Mengniu Drives Needed Dairy Consolidation
Mengniu’s (HKEx: 2319) new announcement of its third major tie-up in the last month marks the latest step in an important and necessary consolidation for a battered Chinese dairy sector that has been in turmoil for the last 5 years. This kind of retrenchment, which includes a healthy dose of participation by foreign firms, is exactly the kind of medicine that China needs to restore consumer confidence to its fragmented and often unruly food sectors.
Food safety problems have become a regular staple in China in the last 5 years, dating back to a 2008 scandal involving infant baby formula tainted with the industrial chemical melamine. Other scandals since then have covered a wide range of products, including the most recent cases involving chicken with excessive levels of antibiotics and fox and mink meat being sold as mutton.
Many of the problems stem from the market’s high degree of fragmentation, creating a situation where thousands of small companies and individuals – many of them unlicensed – supply products of dubious quality to the nation’s many restaurants, markets and grocery stores.
After seeing its business hit for most of the last 5 years from the original melamine scandal, Mengniu jumped into the headlines last month when it said it would raise its stake in China Modern Dairy (HKEx: 1117), one of its key suppliers, to 28 percent in a deal worth more than $400 million. Later in the month it announced a major new yogurt-making joint venture with French giant Danone (Paris: DANO). (previous post) In the latest tie-up, Mengniu has announced it will buy milk powder maker Yashili International Holdings in a deal valued at about $1.6 billion. (English article)
All 3 of these deals have a foreign angle, which should help to reassure Chinese consumers who have become wary of excessive cost-cutting and lax quality controls at many domestic food firms. China US private equity giant KKR was one of China Modern Dairy’s previous owners, and Yashili’s current stakeholders include Carlyle, another private equity giant. Yashili also sources its products from New Zealand where quality controls are stricter and food safety scandals are much less common. Similarly, Danone is a major global name in food products and a trusted name by most Chinese consumers.
Investors have cheered this overhaul at Mengniu, sensing the company could emerge as a new and trusted leader in China’s tainted dairy sector. The company’s shares are up more than 30 percent since the beginning of May, including a 6 percent jump this week after the Yashili deal was announced.
China needs to encourage this kind of consolidation not only in the dairy sector, but also among its many other food manufacturers to create some national giants with the scale and resources to implement strong quality control to ensure their product safety. Such scale and internal controls are the reason that many Chinese consumers already trust foreign brands like Danone, McDonalds (NYSE: MCD) and Procter & Gamble (NYSE: PG) far more than their domestic peers.
By encouraging such consolidation, China could not only restore consumer confidence to some of its most promising brands but also position those names to become homegrown giants that could someday compete with the big western names in the global marketplace.
Bottom line: Mengniu’s third strategic tie-up in the last month marks the latest step in a needed consolidation of China’s dairy industry, with more to come.
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