In recent months, the dairy industry in China has been increasingly pressured, finally reaching a breaking point that many experts have predicted since COVID-19 disrupted markets globally. The original deputy minister of agriculture and rural affairs, Yu Kangzhen, sounded the alarm back in July, indicating that the Chinese dairy sector faces its toughest challenges since 2008. This bleak outlook hints at deeper systemic issues affecting one of the world's largest dairy markets.

The financial troubles of Mengniu Dairy, one of China's two dairy giants, serve as a stark illustration of this ongoing crisis. Its recent financial report for the first half of 2024 revealed a dramatic drop in both revenue and profit, reflecting a broader trend in the industry. Mengniu achieved total revenues of 44.67 billion yuan within the first half of the year, marking a year-on-year decline of 12.6%. Net profits fell to 2.53 billion yuan, down 17.23% from the previous year, resulting in a basic earnings per share of only 0.623 yuan—a decrease of 18.6%.

During a recent earnings call, Mengniu President Gao Fei was candid about the disappointing figures, citing weak consumer demand and inconsistencies in supply channels for various dairy categories. The cold hard facts reveal a direct correlation between changing consumer habits and declining sales, especially in sectors where Mengniu had previously thrived, such as long-lasting milk and domestic ice cream.

In an additional complication, the transition of leadership took place earlier this year when former president Lu Minfang stepped down. Gao Fei, who has been with the company since 1999 and comes from within the ranks of Mengniu, is now grappling with the significant downturn in performance facing the company. Although having considerable experience, the timing of his ascent to the presidency amidst a faltering dairy market presents its own set of challenges.

Notably, all four of Mengniu's key product segments showed declining sales in the first half of the year. Liquid milk revenue plummeted by 12.9% to 36.26 billion yuan, constituting 81.2% of total revenue. The ice cream division faced an even harsher downturn, with income dropping by 21.75% to 3.37 billion yuan. Furthermore, the powdered milk segment witnessed a 13.6% decrease in sales, finishing with 1.64 billion yuan, while cheese product revenues decreased by 6.28% to 2.11 billion yuan.

One critical factor contributing to Mengniu's struggles is the overproduction of raw milk within China's dairy sector. In 2023 alone, the country's raw milk output increased by 2.65 million tons, or a staggering 6.7% over the previous year, marking a record high. With domestic raw milk prices declining for 27 consecutive months through May, the industry faces severe profitability issues, where more than 80% of dairy companies are reportedly suffering losses.

Moreover, the existing consumption patterns have been under severe stress since 2021, leading to a consecutive decline in per capita dairy consumption among Chinese residents over two consecutive years. This, in turn, has exacerbated the surplus of raw milk supply, putting additional pressure on producers like Mengniu.

As a result of the diminishing raw milk prices, Mengniu faced substantial increases in inventory impairment losses in the first half of the year, totaling around 346 million yuan compared to just 23 million yuan in the same period last year. This inventory impairment accounted for 0.77% of the company's overall revenue. Additionally, joint venture profits took a considerable hit, with Mengniu reporting a loss of 170 million yuan.

The financial report's figures illuminate stark contrasts in performance between Mengniu and its closest rival, Yili Group. While Mengniu grappled with pronounced declines across all its product categories, Yili smartly countered the general downturn with selective growth in their powdered milk segment, which enjoyed a 7.31% increase in revenue amidst an otherwise bleak half-year report.

The dynamics between these two major players encapsulate the shifting landscape within China's dairy industry, where leadership stability and strategic direction directly correlate to market performance. Whereas Mengniu has seen frequent change in leadership—now with Gao Fei taking the helm for the fifth time since its founding—Yili has maintained the steady hand of Pan Gang since 2005, leading to a sustained approach and consistent growth.

The disparity deepens when one examines the product mix: Yili's aggressive push into diverse categories has noticeably buoyed its performance. In recent years, Mengniu attempted to diversify through strategic acquisitions, such as its purchases of Yashili International and Dumex China in the powdered milk sector. However, poor visibility in profit margins, alongside an increasingly competitive landscape, has left Mengniu in a challenging position—culminating in continual year-on-year declines for their powdered milk segment.

The damage appears more than superficial, stretching into long-term strategic decisions. Previous venture decisions, such as Mengniu's sale of its Jiulbao brand and its acquisition of Bellamy's Organic, have not materialized into sizable and desired gains. While the latter acquisition was designed to elevate Mengniu's standing in the premium end of the market, the reality is that revenue from Bellamy has plummeted post-acquisition—a far cry from the growth expected.

Looking ahead, Mengniu's management strategy includes plans for share buybacks and enhancing portfolio diversity to combat the challenging climate. However, this doesn't resolve the prevailing issue of overcapacity in the raw milk supply chain. Furthermore, with increasing challenges posed by reduced birth rates and rising rivalry, hopes of reclaiming profitability in the powdered milk segment seem far-fetched for now. If current trends continue unaddressed, the company’s claim to competitive strength could falter amidst a declining customer base.

Nonetheless, as Mengniu strives for growth, Gao Fei has embraced an overarching strategy that he termed "One Body, Two Wings," aimed at balancing traditional dairy segments and an exploratory approach toward international expansion and innovation. While this ambitious plan proposes a bright spot in an otherwise troubled landscape, it will require significant follow-through to realize. Lessons learned from rival companies like Nestlé highlight this, as they have consistently harnessed innovation to prevail in non-European markets, which is a prime objective for Mengniu.

For now, the picture remains cloudy. Both Mengniu and Yili continue their rivalry amid 2024's uncertainties, beset by various headwinds. Should these domestic challenges persist unmitigated, the tide of consumer confidence will dissuade investors, reflecting on Mengniu's stock price, which has consistently dropped since 2021. In contrast to historical highs, current evaluations have shrunk significantly, indicative of a fragile industry clinging for recovery. Until operational and strategic redirection is fully realized, the future of Mengniu remains precarious.