs of cattle production and falling dairy prices. Pure Source Dairy Farms, bought for $124 million in June last year, has also been a drag on profits with a low utilization rate and gross margin. The company’s gross margin on the raw milk business slipped to 27.2% in the first half of the year, a fall of 7.5 percentage points from the year-earlier period, while administrative costs rose 48.5% and financing costs jumped 65.5%, weighing on profitability.
Dairy industry peers are having a similarly tough time. At Youran Dairy Group, first-half revenue grew 19.4% but net profit plunged 76.5%, while over at Shengmu Organic Milk revenue edged up 7.1% while net profit tumbled 11.7%.
The growing cost of cattle feed is the biggest risk facing raw milk suppliers, as the prolonged war between Russia and Ukraine pushes up the prices of agricultural products. AustAsia spent $223 million to feed its cattle last year, a 31.5% year-on-year increase. Feed expenses kept rising in the first half of this year, jumping 33.5% to $139 million, equivalent to more than half of the company’s revenue from the raw milk business.
With no sign of an end to the conflict in Ukraine, feed prices are unlikely to revert to pre-war levels anytime soon. Therefore, AustAsia Group is trying to adjust its feed formulas to minimize the hit from raw material prices.
Meanwhile, the prices of raw milk have been on the turn, after rising for several years. As competition for quality milk supplies intensified, downstream diary producers invested heavily in the upper end of the supply chain by acquiring or building ranches themselves. With the dynamics of supply and demand shifting, the average price of the company’s raw milk came off its peak, falling 3.5% in the first half of the year to $717 per ton.
Given the unsavory factors, profits from the raw milk business continued to slip in July and August, despite rising revenue, the company said in its updated prospectus. And it forecast a fall in net profit for the full year.
For an indication of the IPO’s value, investors can look to the price-to-earnings (P/E) ratios of AustAsia’s three main competitors, Youran Dairy Group, Shengmu Organic Milk and Modern Dairy. These range from 5.4 times to 7.3 times, with an average of 6.1 times. If the company’s first-half net profit figures are extrapolated to the whole year, the formula produces an estimated valuation of 2.6 billion yuan ($358 million).
But the eventual value will depend on whether the whole Hong Kong market can rally. If the IPO is launched into a weak stock market, the raw milk producer may have to lower the valuation to sweeten the flavor of its shares for investors.
