June 3, 2004

 

 

Mengniu Dairy Aims To Cash In On China's New Thirst
 

China Mengniu Dairy, the country's biggest liquid milk producer, launched the retail portion of a Hong Kong initial public offering that could raise up to US$176 million this week.

 

"We hope to be one of the ten largest dairy firms worldwide in 10 years," said Niu Gensheng, founder and chairman of the fast-growing Inner Mongolia-based firm known for its advertisements featuring China's space programme.

 

Dairy product sales in China have grown about 30 percent a year in the past five years, said Sandy Chen, an analyst in Shanghai with Dutch agricultural specialist Rabobank. Still, the average Chinese consumes just 13 kilograms of dairy products per year, compared with 50-60 kilos in Taiwan and 70-80 in Japan.

 

Rising incomes and a milk-drinking push by Beijing are fuelling consumption, even though milk is not a traditional part of the Chinese diet.

 

Chinese people are also more lactose intolerant than Western consumers. Little Chinese research has been done, but U.S. studies have found 90 percent of Asian-Americans are lactose intolerant, compared with about 20 percent of the wider U.S. population.

 

Chen said that the problem is decreasing as children are raised on milk and are accustomed to digesting it. Drinking yogurt is an alternative for those with lactose intolerance, he said.

 

In hopes of building a healthier population, China has promoted milk to students and soldiers. Beijing wants urban dwellers across the country to nearly double their intake of liquid milk by 2010 to 32 kilos per person -- the same amount that residents of Beijing and Shanghai now drink.

 

Japan and South Korea saw similar surges in dairy consumption over 10 to 15 years in the 1950s and 1970s. "China is just about five years into this rapidly growing phase," Chen said.

 

DOMINANT LOCALS

 

Founded in 1999, Mengniu -- which means "Mongolian Bull" -- is growing fast, holding a 20.6 percent share of a mainland liquid milk market. It dominates the market alongside local players Yili Co Ltd and Shanghai's Bright Dairy, which is the largest overall dairy firm in China.

 

The country's dairy industry is worth about US$7 billion, or about 17 percent of packaged food spending in China, according to Morgan Stanley, which is underwriting Mengniu's IPO.

 

Among foreign players, only Nestle, a major seller of powdered milk, has enjoyed significant success in China.

 

"With the dairy sector, the whole supply chain is quite long and complicated," said Chen. "It is a bit difficult for foreign dairy players to manage the sourcing of raw milk."

 

Other foreign participants include Groupe Danone, which owns 3.75 percent of Bright Dairy. The French giant hopes to raise its stake to 7.5 percent.

 

But Kraft Foods sold its China dairy unit in 1991 to Beijing Sanyuan Food Co Ltd. Insolvent Italian giant Parmalat, meanwhile, is exiting its China businesses.

 

Market watchers said that given the supply chain challenges and the scale of domestic players, foreign firms will need to enter or expand in China through takeovers or joint ventures.

 

The sector's rapid growth has nonetheless attracted new entrants, such as New Hope Group, a private firm. Taiwan's largest food producer, Uni-President, has also been building its dairy operations in China and is eyeing acquisitions.

 

New Zealand's Fonterra Co-Operative Group, the world's top dairy exporter, is close to a deal to buy a stake of about 39 percent in China's Shijiazhuang Sanlu Group.

 

FIERCE COMPETITION

 

Some fund managers said added competition would erode prices and crush margins, a scenario that has long plagued China's beer sector. Morgan Stanley predicts Mengniu's operating margins will shrink to six percent this year from 7.4 percent in 2003 as it lifts promotional spending to fend off heightened competition.

 

Rabobank's Chen said the rate of growth in the sector will decline, and also warned of temporary oversupply.

 

"That actually means dairy processors are trying to fight for market share. At the same time, they have to fight to secure stable supplies of raw milk," he said.

 

Fund managers said that Mengniu is overreaching by raising the price range of its IPO to 15-19 times forecast 2004 profit. Hong Kong-listed China firms trade at an average of about 10 times forecast profits.

 

Another concern is that Mengniu does not own a dairy herd, but instead buys raw milk, mostly from small farmers.

 

"They don't have the cows themselves. They have to go to the farm to buy the milk," said Yang Liu, a China-focused fund manager with Atlantis Investment in Hong Kong.

 

In China, processing demand exceeds available raw milk by about five percent. The difference is made up by powder imports from Australia and New Zealand, according to Chen.