(Yicai Global) Dec. 24 -- China Shengmu Organic Milk, a dairy company which has logged huge losses for two years running, announced today it will sell 51 percent of its subsidiary to Chinese dairy giant China Mengniu Dairy for CNY303 million (USD43.5 million).

Shares [HK:1432] of Hong Kong-listed Shengmu rose 23.33 percent to HKD0.37 (USD0.1 cent) to the daily limit by midday close on the announcement. 

The company will sell its stake in Inner Mongolia Shengmu High-Tech Dairy to China Mengniu Dairy's wholly-owned Inner Mongolia subsidiary for USD303 million under the investment deal between the two parties, per an announcement by Shengmu today. 

Bayannur, Inner Mongolia-based Shengmu will transfer all its downstream business chain of dairy products, intellectual property and other assets to the joint venture as a condition for the share purchase agreement. With all this in hand, the JV will produce and distribute organic dairy products, excluding infant milk formula.

Hong Kong-headquartered Mengniu's Inner Mongolian subsidiary and Shengmu will hold 51 percent and 49 percent interest of Inner Mongolia Shengmu High-Tech Dairy, respectively, after the acquisition, and the new JV's financial data will also be consolidated into Mengniu's reports. 

Shengmu, the country's largest producer of raw organic milk, owns 117,000 head of dairy cattle, with nearly 90,000 of these certified organic. It had turned out 245,000 tons of organic milk and 95,000 tons of non-organic milk and had sold 37,000 tons of its proprietary label organic liquid milk products by June 30. 

The deal may help Mengniu further optimize the distribution of organic milk sources to accelerate the development of the company's organic dairy brand, the company's vice president Ji Xiaodong told Yicai Global today, adding Mengniu may introduce better quality and supply chain management to Shengmu to help it achieve better operating efficiency and benefits. 

Mengniu is itself a major customer of Shengmu's raw milk, said dairy analyst Song Liang, adding it also intends to control the milk source via the acquisition since the company now plans to develop its pasteurized milk business and still needs a high-quality milk source for this. 

Mengniu's share purchase is also a timely lifeline for Shengmu, which performed well before 2016 with net profit of CNY960 million. Conditions suddenly changed thereafter, however, with the company losing CNY824 million and CNY1.13 billion (USD163.3 million) last year and over the first half, respectively. 

Shenmu even gave up organic certifications for some of its ranches this year to increase its income and pare costs.  

Market pundits have offered varying takes on Shengmu's huge losses. One deems raw milk production costs disproportionately high to sales prices. Fierce downstream competition is also a factor cited, as is that the company lacks sufficient downstream marketing ability and its performance is unsound. 

Shengmu issued a profit warning on Dec. 21 in which it said it will continue to post losses this year since it will set aside CNY1 billion to cover trade and other receivables.

Editor: Ben Armour