HONG KONG: After seeing their earnings plunging into the red in 2008, mainland dairy producers are expected to gather back their growth momentum and show a solid revenue improvement one year after the melamine-contaminated milk scandal in last September.

Net profits of the major listed diary companies including China Mengniu Dairy, Inner Mongolia Yili and Bright Dairy were all hit with deficits in 2008, as the melamine scandal heavily depressed companies' sales and incurred additional costs for disposing of raw milk and on-shelf milk products.

Around 22 dairy firms on the mainland were found to have sold melamine-tainted dairy products, which in high doses leads to kidney stone formation. The scandal caused deaths of at least six children and sickened 300,000 in the country.

To the market's surprise, most of the mainland dairy firms have managed to report healthy earnings numbers in the first half of this year, despite their significant profits slump in 2008.

Net earnings of Mengniu, the largest liquid milk producer on the mainland, bounced back to 661.9 million yuan in the first half, after reported net loss of 948.6 million yuan in 2008. Its rival Yili also showed a 118 percent surge in its first-half profits at 254 million yuan.

Lawrence Chor, a food and beverage analyst at Hong Kong-based Taifook Securities expects Mengniu to maintain its leading position, while the strategic investment by China National Oils, Foodstuffs and Cereals Corp (COFCO) and Hopu Investment Management in July will yield positive synergies for Mengniu over time.

"The strong distribution network of COFCO will help promote Mengniu products in the country, which will also boost the company's overall sales," Chor said.

COFCO and Hopu are currently the biggest stakeholders in Mengniu, holding around 20 percent of the company's stake.

Jiang Zhihui, a Shenzhen-based food and beverage analyst at Daoheng Securities, expects sales of diary firms in 2009 to recover to 90 percent of the pre-melamine-scandal level, benefiting from the drop in raw milk prices early this year.

"Profit margins of many dairy producers have showed significant improvement in the first half, because of the decline in raw milk prices. The profit margin of Mengniu has even surged to a historic high," Jiang said.

He expects Yili's earnings in the second half to outperform Mengniu, as Yili starts to gain market share in the higher-profit milk powder sector.

"Yili is the biggest dairy company on the mainland that produces milk powder, the company's investment in milk powder will be quite significant," Jiang said, but added that the fast expansion of international milk-powder makers on the mainland may threaten the market-leading position of Yili in the longer term.

Echoing Jiang, JP Morgan expects Yili's market share in milk powder to further increase, after the closure of milk powder producer Sanlu Group.

JP Morgan also believes Shanghai-based Bright Dairy is becoming more popular after the scandal, as mainland consumers are more confident about the safety and quality standards of milk products being made in the cities.

Taifook's Chor said the three major dairy producers Mengniu, Yili and Bright Dairy may continue to gain market share and maintain their leading position in the country's dairy market.

"Expansion of the small-and-medium-sized milk producers on the mainland will be quite limited, as their financial structures are not comparable with the big players," Chor said, adding that the market consolidation will benefit the sales growth of the major dairy firms in the foreseeable future.

(HK Edition 10/24/2009 page5)