China’s market for dairy products is at an early stage and poised for stellar
growth. The country’s current dairy consumption stands only at about a fifth of
the world average, according to the Ministry of Agriculture in China, but the
People’s Republic of China (PRC) aims to change this as there is a clear
governmental push to promote the drinking of milk as part of a healthier diet.
“I have a dream to provide every Chinese, especially children, sufficient milk
each day,” said Chinese Premier Wen Jiabao in April of 2006. Currently in place
are government subsidy programs for school children along with state-run
educational TV programs that promote the benefits of drinking milk. And given
that there are about 200 million primary school children in China, growth
potential is sizeable.
The PRC’s put its money where its mouth is too, with programs to grow the
Chinese dairy industry including exemption from corporate income tax and Value
Added Tax (VAT) rebates.
American Dairy (NYSE: ADY) is a small-cap Chinese stock clearly
benefiting from this push, and provides investors with the opportunity for
impressive growth given the expanding market and attractive valuation. The
company’s wholly owned subsidiary, Feihe Dairy, is a growing producer and
distributor of milk powder and soybean products in China. Among the firm’s
merits are modern processing facilities, good sourcing of raw milk, strong brand
recognition, established distribution networks, and continued product
development and diversification.
Strategically situated in the key “Milk Belt” of Northeastern China, American
Dairy is close to its network of milk suppliers, a critical factor given the
competition for raw milk in the country. Helping to drive growth is the
company’s focus on quality and brand recognition.
The company estimates that around 68% of revenues this year will be derived from
the production of milk powder with the remaining from soybean and walnut-based
products. Another positive is the company’s strategy to focus on higher margin
products such as infant formula, yogurt and cheese products to satisfy rising
demand.
American Dairy experienced significant growth in 2005. Revenue for the year was
$68 million, an increase of 82% from $37.4 million the previous year. Net income
was $11.6 million, or $0.74 per share, an increase of 78.5% from $6.5 million,
or $0.47, in 2004.
In the second quarter of 2006, revenue grew 72% to $26.1 million from $15.1
million in the year ago quarter. Growth in the company’s infant formula and milk
powder products drove the revenue growth. Second quarter earnings surged 86% to
$5.3 million, or $0.31 per diluted share from $2.8 million, or $0.18 per diluted
share in the year ago quarter.
As part of its growth strategy, American Dairy aims to expand sales of its
products to contiguous markets across China with high population density. The
company said it would also enter into other markets via joint ventures,
licensing, or arrangements with local farmers. Key objectives of this growth
strategy include expanding its customer base via the selling of fluid milk
products in no-return containers and increasing sales of higher margin solid
milk products such as yogurt and cheese.
Looking ahead, American Dairy is estimated to earn $1.18 per diluted share on
revenues of $120.17 million in 2006, up 59.5% and 76.7%, respectively, from
2005, according to a single estimate by Westminster Securities. The earnings
estimate gives the stock an attractive valuation of 12.3X its estimated FY06
EPS.
With shares of American Dairy down about 30% from its 52-week high of $19.98,
the current price and valuation look attractive for growth-oriented investors
looking for a solid Chinese growth company. We believe the shares could trade
significantly higher in the next twelve months and expect that shares will trade
at $18.00 in the next month, translating into an extremely conservative 15X the
FY06 estimate of $1.18 and 18X trailing 12 month EPS. This represents a 28.6%
increase from the current price of $14.00. We would be buyers of the stock at
the current share price.
