Amid a weak consumption recovery, the dairy sector has demonstrated resilience, and Yum China is poised for improvement.

Overview

Through recent on-the-ground research into China’s mass consumption sector, Morgan Stanley reaffirmed its view of a “soft recovery” across the broader consumer landscape. While macro‑level consumption trends remain subdued and monthly data continue to exhibit volatility, performance across subsectors is diverging: dairy products have demonstrated the greatest resilience, with industry leaders Yili and Mengniu both projecting robust growth prospects through 2026; restaurant giant Yum China expects quarter‑over‑quarter improvement in the second quarter; meanwhile, the beverage segment faces margin pressures stemming from rising raw‑material costs. The report maintains an Overweight rating on Yili, Mengniu, Yum China, and Lao Pu Gold, while assigning an Equal‑Weight rating to Master Kong Holdings.

Core views

Dairy Products: The Most Resilient Sub-Segment Research indicates that, as of April, liquid milk sales remain on a healthy trajectory. Yili Co., Ltd. (600887.SS) and Mengniu Dairy (2319.HK) both aim to restore growth in liquid milk by 2026, while anticipating gaining market share from smaller competitors amid the potential rebound in raw milk prices. - Mengniu Dairy: Targets mid-single-digit sales growth by 2026. In Q1 2026, “Telunsu” posted double-digit growth, and its basic white milk recorded mid-to-high single-digit gains; this momentum continued into April. With bulk raw milk prices stabilizing, the company expects limited room for gross margin expansion in 2026 and aims to maintain operating profit margins at year‑over‑year levels through operational efficiency. Capital expenditures will remain below RMB 2 billion, with stable or higher dividend per share (DPS). - Yili Co., Ltd.: Maintains a roughly 5% sales growth target for 2026. UHT milk is posting positive growth, infant formula (IMF) is expanding at a mid-to-high single-digit rate with rising market share, and adult milk is growing at a double-digit pace. Liquid milk sales remained robust in April–May, supported by low inventory levels. The company plans to enhance gross margins in 2026 through product mix optimization, while expecting a slight increase in the sales expense ratio and steady year-over-year net profit margins. Foodservice and Fresh‑Brewed Beverages: Yum China Shows Quarter‑Over‑Quarter Improvement; Tea Beverage Competition Shifts Toward Innovation - Yum China (YUMC.US): Same-store sales growth (SSSG) year-to-date has been in line with expectations, with second-quarter performance projected to improve versus the first quarter. Pre‑May Day school spring break provided support for April results. Following partial price hikes on delivery items earlier this year, demand has proven resilient. As last year’s high cost base fades, year-over-year margin pressures should ease starting in Q2, with restaurant margins expected to improve YoY in 2026. Delivery business will continue to grow over the full year, albeit at a slower pace than in previous quarters. - Fresh‑Brewed Tea Beverages: Face ongoing pressure in Q2–Q3 2026, primarily due to last year’s elevated base and reduced subsidies from delivery platforms. Industry competition has shifted from price wars to product innovation, with overall pricing remaining stable. Food & Beverage: Master Kong Faces Cost Headwinds Master Kong Holdings (0322.HK) targets low‑single-digit sales growth by 2026, with year-to-date performance broadly on track—both instant noodles and beverages are growing within this range. Among beverages, tea products are expected to outperform the broader market, while packaged water remains under pressure. Starting in June, the company began purchasing PET materials at prevailing market prices, and with PET costs anticipated to stay elevated through Q3, profit margins will face pressure in the coming quarters. Meanwhile, the instant noodle business maintains relatively stable sales and profitability, with manageable cost dynamics. The company aims to distribute a 100% payout ratio. Gold & Jewelry: Steady Gold Prices Boost Demand; Competition Shifts Toward the Premium Segment Demand for gold and jewelry improved month-over-month in May, largely driven by gold prices stabilizing after volatility in the first quarter. Going forward, gold price stability will remain a key driver of demand. Industry competition is intensifying, with traditional brands increasingly targeting the premium segment—entering luxury shopping malls and vying for skilled OEM artisans. - Lao Pu Gold (6181.HK): Saw month-over-month improvement in demand in May. Although second-quarter demand fell slightly short of expectations, profit margins expanded strongly. - Shanghai Yuyuan (600655.SS): As a property owner, it has introduced more heritage gold brands into its retail portfolio; as the parent brand of “Lao Miao,” it seeks to elevate its positioning through additional high-end offerings and store upgrades, while closing lower‑end outlets to focus on the premium market.

Analysis framework

This report is based on on-the-ground research conducted by Morgan Stanley’s analyst team (the China Broader Consumption Trip), drawing first-hand operational data and forward-looking guidance from direct discussions with management at leading companies across various sub‑sectors. The analytical framework combines a top‑down and bottom‑up approach: 1. Macro backdrop: We begin by characterizing the overall consumer environment as one of “soft recovery,” with volatile monthly momentum, thereby ruling out expectations of a broad-based, robust rebound. 2. Sector comparison: Against the backdrop of a weak recovery, we identify sub‑sectors that exhibit either “resilience” or “improvement.” Dairy is viewed as the most resilient segment, underpinned by its essential‑goods nature and the trough in the raw‑milk cycle; catering is seen as an improving sector, benefiting from base‑effect tailwinds and the pass‑through of price hikes; meanwhile, beverages are flagged as risky due to cost-side headwinds from PET prices. 3. Company validation: We validate our sector calls by examining granular metrics at the company level, including sales growth, margin guidance, and capital‑expenditure plans. For instance, the share‑gaining targets set by Yili and Mengniu corroborate the thesis of rising industry concentration, while the resilience of demand at Yum China following delivery‑channel price increases underscores the strength of brand pricing power.

Methodology notes

• Industry/Industrial Analysis FrameworkSupply-and-Demand Framework

  The Raw Milk Cycle and Cost Pass-Through

  The research report notes that the stabilization of raw milk prices is a key backdrop for the dairy industry. Within the supply-and-demand framework, stable upstream raw material costs help downstream dairy companies manage their cost structure. Meanwhile, leading players are mitigating potential margin pressures by upgrading their product portfolios—such as with brands like Telunsu and adult milk powder—reflecting a shift in the industry from volume‑driven growth to quality‑led expansion.

• Company Fundamentals and Financial FrameworkProfit Quality Analysis

  Profit Margin Driver Decomposition

  The research report meticulously dissects each company’s profit-margin drivers: Mengniu sustains its operating‑margin margin through “operational efficiency,” Yili boosts its gross‑margin margin via “product mix,” Yum China improves restaurant-level profitability as the high base effect fades, while Master Kong’s margins are constrained by “PET‑price‑linked procurement.” This analysis helps investors determine whether profit‑margin changes are structural or cyclical in nature.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Yili Co., Ltd. (600887.SS)

  Benefits: The dairy industry demonstrates the greatest resilience, with rising market share and an optimized product mix driving improvements in gross margins.

  Strengths

  Liquid milk sales remain robust, with inventory levels at low levels; adult powdered milk posted double-digit growth; the company aims to boost its gross margin by 2026.

  Weaknesses

  The sales expense ratio may rise slightly.

  Comparison

  Like Mengniu, Yili is also a duopoly player in the industry; however, Yili places greater emphasis on margin improvement driven by its product portfolio, while Mengniu prioritizes operational efficiency to safeguard profitability.

  Risks

  Significant volatility in raw milk prices; consumer recovery falls short of expectations.

• Mengniu Dairy (2319.HK)

  Key benefits: Liquid milk sales have resumed growth, and the Telunsu premium product line is delivering strong performance.

  Strengths

  Telunsu posted double-digit growth in Q1; raw milk prices have stabilized; capital expenditures remain restrained (below RMB 2 billion); and dividends are expected to remain stable or increase.

  Weaknesses

  In 2026, there is limited room for gross margin expansion.

  Comparison

  Compared with Yili, Mengniu places greater emphasis on maintaining a stable operating profit margin (OPM) through operational efficiency.

  Risks

  Intensified market competition has led to increased marketing expenditures.

• Yum China (YUMC.US)

  Benefit: Same-store sales improved quarter-over-quarter in Q2, and demand remained resilient even after delivery pricing was raised.

  Strengths

  Profit margin pressures have eased as the high base effect fades; the food-delivery business continues to grow; and the company’s pricing power has been validated.

  Weaknesses

  Takeout growth has slowed compared with the earlier period.

  Comparison

  In the restaurant sector, Yum’s standardized operations and digital capabilities give it greater risk resilience and stronger recovery momentum in a tepid economic rebound.

  Risks

  Macroeconomic factors influence consumers’ willingness to dine out; food safety risks.

• Master Kong Holdings (0322.HK)

  Neutral/Adverse: Facing margin pressure from rising PET costs.

  Strengths

  The instant noodles business remains stable; a 100% dividend payout ratio offers strong dividend appeal.

  Weaknesses

  The beverage sector, particularly the water subsector, is under pressure; Q2–Q3 margins were squeezed by higher procurement costs in the PET market.

  Comparison

  Compared with the improving outlook for dairy and foodservice, Master Kong is facing headwinds on the cost side in the short term.

  Risks

  Raw material prices continue to rise; competition is intensifying.

• Lao Pu Gold (6181.HK)

  Benefits: Stabilized gold prices are driving demand, while the high-end positioning is enabling strong profit margin expansion.

  Strengths

  May demand improved month-over-month; profit margins expanded robustly; the company is focusing on high-end traditional gold products.

  Weaknesses

  Q2 demand was slightly below expectations.

  Comparison

  Compared with traditional jewelry brands, Lao Pu Gold demonstrates stronger brand premium and higher profit margins in the high-end niche market.

  Risks

  Sharp fluctuations in gold prices are dampening consumer demand, while competition in the high-end market is intensifying.

Key data

• Mengniu’s 2026 Sales Growth TargetSingle-digit in ChinaTulun Su posted double-digit growth in Q1, while basic white milk achieved mid-to-high single-digit growth.
• Yili’s 2026 Sales Growth Target~5%Adult milk powder posted double-digit growth, while the IMF recorded mid-to-high single-digit growth.
• Master Kong’s 2026 Sales Growth TargetLow single digitsInstant noodles and beverages both fall within this range, with tea drinks outperforming water.
• Mengniu Capital Expenditure (Capex)<2 billion yuanThe 2026 guidance indicates a measured pace of expansion.
• Master Kong’s Dividend Payout Ratio Target100%High Dividend Pledge

Impact & implications

For investors, research reports suggest that, amid a weak consumption recovery, priority should be given to stocks underpinned by “certainty of growth” and “improving profit margins.” 1. Leading dairy companies (Yili and Mengniu), benefiting from expanding market shares and optimized product mixes, offer relatively predictable earnings prospects in a context of stable cost dynamics, making them well-suited for defensive allocation. 2. Yum China’s quarter-over-quarter improvement is clearly supported by solid fundamentals, with validated pricing power in its delivery business; its near-term earnings elasticity warrants close attention. 3. Caution is advised regarding potential margin volatility in the beverage sector—such as Master Kong—driven by the market‑based procurement of PET raw materials, which could weigh on short-term share performance, even though its long‑term dividend policy (100% payout) provides a degree of downside protection. 4. The luxury‑oriented trend in the gold and jewelry industry remains pronounced, with premium brands like Lao Pu Gold demonstrating stronger margin expansion; however, vigilance is required to monitor how gold price fluctuations may impact end‑consumer demand.

Risks

• Overall, the recovery in consumption has been weaker than expected, with monthly momentum remaining volatile.
• Fluctuations in raw material costs (such as PET and raw milk) exceed the company’s guidance range.
• Intensified industry competition has led to the resurgence of price wars or a rise in expense ratios.
• Fluctuations in gold prices have a negative impact on end-demand for gold and jewelry.

What to watch

• Trends in raw milk prices and changes in market share among Yili and Mengniu in the dairy industry.
• The actual extent of improvement in Yum China’s second-quarter same-store sales growth (SSSG) and restaurant-level profit margins.
• The specific impact of PET procurement costs on profit margins for Tingyi Holding in the second and third quarters.
• Gold price stability and the single-store sales performance of premium brands such as Lao Pu Gold.