Hyundai Animal Husbandry (01117)'s 2023 interim financial report sent several interesting key signals.

According to financial reports, Hyundai Animal Husbandry's revenue for the first half of 2023 was RMB 6.633 billion (equivalent unit below), up 17.8% year on year; net profit was 217.9 million yuan, down 59% year on year; net cash flow from operating income surged 70% year on year to 2.18 billion yuan during the period, and free cash flow turned positive, from -559 million yuan in the same period last year to 897 million yuan.

Increased revenue does not increase profits. If measured simply from this indicator, modern animal husbandry has not handed over a satisfactory answer to the market. However, financial reporting is not a single digital report, but rather a comprehensive financial measurement, such as the two most important comparison criteria:

Net profit, operating cashflow/free cash flow.

Analyzed from the perspective of net profit, although this indicator, the modern animal husbandry industry has declined by 59%, maintained continuous profit, and outperformed the entire industry, and even far superior to its peers.

As can be seen from the table above, under the premise that feed costs rose sharply year-on-year and raw milk sales declined in the first half of the year, the decline in net profit of modern animal husbandry was clearly superior to that of peers.

According to the data, feed prices were at an all-time high in 2022. Prices of soybean meal/alfalfa grass/cottonseed rose 25%, 36%, and 20% year-on-year, with a cumulative increase of 44%, 51%, and 61% over the past three years. Moreover, in the first half of 2023, the feed cost of raw milk increased by about 7%. For example, the price of soybean meal increased by about 6%, which caused raw milk companies to lose more than 60%.

Compared with this, modern animal husbandry accounts for 94% of gross profit of raw milk, and gross margin fell from 32.2% to 28.3%, a decrease of only 3.9 percentage points, indicating that modern animal husbandry controls costs and increases production efficiency. In a situation where the industry is losing money, companies that can maintain profits are the winners in this industry.

What's more remarkable is that while net profit was cut short, Hyundai Animal Husbandry's cash EBTIDA only dropped by 12%.

In fact, net profit is confusing. It will be affected by factors such as capital structure, income tax, and non-core or non-current business of the enterprise, while EBTIDA can more effectively predict the future financial statements prospects of the enterprise and correctly reflect the overall value of the enterprise.

From the other side, EBTIDA is a reflection of a company's cash flow.

The quality of a company's operations must not only be based on a profit and loss statement (income statement), but it must also have a steady operating cash flow. Operating cash flow is a prerequisite for the survival of an enterprise, and what determines the life cycle of an enterprise is the cash flow generated from operating activities.

Due to the influence of corporate credit policies, capital expenditure cycles, and market competition, there will be a divergence between cash flow and net profit trends. Therefore, when the net profit trend is not consistent with the cash flow trend, the cash flow trend is used as the basis for judgment.

From the perspective of operating cashflow/free cash flow, in the first half of the year, Hyundai Animal Husbandry's net operating cash flow reached an astonishing 2.18 billion yuan, and free cash flow soared to 897 million yuan, indicating that modern animal husbandry has a lot of internal capital that can be freely used, which helps reduce the company's debt size and leverage ratio, and is also an important pool for returning shareholders.

In the second half of the year, cash flow will continue to expand.Even over the next two years, cash flow remained solid, and deleveraging continued.Mainly based on a few factors:

A. Revenue continued to grow: The annual milk volume for the full year of 2023 exceeded 2.5 million tons and should exceed 8%, exceeding expectations — the performance guidelines given by Hyundai Animal Husbandry at the beginning of the year indicated that milk production for the whole year would increase by 3%;

B. New businesses contributed more: for example, modern feed and modern grass industries began to increase revenue and profit — in the first half of the year, sales revenue growth rate of new businesses reached 105% and reached a record 1.59 billion yuan. This made the main business of modern animal husbandry begin to form a growth flywheel model;

C. Match specialty milk production to increase the added value of the product. For example, organic milk with higher gross margins and A2 milk are entering the market — considering only 400 tons/day of organic milk production in the Palestinian Union region, it contributes more than 50 million in net profit per year;

D. Prices of raw materials fell year-on-year: Prices of raw materials for soybean meal and other protein feeds began to fall in 2023 compared to the second half of 2022, and the modern animal husbandry industry has anchored futures prices — feed digested in the first half of the year from January to March was the 2023 contract and price, but after April, the lower prices for the new year were implemented, and production costs should drop compared to 2022;

E. Bank loan expenses decreased in 2023: one-year accounts were 3.2 billion yuan, down about 1.8 billion yuan from the end of last year, and interest rate costs were reduced — the annual interest rate for bank loans in the first half of the year was between 1.65-4.20%, while at the end of 2022 it was 1.65-8.16%. The share of long-term debt in the first half of the year increased from 60% at the end of last year to 74% at the end of June this year, and the debt structure continued to be optimized in the second half of the year;

F. Capital expenses have declined sharply: investment in mergers and acquisitions and holding shares will also be reduced for the most part, and more people will prefer leasing ranches and entrustment operations; even maintenance costs for own ranches will begin to decrease, and are lower than in 2022.

If 2022-2023 is a painful year for raw milk companies in China, then starting in 2024, with the clearing of the industry, leading raw milk companies may usher in a year of strong recovery.

From long-term management, especially with the next 2-3 years as a timescale, the modern animal husbandry industry will usher in a longer growth point, along with improvements in operating cashflow/free cash flow.

1. Continued expansion: With the current drop in milk prices, many ranches are losing money and leaving a lot, which has led to a rapid increase in the concentration of the top 20 and 30 raw milk companies. According to the plan, modern animal husbandry will exceed 500,000 dairy cows in 2025 - an increase of 9.4% in the first half of the year to 419,000;

2. The business is more stable: the contribution of new business is higher, and the dependence of a single large customer is further reduced;

3. The pressure on bulk feed prices will ease further in 2024: as the Russian-Ukrainian war comes to an end and the climate impact of El Niño comes to an end, the price of feed will most likely return to the range below 4,000 yuan/ton — the price of soybean meal exceeded 5,000 yuan/ton in August;

4. Yield has further increased: The company's guidelines are that by 2025, the total yield of dairy cows will exceed 13 tons - in March 2023, the yield of dairy cows in modern animal husbandry is close to 13 tons, and this target is likely to be completed ahead of schedule in 2024;

5. Pasture maintenance and capital expenses continue to be drastically reduced. The goal of modern animal husbandry is to keep the balance ratio and the interest-bearing debt ratio within 50% and 45%, respectively, by 2025;

6. A large number of reserve cows have become lactating cows, bringing stronger cash flow: In the next 1-2 years, a large number of self-breeding reserve cows in modern animal husbandry will be converted into lactating cows, bringing strong cash EBITDA.

Conclusions:

Buffett believes that the free cash flow of stocks purchased by investors should continue to be abundant. This is a very important aspect of examining whether the stock is worth investing in. In his view, the free cash flow generated by an enterprise is the most real thing an investor can own.

Stock prices are a function of discounted cash flow models, and changes in future free cash flow expectations are the main determinants of stock price changes and stock market returns. For companies that have growing expectations for future free cash flow, their stock prices should rise well over time.

In this sense, the modern animal husbandry industry has asymmetric upward potential: rapid expansion and growth. In the past five years, modern animal husbandry revenue has reached a compound growth rate of 21.11%, and there is still no sign of deceleration — about 18% in the first half of the year; it is expected to maintain steady growth in terms of expected future cash flow; in addition, there is an emerging story of dividend growth — with continuous dividend payments and a payout rate of 20% or more for the past three years.

Judging from market demand, the amount of milk consumed per capita in China will grow at the most moderate rate of 3-4% in the future. Data shows that for every 1,000 US dollars of per capita GDP growth, per capita milk consumption can increase by 1.1 kg. According to this forecast, “2025 and 2030? “China's milk consumption can reach 62 million and 69 million tons, respectively, with increases of about 5 million and 12 million tons, respectively.” Li Shengli, a professor at China Agricultural University, said.

Despite being affected by the general environment, under the combined effects of rising costs and falling prices, the raw milk supply and raw material supply side, including modern animal husbandry, are facing downward pressure on performance. However, as the concentration of leading companies increases, the industry may begin to pick up in the next year, and it is a probable event that the profits of leading companies will benefit from earlier expansion.

The business we are looking for is a company with a long-term competitive advantage in a stable industry. A high-quality standard with free cash flow and high dividends will be an important option. The Zhitong Finance App believes that factors such as business expansion, an increase in the amount of milk per unit, a reduction in capital expenses, and the conversion of reserve cows to lactating cows are catalysts that will drive the future free cash flow expectations of the modern animal husbandry industry to continue to rise, and that dividends in return to shareholders will also increase.

Therefore, in terms of industry trends and corporate fundamentals, the current modern animal husbandry industry is an important target worth investing more attention in and being able to set up small positions to observe.