9 Nov 2020

CMB International Securities | Equity Research | Sector Initiation

China Beer and White Wine Sector

Leaders to benefit from ASP growth and sector OUTPERFORM consolidation; top picks are Moutai and CR Beer (Initiation)

We initiate coverage of China beer and white wine sectors with Outperform rating. China beer and white wine sector Premiumization and production efficiency improvement are key growth drivers of beer sector. We prefer CR Beer to Tsingtao Brewery because we expect CR Beer Albert Yip to deliver stronger adj. EPS CAGR through the partnership with Heineken. High- (852) 3900 0838 end white wine segment has a favorable competitive landscape. Its limited supply [email protected] has supported price appreciation. We prefer Moutai to Wuliangye because we expect Moutai to raise ex-factory price earlier than Wuliangye. China’s premium and super  Premiumization and production efficiency improvement are key growth premium beer sales value to grow drivers of beer sector. (1) Premiumization: China’s market share of the at 8.5% CAGR from 2018 to 2023E premium and super premium categories was 16.4% by volume in 2018, which (US$ bn) was significantly lower than the US/Korea (42.1%/25%). Value of premium and 70 super premium categories is estimated to increase by 8.5% CAGR from 2018 60 to 2023E. (2) Production efficiency: Plant closures, optimization of capacity 50 and sales mix increase of canned beer and bottled beer with returnable bottles 40 concept can enhance efficiency. (3) Industry consolidation: We expect sector 30 leaders to lower SG&A expenses ratio suggested by US market history. 20  High-end segment is preferred in white wine sector. There is oversupply 10 0 in low to mid-end as consumers prefer quality to quantity. High quality white 2013 2018 2023E wine, which is an extremely scarce resource (<1% of total prod. vol.), has been Source: GlobalData appreciating. High-end segment has a favorable competitive landscape. Moutai is the unrivalled leader and Moutai and Wuliangye take 80-85% market Large margin upside potential for share in China. Demand of high-end is more resilient than sub high-end amid China’s beer leaders economic downturn. We expect Moutai/Wuliangye could achieve 16%/16% market share (LHS) EBITDA margin (%) (RHS) 100% 50% 95% China Brazil US Japan 90% 45% revenue CAGR in FY19-22E through increases of both volume and ASP. 85% 42.3% 80% 40% 75% 40.8% 70% 66.3% 35% 65% 32.4%  Prefer Moutai (600519 CH, Buy) to Wuliangye (000858 CH, Buy). We think 60% 30% 55% 28.9% 25% 50% 37.6% Moutai could lift ex-factory price by 24% to RMB1,199 in 1Q21E given that 45% 42.0% 25.6% 16.9% 14.8% 30.3% 20% 40% 21.5% 14.4% 35% 12.1% 12.9% 15% price spread earned by distributor is much greater than the Company and, 30% 23.2% 23.0% 25% 20.0% 10% 18.4% 20% 14.0% historically, price hike usually happened in first year of FYP and 1Q. We 15% 10.7% 5%

10% 6.1%

(Americas)

Asahi

Yanjing

Molson Coors

Carlsberg

AB AB InBev America) AB InBev

Tsingtao CRBeer

BudAPAC Kirin

5% Heineken 0%

(South

(Asia)

(West) (US)

believe the article written by Central Commission for Discipline Inspection on (US) 22 Sep could not block price hike. We saw Moutai raised price in Jan 2018 though the Commission posted an article in Jul 2017 to alert government Source: Company data, GlobalData, officials’ consumption of high-end wine. Our TP of RMB2,153.30 for Moutai blog.drinktec.com, Reuters, CMBIS estimates represents 46.8x FY21E P/E, at 15% premium on other A-share consumer segment leaders’ average of 40.7x. Above designated size white wine enterprises’ revenue in  Prefer CR Beer (291 HK, Buy) to Tsingtao Brewery (168 HK, Buy). We China grew at 11% CAGR in 2016- forecast CR Beer to deliver stronger EPS CAGR than Tsingtao Brewery (19% 19 (RMB bn) vs 14%) in FY19-22E. The partnership with Heineken is a combination of both Revenue of above-scale enterprises (LHS) Reported YoY growth (RHS) 900 40% companies’ strength (Heineken’s international product portfolio + CR Beer’s 850 26.8% 30% 800 nationwide distribution network), which should accelerate CR Beer’s 14.4% 20% 750 11.2% 10.1% 12.9% 4.8% 8.2% premiumization. Heineken brand recorded outstanding double-digit volume 700 5.2% 10% 650 612.6 0% growth in 1H20 amid epidemic. We estimate Heineken China’s utilization rate 600 565.4 561.8 555.9 536.4 -10% 550 501.8 525.9 was low at ~28% in 2018. The strong sales growth post partnership should 500 -20% 446.6 450 -30% notably improve GPM and profitability. Our TP of CR Beer at HK$61.90 is 400 -40%

based on 46.0x FY21E adj. P/E, at the high-end of historical P/E band. 350

2013 2014 2015 2018 2019 2016 2017 300 2012 -50% Valuation Table Mkt Cap Price TP Upside P/E (x) P/B (x) ROE (%) Source: National Statistics Bureau Name Ticker Rating (LC bn) (LC) (LC) (%) FY20E FY21E FY20E FY20E CR Beer 291 HK Buy 158 48.85 61.90 27 48.5 36.3 6.5 14.0 Tsingtao – H 168 HK Buy 106 62.40 78.10 25 33.7 28.7 3.6 11.1 Tsingtao – A 600600 CH Hold 93 80.61 78.70 (2) 49.3 42.0 5.3 11.1 Moutai 600519 CH Buy 2,136 1,700.62 2,153.30 27 46.9 37.4 12.1 31.1 Wulaingye 000858 CH Buy 1,006 259.41 307.80 19 49.2 39.9 10.5 25.5 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 1 MORE REPORTS FROM BLOOMBERG: RESP CMBR AND http://www.cmbi.com.hk 9 Nov 2020

Contents

Focus Charts ...... 3 Investment Thesis ...... 4 Valuation ...... 8 Overview of China’s beer industry ...... 11 Premiumization level behind Korea and the US ...... 11 US beer sector history showed huge room for China’s premiumization ...... 15 Premiumization and industry consolidation are key EBITDA margin drivers ..18 Margin upside potential for domestic leaders is large ...... 19 Overview of China’s white wine industry ...... 21 Accelerating consolidation and increasing profitability ...... 21 High-end segment is more preferred to sub high-end segment ...... 24 CR Beer (291 HK) ...... 25 Focus Charts ...... 26 Partnership with Heineken to accelerate premiumization ...... 27 Continuing to improve production efficiency ...... 33 Earnings forecast ...... 35 Financial Summary ...... 39 Tsingtao Brewery (168 HK) ...... 40 Focus Charts ...... 41 Continuing premiumization ...... 42 Restricted share award scheme to incentivize key employees ...... 44 Earnings forecast ...... 49 Financial Summary ...... 53 Kweichow Moutai (600519 CH) ...... 54 Focus Charts ...... 55 National wine brand prestige ...... 56 Scarcity nature due to tight supply ...... 58 Large room to increase ex-factory price ...... 61 Channel diversification to enhance growth ...... 62 The impact of CCP Central Commission for Discipline Inspection’s article .....64 Earnings forecast ...... 65 Financial Summary ...... 70 Wuliangye (000858 CH)...... 71 Focus Charts ...... 72 Reform measures aiming at return to the glory days ...... 74 Channel reform to accelerate sales growth ...... 76 Earnings forecast ...... 78 Financial Summary ...... 83

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 2 9 Nov 2020

Focus Charts

Figure 1: Above designated size beer enterprises’ Figure 2: Above designated size white wine revenue grew at 5% CAGR from 2016 to 2019 enterprises’ revenue grew at 12% CAGR in 2016-19

(RMB bn) (RMB bn) Revenue of above-scale enterprises (LHS) Reported YoY growth (RHS) Revenue of above-scale enterprises (LHS) Reported YoY growth (RHS) 250 20% 900 40% 9.3% 850 26.8% 5.1% 7.1% 30% 6.8% 4.8% 10% 2.3% 800 1.5% -1.3% 14.4% 20% 750 11.2% 10.1% 12.9% 0% 4.8% 8.2% 200 700 5.2% 10% 188.6 189.7 183.3 181.4 650 176.6 -10% 612.6 0% 600 565.4 561.8 161.2 158.1 -20% 555.9 536.4 -10% 550 501.8 525.9 150 147.3 500 -20% -30% 446.6 450 -30% -40% 400 -40%

350

2013 2014 2015 2018 2019 2013 2014 2015 2018 2019 2016 2017 2012 2016 2017 100 2012 -50% 300 -50%

Source: National Statistics Bureau Source: National Statistics Bureau

Figure 3: Premium and super premium beer sales Figure 4: Market share of top 10 white wine players value to grow at 8.5% CAGR from 2018 to 2023E was 40% by sales in 2019, still room to consolidate

(US$ bn) CR10 40.0% 26.6% 70 0.8% Kouzi Distillery 0.6% 0.9% 60 King's Luck 0.5% 1.5% 50 Lang Jiu 0.9% 1.8% Shunxin Agriculture 1.1% 40 Anhui Gujing 1.9% 2019 1.2% Shanxi Fen Wine 2.1% 2017 30 1.1% Luzhou Laojiao 2.8% 1.8% 20 Yanghe 4.1% 3.5% 10 Wuliangye 8.9% 5.3% 15.2% Moutai 10.3% 0 2013 2018 2023E 0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

Source: GlobalData Source: Lanjiu prospectus

Figure 5: US beer history showed EBITDA margin Figure 6: PBT of above designated size white wine expansion amid premiumization and consolidation enterprises grew at 26% CAGR in 2016-19

(RMB bn) Anheuser Busch Miller Coors - US PBT (LHS) PBT margin (RHS) 35% 200 30% 23.3% 25.0% 190 18.2% 28.2% 28.8% 28.8% 18.4% 30% 27.4% 180 16.0% 13.3% 13.0% 20% 26.3% 26.9% 13.1% 25.5% 170 24.7% 24.6% 24.1% 23.6% 10% 25% 22.8% 23.2% 160 21.0% 150 140.4 20.5% 20.6% 20.7% 0% 140 20% 17.6% 130 125.1 15.4% 15.5% 15.9% -10% 14.4% 14.1% 14.2% 14.2% 120 13.3% 13.6% 13.5% 15% 12.9% 12.7% 110 102.8 12.1% 12.4% 12.5% -20% 10.8% 100 12.6% 12.0% 10% 12.8% 13.2% 12.2% 12.2%12.8% 13.2% 90 82.1 80.5 79.7 -30% 11.2% 11.9% 12.0% 12.1% 10.2% 80 9.9% 10.0% 10.4% 69.9 72.7 8.5% 70 5% -40%

60

2013 2014 2015 2018 2019 2016 2017 50 2012 -50% 0% FY91 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07

Source: Company data, CMBIS estimates Source: National Statistics Bureau

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 3 9 Nov 2020

Investment Thesis China beer sector

We think the following are growth drivers of beer sector: (1) Premiumization: Market share of the premium and super premium categories was 16.4% by volume in 2018, which was significantly lower than the US/Korea (42.1%/25%), according to GlobalData/Bud APAC, suggesting huge upside potential for the growth of premium and super premium categories. Value of premium and super premium categories is estimated to increase by 8.5% CAGR from 2018 to 2023E, which is stronger than 4.7% CAGR for China beer market in the period. (2) Improvement of production efficiency: Plant closures, optimization of production capacity, increase sales of bottled beer with returnable bottles concept and increase sales mix of canned beer. (3) Industry consolidation: Market share of top five players in China in terms of volume was 70.4% in 2018, according to GlobalData. We think there is still room for consolidation as seen in US (88.4% in 2009) and Japan (~92% in 2018). US market history showed that SG&A expenses ratio would decrease amid industry consolidation.

US beer sector history showed premiumization and industry consolidation are margin growth drivers

US top three players’ total market share increased from 76.1% in 1991 to 78.5% in 2007. Thanks to increasing industry consolidation, SG&A expenses ratio of market leader, Anheuser Busch, decreased 1.4ppt during the period. Also, GPM of Anheuser Busch and Coors (No.3) widened by 4.9ppt and 8.3ppt from FY91 to FY04, respectively, led by 1.4% and 4.1% ASP CAGR. EBITDA margin of Anheuser Busch and Coors (No.3) expanded 8.3ppt and 5.5ppt from 1991 to 2004, respectively.

CR Beer (291 HK, Buy; TP: HK$61.90) - Partnership with Heineken to accelerate premiumization

 Partnership with Heineken to accelerate premiumization The Company could bring in Heineken’s international product portfolio to compete with Bud APAC and Carlsberg, while Heineken could leverage on the Company’s nationwide distribution network to expand its brand presence. Heineken brand recorded double-digit growth in 1H20 amid epidemic (vs. Bud APAC’s 20.5% volume decline). Management targets to raise retail price to reinforce Heineken’s premium brand image underpinned by advertising investment. This could improve profitability of distributor/POS and help the brand’s network penetration. We estimate Heineken China’s capacity utilization rate was just ~28% in 2018. The fast sales growth post partnership deal should significantly improve GPM and profitability of Heineken China. Management is studying Heineken’s capacity expansion plan. Heineken is one of the official sponsors of UEFA 2021 European Cup and CR Beer is not required to share this sponsorship fee. This could be a good marketing opportunity. During 2016 European Cup, more than 1.2bn viewers in China watched the broadcast.

 Continue to improve production efficiency Though the Company is a central state-owned enterprise, management is determined to optimize efficiency, including shutting inefficient plants and laying off employees. Its utilization rate was 55.8% in FY19, less than Bud APAC and Tsingtao Brewery’s 59.4%. Going forward, the Company would continue to enhance efficiency by optimizing production capacity, closing plants as well as expanding sales of canned beer and bottled beer with returnable bottle concept.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 4 9 Nov 2020

 Initiate at Buy We set our TP of HK$61.90 based on 46.0x FY21E adjusted P/E, at the high-end of historical P/E band. We think Heineken China has enormous growth potential (high brand recognition but low penetration) and expect Heineken China would be a key growth driver for the Company. We estimate the Company to post 19% adj. EPS CAGR from FY19 to FY22E (vs Tsingtao Brewery’s 14%).

Tsingtao Brewery – H share (168 HK, Buy; TP: HK$78.10), A share (600600 CH, Hold; TP: RMB78.70) – Continuing premiumization and incentive scheme to drive growth

 Continuing premiumization Tsingtao Beer is one of China’s top 10 famous trademarks and has good brand recognition in overseas. According to World Brand Lab, its value ranked the first among Chinese beer brands in 2020. The Company had around 14.4% market share in premium and super- premium segment in 2018, behind Bud APAC but ahead of CR Snow Beer. The Company has launched certain specialized beer products in recent years and sales volume mix of high-end Tsingtao beer increased from 14% in FY14 to 23% in FY19. In July, the Company launched a super high-end new product, Centennial Journey, which sets the new height of retail price of domestic high-end beer to lift Tsingtao brand equity.

 First ever share incentive scheme The Company’s A share Incentive Plan was approved in Jun 2020. We think its wide employee coverage (1.6% of total staff) and attractive share award price at RMB21.18 (71% discount to current price) could be effective to incentivize management team. Given that its revenue ranked third among peers but its EBITDA margin was the lowest in FY19, we think there is large room to improve operating efficiency and margin.

 Initiate H share at Buy and A share at Hold We estimate the Company to post 14% adj. EPS CAGR from FY19 to FY22E, led by 5% revenue CAGR and 3.0ppt EBIT margin expansion driven by premiumization.

We set our TP of H-share at HK$78.10, based on 36.0x FY21E P/E which represents the historical 1-yr forward P/E plus 1 s.d. Continuing premiumization and efficiency optimization are earnings growth driver of the Company.

Our A-share TP RMB78.70 is based on 41.0x FY21E P/E, representing 14% premium on H-share target P/E of 36.0x. From 2004 to now, A-share 1-year forward P/E trades at 14% premium to H-share’s on average.

China white wine sector

We think the following are growth drivers of white wine sector: (1) Premiumization: Unlike low to mid-end, we think the growth outlook of sub high-end and high-end would be better. As disposable income increases, consumers are becoming more health consciousness and prefer drinking better to more. The limited supply of high-end, quality white wine would support ASP increase. (2) Industry consolidation: There is oversupply in low to mid-end as consumers preferred quality to quantity. Small enterprises faced severe competition pressure under rapid industry consolidation. Number of above-scale white wine enterprises declined from 1,593 in 2017 to 1,176 in 2019. According to the Vice-Chairman of China Alcoholic Drinks Association, number of above-scale enterprises is expected to fall below 1,000 in 2020E. In terms of revenue, market share of top 10 players increased from 26.6%

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 5 9 Nov 2020 in 2017 to 40.0% in 2019. Renowned national and regional brands would further gain market shares.

High-end segment is more preferred to sub high-end segment

Firstly, high-end white wine has investment attributes because of its premium quality and scarcity. High quality white wine is an extreme scarce resource, representing less than 1% of total white wine production volume. Its price has been increasing steady for long time. For example, we observed retail price of Moutai increased from around RMB200 in 2000 to near RMB3,000 now (~14% CAGR). The ex-factory price of Moutai and Wuliangye also increased at a CAGR of 9% and 6% from 2003 to 2019, respectively.

Secondly, high-end segment has a favorable industry competitive landscape. Moutai is the undisputable market leader and top two players, Moutai and Wuliangye, take around 80- 85% market share. Other participants also include Laojiao’s Guojiao 1573, Qinghua Langjiu, Yanghe’s Dream Blue (M6 and above), Fen Wine’s Qinghua 30 etc. On the other hand, sub high-end segment is more competitive and fragmented. There are a lot major players such as Jiannanchun, Honghua Langjiu, Yanghe’s Dream Blue, Lujiao Tequ, Shede, Fen Wine’s Qinghua series, Swellfun, King’s Luck, Kouzi, Gujing, Xijiu, series wine of Moutai etc.

Thirdly, the demand for sub high-end is more volatile than high-end. As reflected in 1H20 results, the demand for high-end was more resilient than sub high-end amid economic downturn. During sector down cycle between 2012 and 2014, we also saw revenue of Moutai and Wuliangye (-2% CAGR) performed better than sub high-end (-23% CAGR). While both Moutai and Wuliangye reported low-teens revenue growth, several sub high- end brands recorded revenue decline. We think sub high-end is more related to family consumption and discretionary consumption. When income reduces, consumers could cut consumption of sub high-end white wine. On the contrary, the consumers for high-end white wine are more affluent, and their consumption demand is quite rigid amid economic downturn.

Kweichou Moutai (600519 CH, Buy; TP: RMB2,153.30) - Unrivalled market leader; price hike the next catalyst

 Price hike could happen in 1Q21 The price spread (wholesale price minus ex-factory price) of distributor is much greater than the Company’s (ex-factory price x GPM). A number of white wine brands had raised price in 2019 such as Guojiao 1573, Qinghua 30, Hongyun Langjiu, Jiannanchun, Xi Feng Liquor etc. Historically, price hike usually happened in first year of FYP and 1Q. We think the Company could raise its ex-factory price by 24% to RMB1,199 in 1Q21E at the earliest to have a good start in the 14th FYP (实现良好开局).

 Central Commission for Discipline Inspection’s article will not block price hike On 22 Sep, the Commission posted an article to alert the recent tide of price hikes of high- end white wines might bring back corruption and improper publicly-funded dining. In July 2017, we saw the Commission posted an article to alert government officials’ consumption of Moutai and Wuliangye through business banquets with private companies owners and by public-funding. That said, the Company still raised price in Jan 2018.

 Perceived National wine brand prestige Moutai liquor is called one of the world’s top three distilled wines. Also, it had been served in China’s national banquet. Moutai liquor won 20 times during international wine

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 6 9 Nov 2020 competition and was awarded “National Famous Wine” five times in the National Wine Appraisal. In addition to various marketing campaigns, such as time reporting ad in CCTV, consumers have perceived Moutai as “National Wine”.

 Channel diversification to enhance growth Since 2019, the Company has expanded its direct sales to retailers including supermarkets, e-commerce platforms and tobacco and wine chains. The ex-factory price is set at RMB1,299 or RMB1,399, which is higher than ex-factory price to distributor. Looking forward, we expect volume growth would be led by this segment and B2C. This should enhance ASP and GPM of Moutai sales.

 Initiate at Buy We forecast the Company to post 18% EPS CAGR from FY19-22E. Our TP is set at RMB2,153.30, representing 46.8x FY21E P/E, at 15% premium on other segment leaders’ average of 40.7x.

Wuliangye (000858 CH, Buy; TP: RMB307.80) - Reform to roll back glory days

 Reform to enhance brand equity. The Company was once the sector leader in terms of revenue and ex-factory price. The Chairman Mr. Li kicked off “second entrepreneurship” in 2017 aiming at the return to glory days. The Company has eliminated many series wine brands, and now focuses on core Wuliangye brand “1+3” and four national series wine brands to ensure the brands have a clear hierarchy. The super high-end 501 Wuliangye will leverage on the scarcity and history of its limited mud cellars established in Ming and Qing Dynasty to raise brand equity. Classic Edition of Wuliangye (“经典五粮液”) is made from wine stored for at least 10 years and blended with certain wine made from mud cellars established in Ming Dynasty and Qing Dynasty to support its premium value. This wine is launched at ex-factory price of RMB1,499 and retail price of RMB2,699 in Oct 2020. Also, the Company would gradually extend its storage period before available for sale of base wine to three years to enhance product quality and value (vs Moutai’s four years).

 Channel reform to accelerate sales growth. In 2019, the Company reformed its brand business unit by decentralizing more power to frontline staff to further penetrate into lower tier cities. Code scanning systems were installed to better monitor channel sales and inventory level to control wholesale price, laying a solid foundation for realizing both volume and ASP growth. Amid epidemic, the Company began to develop corporate group purchase channel by partnering with distributors in 2020 to explore new sales channel.

 Initiate at Buy We forecast the Company to post 20% EPS CAGR in FY19-22E. Our TP is set at RMB307.80, representing 47.3x FY21E P/E, at 1.01x to our target P/E for Moutai.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 7 9 Nov 2020

Valuation

 CR Beer (291 HK, Buy; TP: HK$61.90) We set our TP of HK$61.90 based on 46.0x FY21E adjusted P/E, at the high-end of historical P/E band. We think Heineken China has enormous growth potential (high brand recognition but low penetration) and expect Heineken China would be a key growth driver for the Company. We estimate the Company to post 19% adj. EPS CAGR from FY19 to FY22E (vs Tsingtao Brewery’s 14%).

 Tsingtao Brewery – H share (168 HK, Buy; TP: HK$78.10) We set our TP of H-share at HK$78.10, based on 36.0x FY21E P/E which represents the historical 1-yr forward P/E plus 1 s.d. Continuing premiumization and efficiency optimization are earnings growth driver of the Company.

 Tsingtao Brewery – A share (600600 CH, Hold; TP: RMB78.70) Our TP RMB78.7 is based on 41.0x FY21E P/E, representing 14% premium on H-share target P/E of 36.0x. From 2004 to now, A-share 1-year forward P/E trades at 14% premium to H-share’s on average.

 Kweichou Moutai (600519 CH, Buy; TP: RMB2,153.30) Amid epidemic, the Company still delivered positive growth rates of revenue and NP in 1H20, suggesting its resilient business nature. The Company also has strong brand power, product scarcity nature and high ROAE, so we think it deserves to trade at premium to other segment leaders. We set our TP at RMB2,153.30, representing 46.8x FY21E P/E, at 15% premium on other segment leaders’ average of 40.7x. We forecast the Company to post 18% EPS CAGR from FY19 to FY22E.

 Wuliangye (000858 CH, Buy; TP: RMB307.80) We compared the Company’s 1-yr forward P/E to Moutai’s beginning FY13 (since Moutai became market leader) and found the Company’s 1-yr forward P/E trading at 10% discount to Moutai’s on average. The Company’s forward P/E usually traded at greater discount to Moutai’s when Wuliangye’s wholesale price was below ex-factory price (“inverted”). The Company completed channel reform, inventory control and profit sharing to channel in 1H19, and then reduced quotas in certain distributors and developed corporate group purchase channel amid epidemic to successfully stabilize wholesale price. We think such reform measures could help reduce the likelihood of “inverted prices”, which should support the Company’s 1-yr forward P/E to Moutai to be justified to trade at above historical average. We set the Company’s 1-yr forward P/E at 1.01x of Moutai’s (hist. avg. +1 s.d.). Given that we value Moutai at 46.8x FY21E P/E, we set our TP of the Company at RMB307.80, based on 47.3x FY21E P/E (1.01x to Moutai’s target FY21E P/E).

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 8 9 Nov 2020

Figure 7: P/E band chart of CR Beer Figure 8: P/E band chart of Tsingtao – H share

HK$ 90 42x HK$ 85 70 80 65 75 36x 70 60 The P/E peak post 46x merger was higher 65 than the previous 30x 55 Completed merger peak 60 with Heineken China 40x 50 on 29 Apr 2019 55 50 24x 45 35x 45 40 30x 40 18x 35 35 24x 30 30 25 The P/E trough during epidemic was the 25 20 same as the previous 15 trough 20 The P/E trough during epidemic was 10 higher than the

15 previous trough

Jul-16 Jul-20 Jul-15 Jul-17 Jul-18 Jul-19

10 Jul-14

Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19 Oct-20 Apr-14 Oct-14 Apr-15 Oct-15 Oct-19 Apr-20

Jan-17 Jan-18 Jan-19 Jan-20 Jan-14 Jan-15 Jan-16

Jun-16 Jun-17 Jun-19 Jun-20 Jun-18

Mar-18 Mar-16 Mar-17 Mar-19 Mar-20

Sep-15 Sep-16 Dec-16 Dec-17 Sep-18 Sep-19 Dec-19 Sep-17 Dec-18 Sep-20 Dec-15 Source: Bloomberg, Company data, CMBIS estimates Source: Bloomberg, Company data, CMBIS estimates

Figure 9: P/E band chart of Tsingtao – A share Figure 10: P/E band chart of Kweichou Moutai

RMB RMB 100 2400 52x 95 54x 2200 90 85 2000 80 46x 41x 75 1800 70 1600 65 38x 60 1400 30x 55 1200 50 30x 1000 45 19x 40 22x 800 35 30 600 8x 25 400 20 15 200

10 0

Jul-12 Jul-13 Jul-19 Jul-20 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18

Apr-12 Oct-12 Apr-13 Oct-13 Apr-19 Oct-19 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-20 Oct-20

Jan-14 Jan-15 Jan-17 Jan-12 Jan-13 Jan-16 Jan-18 Jan-19 Jan-20

Jul-15 Jul-16 Jul-19 Jul-20 Jul-14 Jul-17 Jul-18

Oct-14 Oct-15 Oct-17 Oct-18 Oct-19 Oct-16 Oct-20

Apr-16 Apr-17 Apr-18 Apr-20 Apr-14 Apr-15 Apr-19

Jan-14 Jan-17 Jan-18 Jan-16 Jan-19 Jan-20 Jan-15 Source: Bloomberg, Company data, CMBIS estimates Source: Bloomberg, Company data, CMBIS estimates

Figure 11: P/E band chart of Wuliangye

RMB 300 50x

280

260 40x

240

220

200

180 30x 160

140

120 20x

100

80

60 10x 40

20

0

Jul-14 Jul-17 Jul-18 Jul-15 Jul-16 Jul-19 Jul-20

Apr-15 Oct-15 Apr-16 Oct-16 Oct-19 Apr-20 Oct-20 Apr-14 Oct-14 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19

Jan-14 Jan-15 Jan-18 Jan-19 Jan-16 Jan-17 Jan-20

Source: Bloomberg, Company data, CMBIS estimates

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Figure 12: Peers’ valuation table Mkt cap P/B ROAE FY0-3 Stock (HK$/US$/ P/E (x) EPS growth (%) (x) (%) EPS FY2 code Rating Price RMBmn) FY1 FY2 FY3 FY1 FY2 FY3 FY1 FY1 cagr PEG Bud APAC 1876 HK NR 22.55 298,639 60.6 34.2 28.8 (36) 77 19 3.8 6.4 10.4 3.3 CR Beer 291 HK Buy 48.85 158,478 48.5 36.3 29.7 2 34 22 6.5 14.0 18.5 2.0 Tsingdao Brewery 168 HK Buy 62.40 107,823 26.4 22.5 19.8 12 17 14 3.6 11.1 14.2 1.6 H share beer sector 45.2 31.0 26.1 (7) 43 18 5 11 14.4 2.3

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1 Haitian Flavouring 603288 CH NR 169.90 550,551 83.8 70.4 59.8 23 19 18 26.3 32.8 19.8 3.5 Yili 600887 CH Buy 38.88 236,515 32.0 27.0 23.5 6 18 15 8.3 27.1 13.0 2.1 Yonghui 601933 CH NR 8.07 76,796 31.2 24.9 19.8 56 25 26 3.6 15.4 34.9 0.7 C&S Paper 002511 CH NR 22.10 28,909 31.8 26.2 22.1 48 22 18 5.9 19.1 28.6 0.9 Shanghai Jahwa 600315 CH NR 43.14 28,958 68.0 53.5 41.3 (24) 27 30 4.4 6.5 7.9 6.7 A share segment leaders 48.9 40.1 33.6 19 22 19 9.6 20.5 21.3 2.1

Wuliangye 000858 CH Buy 259.30 1,006,501 49.2 39.9 33.2 17 24 20 11.7 25.5 20.3 2.0 Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1 Jiangsu Yanghe 002304 CH NR 174.06 262,306 34.4 30.4 26.8 3 13 13 6.5 19.1 9.9 3.1 Luzhou Laojiao 000568 CH NR 182.80 267,757 47.2 38.7 32.5 22 22 19 11.7 25.4 21.0 1.8 Shanxi Fen Wine 600809 CH NR 234.74 204,583 77.4 60.7 49.1 36 27 24 22.1 29.5 28.9 2.1 Anhui Gujing 000596 CH NR 222.50 94,859 52.2 40.8 33.9 2 28 20 10.7 20.2 16.4 2.5 Sichuan Swellfun 600779 CH NR 72.50 35,420 49.1 37.2 31.4 (13) 32 18 15.0 30.0 10.9 3.4 Jiangsu King's Luck 603369 CH NR 48.67 61,057 37.9 30.6 24.7 11 24 24 7.3 19.3 19.2 1.6 Beijing Shunxin 000860 CH NR 54.31 40,285 43.5 32.6 26.1 14 33 25 4.8 11.0 24.0 1.4 Anhui Kouzi 603589 CH NR 60.12 36,072 24.9 20.8 18.0 (16) 20 16 4.7 18.3 5.3 3.9 A share white wine sector 45.9 36.5 30.5 8 25 19 10.7 22.7 17.0 2.4

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Chongqing Brewery 600132 CH NR 107.00 51,785 88.9 76.5 66.7 (11) 16 15 35.0 31.1 17.5 2.1 Yanjing Brewery 000729 CH NR 8.29 23,366 156.4 85.5 72.1 (34) 83 19 1.8 32.8 19.8 3.5 Zhujiang Beer 002461 CH NR 9.82 21,735 39.3 34.6 30.3 14 14 14 2.5 27.1 13.0 2.1 A share beer sector 83.5 59.6 51.5 (5) 33 15 11.1 25.5 16.1 2.7

Asahi 2502 JP NR 3616.00 17,724 20.9 12.8 11.3 (45) 63 14 1.2 6.4 0.4 31.5 Kirin 2503 JP NR 1985.00 17,540 21.4 14.7 13.1 (71) 46 12 1.9 8.7 (21.8) (0.7) Carlsberg CARLB DC NR 854.60 20,573 21.7 19.0 16.8 (4) 14 13 2.9 13.4 7.5 2.5 Heineken NV HEIA NA NR 81.82 55,833 39.2 23.6 20.2 (52) 66 17 2.9 7.2 (2.6) (9.1) Budweiser BUD US NR 56.22 113,522 28.4 17.6 15.8 (53) 61 12 1.4 3.5 (5.4) (3.2) Int'l beer sector 26.3 17.5 15.4 (45) 50 13 2.1 7.8 (4.4) 4.2 Int'l beer sector - excluding outliers 7.5 2.5

Diageo DGE LN NR 2635.00 80,982 24.1 23.9 21.0 (16) 1 14 10.0 18.6 (1.4) (16.8) Remy Cointreau RCO FP NR 149.20 8,927 62.3 48.1 41.5 (4) 29 16 5.1 8.3 13.0 3.7 Pernod Ricard RI FP NR 147.00 45,606 27.6 26.9 23.4 (14) 3 15 2.5 8.5 0.3 100.9 Brown-Forman BF/B US NR 75.11 35,044 42.4 39.5 36.3 3 7 9 14.4 39.2 6.4 6.2 Constellation STZ US NR 183.48 35,569 19.7 18.3 15.8 2 8 16 2.7 14.4 8.5 2.2 Int'l wine sector 35.2 31.3 27.6 (6) 10 14 6.9 17.8 5.3 19.2 Int'l wine sector - excluidng outliers 9.3 4.0

LVMH MC FP NR 437.05 261,320 52.9 31.4 27.2 (42) 68 16 5.7 11.2 4.2 7.5 Hermes RMS FP NR 844.60 105,633 79.2 56.5 48.9 (27) 40 15 12.4 16.3 5.9 9.6 Richemont CFR SW NR 70.12 44,637 59.5 30.7 24.8 (36) 93 24 2.3 3.5 15.2 2.0 Kering KER FP NR 568.10 84,990 35.5 24.4 21.1 (37) 45 15 6.3 18.3 1.6 14.9 Ferrari RACE IM NR 173.90 40,161 62.0 43.2 36.5 (25) 44 18 18.6 29.5 8.6 5.0 Prada 1913 HK Buy 33.30 10,991 na 54.9 38.2 (117) (488) 44 3.4 (1.4) (1.7) (32.4) Int'l luxury goods sector 57.8 40.2 32.8 (47) (33) 22 8.1 12.9 5.6 1.1 Int'l luxury goods sector - excluding outliers 8.5 6.0 Source: Bloomberg estimates, CMBIS estimates

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Overview of China’s beer industry China’s beer consumption per capita is less than Japan and Korea

According to GlobalData estimates, China’s beer market size was 488mn hL in 2018, equivalent to around 35L per capita consumption. Such consumption level was less than Mexico (74L), US (71L) and Brazil (60L), and also below Japan (44L) and Korea (39L). We think there is still room for China’s beer consumption per capita to increase.

Figure 13: China’s per capita consumption was less than Japan and Korea in 2018

Source: GlobalData

Premiumization level behind Korea and the US Though overall beer sales volume in China declined from 2013 to 2018, the premium and super premium categories were growth drivers of the beer sector. Market share of the premium and super premium categories increased from 10.9% in 2013 to 16.4% by volume in 2018. The proportion of premium and super premium categories remains significantly lower than Korea/the US (25%/42.1%), suggesting huge upside potential for the growth of premium and super premium categories.

According to GlobalData, volume of premium and super premium categories is estimated to increase by 4.9% CAGR from 2018 to 2023E and their sales value is forecast to grow by 8.5% CAGR from 2018 to 2023E. Such growth rate is stronger than the 4.7% CAGR of sales value of China beer market in the period. Market share of the premium and super premium categories is estimated to reach 19.9% by volume in 2023E.

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Figure 14: China’s beer sales volume to grow at Figure 15: China’s premium and super premium 0.9% CAGR from 2018 to 2023E sales volume to grow at 4.9% CAGR from 2018 to 2023E

(mn hL) 550 (mn hL) 540 0.9% CAGR 140 4.9% CAGR 530 120

520 100 510 80 500 60 490 40 480 470 20 460 0 2013 2018 2023E 2013 2018 2023E Source: GlobalData Source: GlobalData

Figure 16: China’s beer sales value to grow at 4.9% Figure 17: China’s premium and super premium CAGR from 2018 to 2023E sales value to grow at 8.5% CAGR from 2018 to 2023E

(US$ bn) (US$ bn) 120 80

110 4.9% CAGR 70 8.5% CAGR

100 60

90 50

80 40

70 30

60 20

50 10

40 0 2013 2018 2023E 2013 2018 2023E Source: GlobalData Source: GlobalData

Industry landscape

 PBT margin expanded on premiumization, capacity optimization and sector consolidation The competition of beer industry is intense. According to GlobalData, top three players namely CR Beer, Tsingtao Brewery and Bud APAC each had 23.2%, 16.4% and 16.2% market share in terms of sales volume in 2018, respectively. Their market shares are quite close to each other. This is different from the beer industries in Brazil and US, where the market leader has dominant leading status.

However, since the slowdown of industry volume growth beginning 2015, the sector players have gradually shifted their key growth strategies from increasing sales volume market share through price competition to increasing profitability through premiumization and capacity optimization.

Number of above-scale beer enterprises is gradually decreasing from 504 in 2012 to 373 in 2019. The market share of top five players in terms of volume increased from 65.2% in 2013 to 70.4% in 2018. Driven by premiumization, capacity optimization and industry

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 12 9 Nov 2020 consolidation, PBT margin of above-scale beer enterprises expanded from 6.5% in 2012 to 8.5% in 2019.

Figure 18: Market share by sales volume from 2013 to Figure 19: Market share in terms of premium and 2018 super premium sales volume from 2013 to 2018

2018 2013 2018 2013

Carlsberg 6.1% Heineken 1.7% 5.9% 1.7%

Yanjing Brewery 8.5% Carlsberg 4.6% 10.6% 4.9%

Bud APAC 16.2% CR Snow 11.0% 12.9% 13.0% 16.4% Tsingtao Brewery Tsingtao 14.4% 15.4% 16.1% 23.2% CR Beer Budweiser APAC 46.6% 20.4% 40.2% 70.4% 78.4% CR5 65.2% CR5 75.9%

0.0% 20.0% 40.0% 60.0% 80.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

Source: GlobalData Source: GlobalData

Figure 20: Number of above designated size Figure 21: Production volume growth has entered enterprises has been gradually decreasing slow growth stage since 2014

600 (mil kL) Production volume (LHS) YoY growth (RHS) 80 10% 550 4.6% 1.1% 0.7% 504 506 70 -1.0% -0.1% -0.7% 0.5% 500 480 3.1% 0% 470 468 447 60 -5.1% 50.62 450 49.02 49.22 47.16 -6.8% -10% 415 50 45.06 44.02 400 38.12 373 40 37.65 -20% 31.19 28.14 350 30 -30% 300 20 -40%

250 10

2012 2014 2015 2016 2017 2019 2013 2018 9M2020

0 9M2019 -50%

2012 2013 2015 2016 2017 2019 2018 200 2014

Source: National Statistics Bureau Source: National Statistics Bureau

Figure 22: PBT margin of above designated size Figure 23: Revenue of above designated size enterprises has been expanding gradually enterprises grew at 5% CAGR from 2016 to 2019

(RMB bn) (RMB bn) PBT (LHS) PBT margin (RHS) 20 9% Revenue of above-scale enterprises (LHS) Reported YoY growth (RHS) 8.5% 8.2% 8.3% 250 20% 19 7.6% 9.3% 8% 5.1% 7.1% 18 7.4% 6.8% 4.8% 10% 7.3% 2.3% 1.5% -1.3% 17 6.9% 7% 0% 6.5% 200 16 188.6 15.1 181.4 189.7 183.3 176.6 -10% 15 6% 14.4 14.0 161.2 14 13.4 158.1 -20% 12.9 5% 147.3 13 12.6 150 12.2 -30% 12 4%

11 10.5 -40%

2013 2014 2015 2018 2019 2012 2016 2017

2013 2014 2015 2018 2019 2016 2017 10 3% 100 2012 -50%

Source: National Statistics Bureau, CMBIS estimates Source: National Statistics Bureau

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Diversifying product offerings to meet consumers’ needs

While lager continues to be mainstream style of beer, breweries have introduced various types of beers to meet evolving consumers’ preferences, such as draft and ice beers, flavored beers, and specialty beers such as wheat beers and dark beers. Such new consumption trends are mainly driven by evolving consumer tastes, drinking habits and preferences and increasing urbanization and growing household spending, resulting in consumer openness to a wider variety of beer types and an ability and willingness to pay more for niche brews such as craft beers.

Craft beer has been gaining popularity in China. A craft brewer can be seen as small, independent and traditional. In US, there are more beer styles and brands to choose from than any other markets in the world. More than 8,000 breweries are responsible for the beer brands available as of 2020 according to craftbeer.com. Craft brewers accounted for 13.6% market share in US in terms of volume according to Brewers Association. In China, craft beer has largely been focused around Beijing, Shanghai and Nanjing. It is increasingly popular with younger consumers and is penetrating new markets in second tier cities such as Hangzhou, Wuhan and Xian. For example, Bud APAC operates Boxing Cat, Goose Island and Kaiba brands in China.

Premium and super-premium beer to grow faster in on-premise channel than off-premise channel

Beer distribution is mainly through distributors or direct delivery to key accounts. Generally speaking, beer sales channel can be classified into on-premise channel and off-premise channel. On-premise channel includes restaurants, bars, nightclubs, KTVs etc, while off- premise channel covers key accounts, traditional channels and e-commerce. Off-premise channel is the bigger channel in terms of volume, representing 50.8% of total volume in 2018.

From 2013 to 2018, on-premise channel had a higher growth rate than off-premise channel in terms of value, driven by the 8.2% CAGR of premium and super premium beer volume (vs 0.4% CAGR in off-premise channel). Most of premium and super-premium beer are consumed on-premise. On-premise channel contributed 74% of premium and super- premium beer consumption in 2013. Such ratio rose further to 80% in 2018 and is forecast to grow to 82% in 2023E. On the other hand, off-premise historically catered to distribute value and mainstream beer. In 2018, 57% of value and mainstream beer volume was consumed off-premise. Such ratio is expected to increase to 59% in 2023E. That said, consumption of premium and super-premium beer in off-premise channel, in terms of volume, is forecast to grow at CAGR of 3.3% from 2018 to 2023E.

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Figure 24: China’s premium and super premium sales Figure 25: China’s premium and super premium volume to grow at 5.3% CAGR in on-premise channel sales volume to grow at 3.3% CAGR in off-premise from 2018 to 2023E channel from 2018 to 2023E

(mn hL) (mn hL) 100 26 5.3% CAGR 90 24 80 22 3.3% CAGR 70 20 60 18 50 16 40 14 30 12 20 10 2013 2018 2023E 2013 2018 2023E

Source: GlobalData Source: GlobalData

Figure 26: China’s value and mainstream sales Figure 27: China’s value and mainstream sales volume to drop at 0.7% CAGR in on-premise channel volume to grow at 0.6% CAGR in off-premise from 2018 to 2023E channel from 2018 to 2023E

(mn hL) (mn hL) 220 300

280 200 -0.7% CAGR 0.6% CAGR 260 180 240 160 220 140 200

120 180

100 160 2013 2018 2023E 2013 2018 2023E

Source: GlobalData Source: GlobalData

US beer sector history showed huge room for China’s premiumization Premiumization trend in US

According to Brewers association, US beer’s premiumization trend began in 1960s with premium beer mix leading the trend. Then, the sales mix of super premium beer took off in mid 1990s and has been rising, driven by imported premium brands and the emerging of many small craft beer breweries. The emerging of super premium beer not only gained market share from value beer but also from premium beer. In 2017, super premium became the biggest segment among beer sector, contributing around 40% of sales mix. On the contrary, sales mix of value beer dropped from around 80% in 1960 to around 20% in 2017.

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Figure 28: US premiumization trend began in 1960s. Premium and super premium accounted for ~80% in 2017

Source: Brewers Association

Figure 29: Number of US breweries began to increase in late 1980s

Source: Brewers Association

US beer market is more consolidated than China

According to Beer Marketer’s Insights, top five players accounted for 78.9% market share in terms of volume in 2019. Anheuser-Busch Inbev was the dominant market leader with 39.9% market share, followed by MillerCoors (22.6%) and Constellation (10.6%). In US, between 2002 and 2008, there were a few large M&As happened in US beer industry. Top five players market share concentration ratio once reached 88.4% in 2009.

Market share of top five players in China in terms of volume was 70.4% in 2018, according to GlobalData. In sector consolidation perspective, such concentration ratio indicates China market could be in the stage of mid 1970s in US.

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Compared to Chinese beer market, the US beer market is more consolidated (vs China’s CR5: 70.4% in 2018) given that the top five players had greater market share. In addition, the market share differences among the top three names are significant, while the market shares of top three names in China are quite close to each other.

Figure 30: Top five US players controlled 78.9% market share in terms of volume

Boston Beer 2.5%

Heineken 3.3%

Constellation 10.6%

MillerCoors 22.6%

Anheuser-Busch Inbev 39.9%

CR5 78.9%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

Source: Beer Marketer’s Insights

Figure 31: Market share of top five US beer players in terms of volume

100% 88.4% 90% 81.8% 80.9%78.9% 80% 74.3% 75.9% 70% 60% 64.0% 50% 40% 47.6% 39.0% 30% 20% 28.5% 24.9% 19.0% 10% 0% 1947 1954 1958 1964 1968 1974 1978 1981 2009 2016 2017 2019 Source: A concise history of America’s brewing industry

Figure 32: Major M&As in North America beer industry Year Event 2002 SAB purchased Miller Brewing Co from Philip Morris to create SABMiller Molson Brewery of Canada and Coors Brewing Company merged to form Molson 2005 Coors 2008 InBev agreed to buy Anheuser-Busch. 2008 SABMiller and Molson Coors created MillerCoors 2016 AB InBev acquired SABMiller and sold MillerCoors to Molson Coors Source: CMBIS

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Premiumization and industry consolidation are key EBITDA margin drivers We analyzed the profit margin trends of top three US beer companies in terms of volume, namely Anheuser Busch, Millers and Coors, from FY91 to FY07. In FY08, the US beer industry happened two merger deals. InBev agreed to buy Anheuser Busch as well as SABMiller and Molson Coors created a JV to merge Miller and Coors. We see the increase of profit margins of the companies from FY91 to FY07 amid industry consolidation and premiumization.

 GPM expanded on premiumization As we mentioned above, the sales mix of super premium beer took off in mid 1990s. We analysed the GPM of Anheuser Busch (ranked No.1 in market share) and Coors’ US market (ranked No.3 in market share). From FY91 to FY04, ASP of Anheuser Busch and Coors rose at a CAGR of 1.4% and 4.1%, respectively. GPM of Anhueser Busch increased by 4.9ppt from FY91 to FY04. The GPM expansion of Coors was even stronger at 8.3ppt during the same period, driven by its faster ASP CAGR. In FY05 and FY06, discount activities of the sector increased heavily which hurt GPM of both companies.

 SG&A expenses ratio lowered on consolidation The US beer industry became more consolidated from 1991 to 2007 with top three players’ market share increased from 76.1% to 78.5%. Also, the market share difference between No.1 and No.2 players expanded from 21.7% to 29.5%. Thanks to increasing industry consolidation, SG&A expenses ratio of Anheuser Busch decreased from 19.3% in FY91 to 17.9% in FY07.

Figure 33: GPM of Coors increased stronger than Figure 34: Anheuser Busch and Coors enjoyed Anheuser Busch from FY91 to FY04 on faster ASP lower SG&A expenses ratio through market share growth gain

Anheuser Busch Coors - US 35% Anheuser Busch 33.7% Coors - US 45% 32.4% 31.5% 30.9% 30.3% 30.4% 30.7% 43% 29.9% 30.2% 29.8% 29.9% 40.9% 29.3% 29.5% 29.5% 40.1% 40.3% 40.4% 30% 28.5% 28.4% 41% 27.3% 38.9% 38.4% 38.4% 39% 37.9% 38.0% 38.1% 38.0% 39.9% 37.2% 36.0% 36.0% 36.3% 38.8% 25% 37% 35.8% 35.5% 34.8% 35.9% 35.0% 38.3% 35.1% 36.8% 36.7% 35% 36.3% 20.3% 20.1% 35.5% 35.3% 19.3% 19.7% 35.4% 20% 18.3% 18.1% 18.2% 18.0% 33% 17.7% 17.5% 17.7% 17.9% 34.5% 34.3% 17.0% 17.4% 17.3% 17.4% 17.3% 31% 33.2% 32.1% 15% 29% 27% 10% 25% FY91 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07 FY91 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

 EBITDA margin Driven by premiumization and increasing market concentration, EBITDA margins of top three US beer companies increased from FY91 to FY07. EBITDA margin of market leader, Anheuser Busch, expanded 8.3ppt from 20.5% in FY91 to 28.8% in FY04 before dropped to 23.2% in FY07 due to GPM decline. Coors US segment also saw EBITDA margin expanded 5.5ppt from 9.9% in FY91 to 15.4% in FY04. We think the underperforming of Miller’s EBITDA margin was due to losing market share.

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Figure 35: EBITDA margins of Anheuser Busch and Coors expanded between 1991 and 2004

35% Anheuser Busch Miller Coors - US

28.2% 28.8% 28.8% 30% 27.4% 26.3% 26.9% 25.5% 24.7% 24.6% 24.1% 23.6% 25% 22.8% 23.2% 20.5% 20.6% 20.7% 21.0%

20% 17.6% 15.4% 15.5% 15.9% 14.4% 13.6% 14.1% 14.2% 14.2% 12.9% 13.3% 13.5% 15% 12.1% 12.4% 12.7% 12.5% 10.8% 12.6% 12.0% 10% 12.8% 13.2% 12.2% 12.2%12.8% 13.2% 11.2% 11.9% 12.0% 12.1% 10.2% 9.9% 10.0% 10.4% 8.5% 5%

0% FY91 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07

Source: Company data, CMBIS estimates

Figure 36: Market share of top three players in US increased between 1991 and 2007 1991 2007 Anheuser Busch 43.9% 48.5% Miller 22.2% 19.0% Coors 10.0% 11.0% CR3 76.1% 78.5% Difference between number 1 and 2 21.7% 29.5% Source: Company data, CMBIS estimates

Margin upside potential for domestic leaders is large We analyzed the competitive landscape of Brazil, US, Japan and China and observed that the higher industry consolidation is, the higher the EBITDA margin of the leading players enjoy. In US, where the beer market is more consolidated and premiumization than China, the market leader could achieve >40% EBITDA margin. We think the EBITDA margin upside potential of domestic brand leaders, CR Beer and Tsingtao Brewery, is large.

 China The EBITDA margin of mmarket leader, CR Beer, was 16.9% in 2019, lower than that of Bud APAC West region and Carlsberg Asia (29-32%) because of higher sales mix of premium and super premium beer. That said, we expect leading players could expand EBITDA margins given the continuing premiumization and industry consolidation trends.

 Brazil AB InBev is the absolute dominant market leader in Brazil with 66.3% market share in 2019. Heineken acquired Kirin’s Brazilian beer business in 2017 to double its market share in Brazil to near 20% and become the country’s number two player. The market share difference between the top two names is high at around 46.3%. We saw that AB InBev enjoyed a lucrative EBITDA margin of 42.3% in South America. Heineken as the number two player also had a good EBITDA margin at 21.5%.

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 US Anheuser Busch, which was acquired by InBev in 2008, has been the market leader in US for a long time. In 2008, SABMiller and Molson Coors created a JV, MillerCoors, to merge Miller (No.2 in US) and Coors (No.3 in US). The market share difference between the top two names was around 19% in 2019. AB InBev enjoyed a high EBITDA margin of 40.8% in US. MolsonCoors as the number two player also had a good EBITDA margin at 25.6%.

 Japan Though the top two players control most of market share in Japan, the market share difference between them is not significant (7.3ppt) compared to Brazil and US markets. As Asahi and Kirin compete for market share, their EBITDA margin was around 15% in FY19. As a market leader, Asahi’s EBITDA margin is much lower than other markets’ leaders.

Figure 37: Market share and EBITDA margin of major beer players in China, Brazil, US and Japan markets in 2019

market share (LHS) EBITDA margin (%) (RHS) 100% 50% 95% China Brazil US Japan 90% 45% 85% 42.3% 80% 40% 75% 40.8% 70% 66.3% 35% 65% 32.4% 60% 30% 55% 28.9% 25% 50% 37.6% 45% 42.0% 25.6% 16.9% 14.8% 30.3% 20% 40% 21.5% 14.4% 35% 12.1% 12.9% 15% 30% 23.2% 23.0% 25% 20.0% 10% 18.4% 20% 14.0% 15% 10.7% 5%

10% 6.1%

(Americas)

Asahi

Yanjing

Molson Coors

Carlsberg

AB AB InBev America) AB InBev

Tsingtao CRBeer

BudAPAC Kirin

5% Heineken 0%

(South

(Asia)

(West)

(US) (US)

Source: Company data, GlobalData, blog.drinktec.com, reuters, CMBIS estimates China and Japan market share data was in 2018, while US and Brazil market share data was in 2019. Bud APAC and Carlsberg did not disclose its China EBITDA margin separately. We used EBITDA margin of Bud APAC’s West region and Calsberg Asia segment, respectively. AB InBev and Heineken did not disclose its Brazil EBITDA margin separately. We used EBITDA margin of AB InBev South America segment and Heineken America segment, respectively.

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Overview of China’s white wine industry Three types of white wine

White wine is a major type of distilled wines in the world and also a traditional liquor unique in China. It is an alcoholic beverage made from grains rich in starch as raw materials, using jiuqu (酒曲) as saccharification starter and adopting solid, semi-solid or liquid fermentation methodology. The production process includes steam-cooking, saccharification, fermentation, distillation, storage and blending. Liquor has a long history and a wide variety, with strong ethnic, regional and cultural attributes. It is an alcoholic beverage popular among consumers.

Liquor can be classified into three categories: sauce-flavored liquor (酱香型), strong- flavored (浓香型) liquor and light-flavored liquor (清香型).

 Sauce-flavored liquor Sauce-flavored liquor is fermented in a stone cellar, and its style is "yellowish and transparent, prominent sauce flavor, elegant and delicate and lasting fragrance in empty glasses". The quality of sauce-flavored liquor depends on the brewing process and post- storage time. While the taste of new wine is spicy, the taste will become more soft and smooth after a long storage period. The quality of strong-flavored liquor depends on the brewing process and cellar mud quality. The country's well-known sauce-flavored liquor manufacturers are mostly distributed in the Chishui River basin connecting Sichuan and Guizhou. The representative brands include Moutai, Langjiu and Xijiu.

 Strong-flavored liquor Strong-flavored liquor is fermented in a mud cellar, and its style is "colorless and transparent, rich in cellar aroma, sweet and mellow, harmonious aroma, clean and refreshing tail". China's well-known strong-flavored liquor manufacturers are widely distributed, and some of them are located in the Yangtze River. The representative brands include Wuliangye, Luzhou Laojiao, Yanghe, Jiannanchun, Shuijingfang, Tuopai, Shuanggou and Gujing etc.

 Light-flavored liquor Light-flavored liquor is fermented in an earthen tank, and its style is "colorless and transparent, pure fragrance, sweet and soft, natural harmony and refreshing aftertaste". China's well-known manufacturers of light-flavoured liquor are mostly distributed in northern China. The representative brand includes Fenjiu etc.

Accelerating consolidation and increasing profitability The competition of white wine sector is keen. Competition advantages come from brand equity, product quality, product style and marketing and distribution model.

White wines can be classified into three major types: sauce-flavored liquor, strong-flavored liquor and light-flavored liquor. Because of shorter production cycle, greater production volume and brands in the market, strong-flavored liquor accounted for around 70% of market share.

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 Industry consolidation accelerated since 2018 According to National Statistics Bureau, production volume growth for above-size white wine enterprises (annual revenue >RMB20mn) has slowed since 2017 as consumers preferred quality to quantity. There is oversupply in low to mid-end as consumers preferred quality to quantity. Small enterprises faced severe competition pressure under the rapid industry consolidation. The sector’s ASP grew at 14% CAGR from 2015 to 2019, reaching RMB74,312/kL in 2019, which is driven by price hike, product mix improvement and exit of small players.

Number of above-scale enterprises declined from 1,593 in 2017 to 1,176 in 2019. According to the Vice-Chairman of China Alcoholic Drinks Association, number of above- scale enterprises is expected to fall below 1,000 in 2020E. Renowned national and regional brands would further gain market shares.

In terms of revenue, market share of top 10 players increased from 26.6% in 2017 to 40.0% in 2019. The increase of market share of high-end brands like Moutai and Wuliangye was most significant (4-5ppt vs other top brands: <1ppt). Unlike low to sub high-end, the supply of quality of high-end wine is limited. According to the Chairman of China Alcoholic Drinks Association (“中国酒业协会理事长”), Mr. Wang Yancai, high quality white wine is an extreme scarce resources in China, representing less than 1% of total white wine production volume.

Figure 38: Number of above designated size Figure 39: Market share of top 10 players increased to enterprises is decreasing as small players exited 40% in 2019 in terms of sales, still room to consolidate

CR10 40.0% 1,800 26.6% 0.8% 1,563 1,578 1,593 Kouzi Distillery 1,600 1,498 0.6% 1,445 King's Luck 0.9% 1,400 0.5% 1.5% 1,176 Lang Jiu 0.9% 1,200 1.8% Shunxin Agriculture 1.1% 1,000 Anhui Gujing 1.9% 2019 1.2% 800 Shanxi Fen Wine 2.1% 2017 1.1% 600 Luzhou Laojiao 2.8% 1.8% 400 Yanghe 4.1% 3.5% 200 Wuliangye 8.9%

5.3% 15.2%

2015 2016 2018 2019 2017 0 2014 Moutai 10.3% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

Source: National Statistics Bureau Source: Lanjiu prospectus

Figure 40: Production volume of above designated Figure 41: Sales volume of above designated size size enterprises fell 10.4% in 9M20 enterprises from 2012 to 2019

(mil kL) Production volume (LHS) reported YoY growth (RHS) (mil kL) Sales volume (LHS) YoY growth (RHS) 22 30% 22 6.3% 10% 3.5% 3.2% 20 20 20% 2.1% 18.6% 0% 18 6.9% 18 7.1% 2.5% 5.1% 10% -11.0% 16 3.2% 3.1% 16 -11.6% -1.8% -10% 13.58 0% 14 14 13.06 12.27 12.57 13.13 -10.4% 12.79 11.53 11.98 -0.8% 11.66 12.03 11.62 -26.4% 12 -10% 12 11.27 -20%

10 10 8.71 -20% 8.55 7.86 7.56 -30% 8 8 5.75 -30% 6 6 4.78 -40% -40%

4 4

2013 2014 2015 2018 2019 2012 2016 2017

2012 2015 2016 2017 2013 2014 2018 2019 9M2020 2 9M2019 -50% 2 -50%

Source: National Statistics Bureau Source: National Statistics Bureau

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Figure 42: ASP increased at 14% CAGR from 2015 to 2019

(RMB) ASP (RMB/kL) YoY growth (RHS) 100,000 40% 28.9% 30% 90,000 18.5% 20% 80,000 8.6% 74,312 1.6% 7.9% 10% 70,000 0% 3.7% 62,735 -0.6% 60,000 -10%

48,661 -20% 50,000 46,905 43,036 43,715 -30% 39,627 43,463 40,000

-40%

2012 2013 2014 2016 2017 2018 2019 30,000 2015 -50%

Source: National Statistics Bureau, CMBIS estimates

 Industry profitability increasing since 2017 The policies to contain corruption and improper public funding business consumption as well as food safety issue (plasticizer) in 2012 kicked off the correction in sub high-end to high-end white wine segments. Industry’s PBT decreased from RMB82.1bn in 2012 and bottomed at RMB69.9bn in 2014. PBT margin narrowed from 18.4% in 2012 to 13.0% in 2016.

Driven by increase of private consumption, production volume growth accelerated beginning 2015. Moutai’s retail price rebounded to >RMB1,000 in 2H16, triggering Wuliangye and Guojiao 1573 to lift ex-factory price in 2H16. The sector’s ASP grew at 17% CAGR from 2016 to 2019 driven by price hike and product mix improvement, reaching RMB74,312/kL in 2019. Therefore, revenue growth of above-scale enterprises started to accelerate beginning 2015. The sector’s PBT margin began recovery in 2017 and reached 25.0% in 2019.

Figure 43: PBT margin of above designated size Figure 44: Revenue of above designated size enterprises has been expanding since 2017 enterprises grew at 11% CAGR from 2016 to 2019

(RMB bn) (RMB bn) PBT (LHS) PBT margin (RHS) 200 30% Revenue of above-scale enterprises (LHS) Reported YoY growth (RHS) 190 25.0% 900 40% 23.3% 180 25% 850 26.8% 30% 170 18.2% 800 160 18.4% 20% 14.4% 20% 16.0% 750 11.2% 10.1% 12.9% 150 13.3% 13.0% 140.4 4.8% 8.2% 15% 700 10% 140 13.1% 5.2% 130 125.1 650 612.6 10% 0% 120 600 565.4 561.8 110 102.8 555.9 536.4 -10% 5% 550 501.8 525.9 100 500 -20% 90 82.1 446.6 80.5 79.7 0% 450 80 -30% 69.9 72.7 400 70 -5% -40%

60 350

2013 2014 2015 2018 2019 2012 2016 2017

2013 2014 2015 2018 2019 2016 2017 50 2012 -10% 300 -50%

Source: National Statistics Bureau, CMBIS estimates Source: National Statistics Bureau

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High-end segment is more preferred to sub high-end segment

 High-end white wine supply is limited High-end white wine has investment attributes because of its premium quality and scarcity. High quality white wine is an extreme scarce resource, representing less than 1% of total white wine production volume. Its price has been increasing steady for long time. For example, we observed retail price of Moutai increased from around RMB200 in 2000 to near RMB3,000 now (~14% CAGR). The ex-factory price of Moutai and Wuliangye also increased at a CAGR of 9% and 6% from 2003 to 2019, respectively.

 Favourable industry competitive landscape Moutai is the undisputable market leader and top two players, Moutai and Wuliangye, take around 80-85% market share. On the other hand, sub high-end segment is more competitive and fragmented. There are a lot major players such as Jiannanchun, Honghua Langjiu, Yanghe’s Dream Blue, Lujiao Tequ, Shede, Fen Wine’s Qinghua series, Swellfun, King’s Luck, Kouzi, Gujing, Xijiu, series wine of Moutai etc.

 High-end white wine demand is more rigid than sub high-end As reflected in 1H20 results and sector down cycle between 2012 and 2014, revenue growth of Moutai and Wuliangye performed better than sub high-end (Figure 39, 40). We think sub high-end is more related to family consumption and discretionary consumption. When income reduces, consumers could cut consumption of sub high-end white wine. On the contrary, the consumers for high-end white wine are more affluent, and their consumption demand is quite rigid amid economic downturn.

We think Moutai and Wuliangye could comfortably achieve 16% revenue CAGR in FY19- 22E through both increases of volume and ASP (“ 量价齐升”). Both companies will announce their “14th Five-Year Plan” and we expect both companies set their 5-year revenue CAGR at 10%+ from FY20 to FY25E.

Figure 45: White wine sector 1H20 results snapshot Revenue NP growth Company growth YoY YoY Wuliangye 13% 16% Beijing Shunxin 13% -15% Kweichou Moutai 11% 13% Shanxi Fen Wine 8% 33% Jiangsu King's Luck -5% -5% Luzhou Laojiao -5% 17% Anhui Gujing -8% -18% Jinhui Liquor -13% -11% Jiangsu Yanghe -16% -3% Sichuan Swellfun -52% -70% Average -5% -4% Source: Bloomberg, Company data

Figure 46: Wine revenue CAGR of high-end brands outperformed during 2012-14 Stock 2012-14 Company name code 2011 2012 2013 2014 2015 2016 2017 2018 2019 2-yr CAGR Jiangsu Yanghe 002304 12,741 17,270 15,024 14,039 15,316 16,499 19,183 22,913 21,967 -10% Luzhao Laojiao 000568 8,428 11,556 10,146 5,007 6,571 8,074 10,115 12,860 15,616 -34% Shanxi Fen Wine 600809 4,467 6,443 6,039 3,877 4,082 4,357 5,982 9,308 11,745 -22% Anhui Gujing 000596 3,179 4,046 4,439 4,526 5,119 5,876 6,822 8,520 10,164 6% Sichuan Swellfun 600779 1,394 1,623 478 360 811 1,176 2,044 2,814 3,538 -53% Average -23% Moutai 600519 18,402 26,455 30,921 31,573 32,654 38,841 58,169 73,565 85,345 9% Wuliangye 000858 20,164 26,125 23,703 20,026 20,346 22,705 28,092 37,752 46,302 -12% Average -2% Source: Company data, CMBIS estimates

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CMB International Securities | Equity Research | Company Initiation

CR Beer (291 HK) Partnership with Heineken to accelerate premiumization BUY (Initiation)

Target Price HK$61.90 We forecast CR Beer to deliver stronger EPS CAGR than Tsingtao Brewery (19% Up/Downside +27% vs 14%) in FY19-22E. Continuing premiumization and production efficiency gain Current Price HK$48.85 strategies are major growth drivers. The partnership with Heineken is a combination of both companies’ strengthens (Heineken’s international product portfolio + CR Beer’s nationwide distribution network). We estimate Heineken China Beer Sector China’s utilization rate was low at ~28% in 2018. The strong sales growth post partnership should notably improve GPM and profitability. We initiate coverage Albert Yip of CR Beer with Buy rating and TP of HK$61.90. (852) 3900 0838 [email protected]  Partnership with Heineken to accelerate premiumization. The Company could bring in Heineken’s international product portfolio to compete with Bud

APAC and Carlsberg, while Heineken could leverage on the Company’s Stock Data nationwide distribution network to expand its brand presence. According to Mkt Cap (HK$ mn) 158,478 Heineken, the integration with CR Beer was ahead of schedule and Heineken Avg 3 mths t/o (HK$ mn) 329.60 brand recorded double-digit growth in 1H20. Management targets to raise 52w High/Low (HK$) 55.95/ 30.45 retail price to reinforce Heineken’s premium brand image underpinned by Total Issued Shares (mn) 3,244.0 advertising investment. This could improve profitability of distributor/POS and Source: Bloomberg help the brand’s network penetration. We estimate Heineken China’s capacity utilization rate was ~28% in 2018. The fast sales growth post partnership deal Shareholding Structure should significantly improve GPM and profitability of Heineken China. The China Resources Co 31.24% Company is studying capacity expansion of Heineken. Heineken 20.67% Source: HKEx  Continue to improve production efficiency. Despite CR Beer is a central state-owned enterprises, CR Beer has actively shut inefficient plants. Its number Share Performance of breweries in China was cut from 98 in FY16 to 72 in 1H20 and its utilization Absolute Relative 1-mth 1.4% -6.3% rate was still less than Tsingtao and Bud APAC in FY19. Going forward, we 3-mth -10.4% -12.5% expect the Company would close plants further and have efficiency gain 6-mth 28.8% 19.6% strategies. Also, it plans to expand the sales of bottled beer with returnable Source: Bloomberg bottles concept to more than 50% of bottled beer by end of 2020 to save costs. 12-mth Price Performance  Proven track record in industry consolidation. The Company was founded (HK$) 291 HK HSI (rebased) in 1993. It had made more than 20 strategic acquisitions in its history and 60 surpassed Tsingtao Brewery to become China’s largest brewery in 2006. 50 Given that China’s beer sector has room to further consolidate, we think CR 40 Beer has comparative advantage in the sector’s consolidation because of its 30 proven M&A track record and central state-owned enterprise status. 20  Initiate at Buy. We estimate the Company to post 19% adj. EPS CAGR from 10 0 FY19 to FY22E, driven by 6% revenue CAGR and 4.3ppt EBIT margin 11/2019 2/2020 5/2020 8/2020 11/2020

expansion led by premiumization and efficiency gain strategies. Our TP of Source: Bloomberg HK$61.90 is based on 46.0x FY21E adj. P/E, at the high-end of historical P/E band. We think Heineken China has enormous growth potential (high brand Auditor: EY recognition but low penetration) and expect Heineken China would be a key

growth driver for the Company. Catalysts: better-than-expected revenue and

margins. Risks: costs pressure, food safety issues. Earnings Summary (YE 31 Dec) FY17A FY18A FY19E FY20E FY21E Revenue (RMB mn) 31,867 33,190 32,072 36,584 39,158 YoY growth (%) 7 4 (3) 14 7 Net profit (RMB mn) 977 1,312 2,438 3,485 4,373 Adj. net profit (RMB mn) 2,538 2,838 2,888 3,860 4,723 Adjusted EPS (RMB) 0.782 0.875 0.890 1.190 1.456 YoY growth (%) 60 12 2 34 22 Consensus EPS (RMB) NA NA 0.812 1.154 1.419 Adjusted P/E (x) 53.8 49.2 48.5 36.3 29.7 P/B (x) 0.3 0.4 0.7 1.0 1.2 Yield (%) 7.2 7.1 6.5 6.0 5.4 Source: Company data, Bloomberg, CMBIS estimates

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Focus Charts Figure 47: Revenue to grow at 6% CAGR from FY19 to Figure 48: Adjusted net profit to grow at 19% CAGR FY22E from FY19 to FY22E

（RMB mn） （RMB mn） Net profit Adj. NP 45,000 6,000 5,500 42,500 6% CAGR 5,000 19% CAGR 4,723 39,158 40,000 4,500 4,373 3,860 36,584 4,000 37,500 3,485 3,500 35,000 2,838 2,888 33,190 3,000 2,538 31,867 32,072 2,438 32,500 2,500 2,000 30,000 1,500 1,312 27,500 977 1,000 25,000 500 FY18 FY19 FY20E FY21E FY22E FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 49: GPM expansion led by premiumization and Figure 50: Sales volume and ASP estimates in capacity efficiency gain FY20-22E

45% GPM Adj. NPM （mn kL） Sales volume - LHS ASP - RHS (RMB/kL) 14.40 3,300 40% 40.4% 41.8% 3,259 38.9% 13.90 3,200 35% 36.8% 3,097 35.1% 13.40 3,100 30% 12.90 3,000 25% 2,903 12.40 2,903 12.02 11.81 2,900 20% 11.90 2,824 11.43 11.29 2,800 15% 12.1% 11.40 10.6% 11.05 9.0% 10% 8.0% 8.6% 10.90 2,700

5% 10.40 2,600 FY18 FY19 FY20E FY21E FY22E FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 51: CR Beer and Heineken have unrivalled Figure 52: Merger with Heineken lifted the Company’s market leadership in China valuation

HK$ 70

65

60 The P/E peak post 46x merger was higher than the previous 55 Completed merger peak with Heineken China 40x 50 on 29 Apr 2019 45 35x

40 30x 35 24x 30

25

20 The P/E trough during epidemic was higher than the 15 previous trough

10

Jun-16 Jun-17 Jun-19 Jun-20 Jun-18

Mar-18 Mar-16 Mar-17 Mar-19 Mar-20

Sep-15 Sep-16 Dec-16 Dec-17 Sep-18 Sep-19 Dec-19 Sep-17 Dec-18 Sep-20 Dec-15 Source: Heineken N.V. Source: Bloomberg, Company data, CMBIS estimates

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Partnership with Heineken to accelerate premiumization Complement the strengthens of both companies

We think the combination of CR Beer and Heineken China is a win-win partnership for both companies. CR Beer can bring in renowned international brand portfolio to compete with Bud APAC and Carlsberg in premium segment. On the other hand, Heineken China only had three breweries in China, which limited its footprint to Hainan, Jiangsu, Fujian and Guangdong, Hong Kong and Macau. The partnership can help it expand distribution network.

 Strengthens of CR Beer CR Beer is the leader in Chinese beer industry with nationwide manufacturing and distribution network (presence in 25 out of 34 regions/cities in China) as well as deep understanding of the industry.

 Strengthens of Heineken Heineken has an international brand portfolio, led by its sought-after Heineken brand. Heineken also has other beer products such as craft beer, cider, low and no-alcoholic beverages to meet changing consumer preferences. These products can be licensed to the Company in China. Also, Heineken’s global presence could accelerate the international growth of the Company’s products.

Figure 53: Heineken has a rich and diversified product portfolio International beer brands International and local craft

Cider category Low and no-alcohol beverages

Source: Heineken

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Unrivalled market leadership

According to Heineken, the combination of the CR Beer and Heineken China strengthened the Company’s leadership with 15%+ market share in over 20 regions, specifically in Hainan (the only brewery in the province) and Fujian (number two premium beer provincial market in China).

Figure 54: Strong presence in 24 regions in China Figure 55: Unrivalled market leadership

Source: Heineken Source: Heineken

Defence of exclusive channels

The cooperation with Heineken not only helps the Company take market share of other high-end brands, it also helps the Company to defend its exclusive channels. For example, there are certain exclusive channels which CR Snow beer only offers CR Snow beer as the only domestic brand to customers. Such channels could introduce competitors to fill the emptiness of international brands. Now the Company can offer Heineken to fill the emptiness of international brands and this could help the Company to defend its exclusive channels against foreign brands.

Integration of Heineken China faster than expected

 Introduce Heineken into more provinces According to the Company, Heineken recorded RMB1,139mn revenue and RMB145mn NP in FY19 since the acquisition was completed in Apr 2019. The integration of Heineken’s teams, systems, factories and customers to the Company and the setup of nationwide sales for Heineken were finished in 2019. Heineken products has been introduced into Snow Beer’s channels in Chengdu market (Sichuan is one of CR Beer’s base markets), Central China and Northeast China, where the Company has high market share (see Figure 53). Penetration in Shenzhen and Shanghai also improves.

 Heineken Silver was launched in Apr 2020 The taste of Heineken Classic is like European lager beer, which Chinese consumers could find its taste too bitter. To cope with Chinese consumers’ tastes, Heineken launched Heineken Silver, a less bitter version, in hypermarket on 25 Apr.

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 Heineken brand saw strong growth in 9M20 According to Heineken, Heineken brand saw double-digit volume growth in 1Q20 despite epidemic and recorded double-digit growth in 1H20. Such performance was better than Bud APAC’s China market (20.5% volume decline). The Company is studying capacity expansion plan of Heineken. Heineken’s 3Q20 mentioned that Heineken brand saw strong double-digit growth as it continues to be rolled-out-throughout the Company’s strong route- to-market, entering new channels and successful introduction of Heineken Silver.

Figure 56: Heineken brand saw double-digit growth in Figure 57: Double-digit growth in China in 1H20 China in 1Q20 despite epidemic according to Heineken webcast transcript

Source: Heineken Source: Heineken

Enormous growth potential of Heineken in China

 Significantly underdeveloped in China compared to Bud APAC and Carlsberg According to GlobalData, Heineken only sold 0.14mn kL of premium and super premium in China in 2018, much lower than Bud APAC (3.74mn) and Carlsberg (0.37mn). Unlike Heineken China, these two groups had nationwide distribution networks in China. Therefore, we think the room for Heineken to grow is enormous since its merger in Apr 2019. According to CR Beer, Heineken China contributed RMB1,139mn revenue and RMB145mn profit after tax (5% of adj. NP of CR Beer) in FY19 since its consolidation in 29 Apr 2019.

 Heineken product well received by consumers in Asia Pacific region According to Heineken, it had the largest number of markets with leadership (No.1 and No.2) in terms of volume in the region in 2018, stronger than its key rivals. Based on its 1H20 ppt, Heineken brand became the number #1 brand in premium segment in Korea. Its Heineken Silver sales was more than doubled in Vietnam. We think all these showed that its product portfolio is well received by consumers in the region.

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Figure 58: Strong leadership in Asia Pacific region

Source: Heineken

 Ramp up utilization rate could significantly boost GPM expansion Heineken had three plants in China (Guangdong, Hainan and Zhejiang) when it was merged with CR Beer. We estimate it had annual production capacity of 0.5m kL and its annual sales was around 0.14m kL in 2018, representing only ~28% utilization rate. CR Beer could leverage its nationwide distribution network and market knowledge to drive sales of Heineken, the jump in utilization rate could significantly improve GPM.

 Increase advertising and lift retail price During 1H20 results presentation, management mentioned that Heineken’s advertising campaign was carried on despite epidemic, which was in contrast to peers’ reduced advertising activities. Market reception was satisfactory and the Company had raised the retail price of Heineken products. Going forward, management targets to increase retail price to reinforce its premium beer image, driven by continuous advertising investment. We think this could improve profitability of distributor/POS and help the brand’s network penetration.

 UEFA 2021 European Cup could be an opportunity Due to epidemic, 2020 European Cup was postponed to 2021. Heineken was one of the official sponsors of the competition. That said, the Company does not need to share the European Cup sponsorship fee. It just pays for its marketing activities in China market. According to people.cn, more than 1.2bn viewers in China watched the broadcast of 2016 European Cup. We expect the broadcast of the Cup in China could further enhance brand equity of Heineken.

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Figure 59: Heineken is official sponsor of 2020 Figure 60: Heineken has built a strong brand in European Cup China

Source: UEFA Source: Heineken

“4+4” brand portfolio for premiumization

The Company plans to adopt a “4+4” brand portfolio (4 brands from each of CR Snow Beer and Heineken) to develop its high-end segment and enhance its competitiveness in first tier cities. Actually, each group has more than four high-end brands in high-end segment, especially Heineken’s global product portfolio. In China, consumers have limited choices in international beer brands, mainly from Bud APAC. However, in western countries, there are more choices available in the market. We think this could provide opportunities for Heineken. The four CR Snow Beer high-end brands The Company puts Snow Beer’s Brave the World Super X, Marrsgreen, Craftsmanship and Opera Mask as the key four high-end brands. Opera Mask is the most high-end in terms of retail price, followed by Craftsmanship, Marrsgreen and Brave the World Super X. Each brand targets different kinds of consumers.

Heineken has a diversified product portfolio The Company has selected Heineken Classic, Heineken Silver and Sol for high-end segment development in China. Because Heineken has a portfolio of more than 300 international, regional, local and specialty beers and ciders, we expect the Company would finalize the last one as its core high-end portfolio in 1-2 years.

Huge growth potential in premiumization Firstly, Heineken is the second largest brewer in the world in terms of volume. According to GlobalData, its sales volume of premium and super premium in China was just 0.14mn hL in 2018, equivalent to 37% of Carlsberg’s and 4% of Bud APAC’s volume, respectively. The partnership with CR Beer should unlock growth potential of Heineken in China market.

Secondly, the sales mix of premium and super premium beer was just 16% in China in 2018, according to GlobalData. When it is compared to the ~80% sales mix of US market, we think there is a long road for China’s premiumization trend to continue.

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Figure 61: “4+4” high-end brand portfolio Brand Brave the World Super X Marrsgreen Craftsmanship Opera Mask

Description Extreme sports and street dance Target aged 25-35 Pairing delicious food with Traditional Chinese culture are marketing initiatives. Target consumers seeking lifestyle this beer style aged 18-25 consumers. and quality.

Retail price (RMB) 8 8.3 10 15 Brand Heineken Classic Heineken Silver Sol TBC

Description Traditional European lager beer Less bitter than Classic Spainish beer like Corona Retail price (RMB) 9.3 9.3 11.1

Source: Tmall

Figure 62: The combined product portfolio of CR Snow beer and Heineken Price CR Beer + Heineken positioning Super premium

Mainstream Source: Tmall, CMBIS estimates

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Continuing to improve production efficiency Although CR Beer is a key state-owned enterprise, CR Beer has actively optimized its plant efficiency, including shutting inefficient plants and laying off employees. We think this showed that management is determined to enhance the Company’s profitability. Its number of breweries in China was cut from 98 in FY16 to 72 in 1H20, with total capacity reduced from 22.0mn kL to 19.6mn kL. Utilization rate based on designed capacity increased from 53.7% in 2018 to 55.8% in 2019, lower than Tsingtao Brewery’ and Bud APAC’s 59.4%. We think the Company still has room to shut its production plants but the pace would not be as fast as past few years.

Highest capacity per capita We observed CR Beer had the highest capacity per capita. In FY19, its efficiency was at 683kL per employee, which was higher than Tsingtao (355kL) and Bud APAC (560kL).

Returnable bottles concept

The Company began sales of bottled beer with returnable bottles concept (“不连樽销售”) in 2H19 and plans to expand the practice to more than 50% of the bottled beer by end of 2020. We think this could improve profit margin in the following ways: (1) VAT savings as bottles charges are not included in the transaction price; (2) higher frequency of reuse of bottles could save average bottle cost; (3) receiving bottle usage fee as other income related to bottle wear and tear charges collected from distributors. Bottle usage fees income jumped from RMB64mn in 1H19 to RMB224mn in 1H20.

Canned beer Cost of operating canned beer is less than bottled beer because of easier transportation and no bottle washing cost. China has only had canned beer for 15 years and we think there is room to increase canned beer sales mix.

More efficiency gain procedures ahead The Company will continue to adopt plant capacity optimization strategy, including optimization of production facilities and shutting plants. However, we think the number of plant closures in future would be less than that in the past few years as utilization rate increased from 53.3% in FY16 to 55.8% in FY19 (still less than Bud APAC and Tsingtao Brewery’s 59.4% in FY19). Beer’s sales seasonality (low season in 4Q) is also considered.

The Company closed two plants in 1H20 and expects further closure in 2H20E. The Company will have efficiency gain strategies ahead to further reduce production cost per tonne. Some of the Company’s plants are now ranked as one of the most advanced breweries in the world, according to management. Driven by premiumization and efficiency gain strategies, management targets to raise its GPM (40.4% in 1H20) to current Bud APAC level (51.5% in 1H20) in five years.

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Proven track record in industry consolidation

CR Snow Beer was established in 1993. Its first brewery facility was set up in Shenyang in 1994. At that time, Chinese beer industry was led by Tsingtao Brewery and Yanjing Brewery. Through strategic acquisitions and organic growth as well as nationwide brand building, CR Snow Beer’s sales volume surpassed Tsingtao Brewery and became the market leader in 2006. Since then, CR Snow Beer has been the largest player in China in terms of sales volume. Given that China’s beer sector has room to further consolidate, we think CR Beer has comparative advantage in the sector’s consolidation because of its proven M&A track record and central state-owned enterprise status.

Proven track record of M&A CR Snow Beer had made more than 20 acquisitions in its history. Thanks to these acquisitions and organic growth, its revenue and profit attributable to shareholders (before MI) increased at a CAGR of 20% and 17%, respectively, from FY94 to FY19. We highlight the acquisition of Kingway Brewery and partnership with Heineken as the Company’s key M&As in its history.

1) Kingway Brewery The Company successfully bid Kingway Brewery with a consideration of HK$6,643mn in Feb 2013. Kingway Brewery is a leading brand in Guangdong with total capacity of 1.45mn tonnes covering Guangdong, Sichuan, Shaanxi and Tianjin. The acquisition strengthened the Company’s market position in Guangdong and further optimized its sales network in China.

2) Heineken China Heineken invested a total amount of HK$24.3bn for 40% equity interests in CRH (Beer) Ltd, holding 51.67% equity of the Company. Heineken has 20.67% economic interest in the Company, at an implied purchase price of HK$36.31/sh. By sales of shares, Heineken contributed its operating entities in China into the partnership with the Company for a total consideration of HK$2.4bn. Also, CRE acquired 5.2m Heineken shares for a consideration of EUR464mn. We think the partnership will advance the Company’s premiumization strategy and unlock Heineken’s full potential in China.

Figure 63: Proven track record in industry consolidation

Source: Company data

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Figure 64: Shareholding structure of CR Beer after partnership with Heineken

Source: Company data

China’s beer sector has further room to consolidate In 2018, China’s top five players had 70.4% market share in terms of volume according to GlobalData. The industry concentration was less than Japan (~93%), US (~79% in 2019), Korea (~83% in 2017). We think there is room for China’s beer sector to consolidate. Given CR Beer’s proven track record in M&A and its central state-owned enterprise status, we think it has comparative advantage in the sector’s consolidation.

Earnings forecast 1H20 NP +11% In 1H20, revenue fell 8% led by 5% volume decline and 2% ASP decline. The business recovered strongly after 26% slump of revenue in 2M20 due to epidemic. Given that food service channel was severely hit by epidemic (major channel for mid to high-end categories) in 1H20, sales volume of mid to high-end beer sales fell by 6.2%. That said, led by Heineken and Super X, sales volume of sub-high end and above increased 2.9%. GPM increased 2.6ppt to 40.4%, driven by better sub-high end and above sales mix, favorable raw materials prices and expanded sales of bottled beer with returnable bottle concept (“不连 樽销售”). We estimate adj. NP rose 3% to RMB2,368mn.

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We forecast the Company to post 19% adjusted EPS CAGR from FY19 to FY22E Sales volume and profitability continued to recover in 8M20. We estimate revenue growth to improve to 2% in 2H20E as sales growth further recovers. In FY21E, we forecast revenue growth to accelerate to 14% on 7% growth each on volume (low base in 1H20) and ASP (continuing premiumization). Looking into FY22E, we estimate 7% revenue growth led by 5% ASP growth.

We forecast EBIT margin to expand from 11.7% in FY19 to 16.0% in FY22E, led by 5.0ppt GPM expansion. Continuing premiumization and capacity efficiency gain strategies are growth drivers of GPM.

Figure 65: P&L assumptions (RMBmn) FY18 FY19 FY20E FY21E FY22E Revenue 31,867 33,190 32,072 36,584 39,158 growth (%) 7.2% 4.2% -3.4% 14.1% 7.0%

Snow Beer 31,867 32,051 30,307 34,214 35,974 growth (%) 7.2% 0.6% -5.4% 12.9% 5.1% GPM (%) 35.1% 36.3% 38.0% 39.2% 40.2%

- sales volume (mn kL) 11.29 11.31 10.86 11.56 11.69 growth (%) -4.5% 0.2% -4.0% 6.5% 1.1%

Heineken na 1,139 1,765 2,370 3,184 growth (%) na na 55.0% 34.3% 34.3% GPM (%) 51.9% 54.4% 57.9% 60.4%

- sales volume (mn kL) na 0.13 0.19 0.25 0.33 growth (%) na na 53.4% 30.4% 30.4%

GPM (%) 35.1% 36.8% 38.9% 40.4% 41.8%

Other income 784 741 910 972 1,039 % rev (%) 2.5% 2.2% 2.8% 2.7% 2.7%

Selling expenses 5,570 5,925 6,126 6,988 7,440 % rev (%) 17.5% 17.9% 19.1% 19.1% 19.0%

Admin expenses 3,140 3,168 3,279 3,525 3,701 % rev (%) 9.9% 9.5% 10.2% 9.6% 9.5%

EBIT 3,272 3,874 3,982 5,244 6,283 % of rev (%) 10.3% 11.7% 12.4% 14.3% 16.0% Source: Company data, CMBIS estimates

Figure 66: CMBIS estimates vs consensus CMBIS Consensus Diff (%) US$ mn FY20E FY21E FY22E FY20E FY21E FY22E FY20E FY21E FY22E Revenue 32,072 36,584 39,158 32,617 36,279 38,972 -2% 1% 0% Gross Profit 12,477 14,784 16,384 12,623 14,569 16,137 -1% 1% 2% EBIT 3,982 5,244 6,283 3,621 4,980 5,958 10% 5% 5% Adjusted Net Profit 2,888 3,860 4,723 2,630 3,751 4,632 10% 3% 2% Gross Margin 38.9% 40.4% 41.8% 38.7% 40.2% 41.4% +0.2ppt +0.2ppt +0.4ppt EBIT Margin 12.4% 14.3% 16.0% 11.1% 13.7% 15.3% +1.3ppt +0.6ppt +0.7ppt Adjusted Net Margin 9.0% 10.6% 12.1% 8.1% 10.3% 11.9% +0.9ppt +0.3ppt +0.2ppt Source: Bloomberg, CMBIS estimates

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Valuation

Merger with Heineken China lifted the Company’s valuation We set our TP of HK$61.90 based on 46.0x FY21E adjusted P/E, at the high-end of historical P/E band. We think Heineken China has enormous growth potential (high brand recognition but low penetration) and expect Heineken China would be a key growth driver for the Company.

We think the merger with Heineken China has lifted the Company’s P/E valuation. During epidemic, the Company’s forward P/E dropped to 30x, which was higher than the previous P/E trough of 24x. On the contrary, we observed the P/E trough of Tsingtao Brewery during epidemic was the same as the previous trough at 18x. The peak P/E of CR Beer after the merger was also higher than the previous peak.

For cross-checking, our TP implied 2.5x FY21E PEG on 19% adj. EPS CAGR in FY19-22E, which is lower than Bud APAC (3.3x) and in line with Carlsberg (2.5x).

Figure 67: P/E band chart of CR Beer Figure 68: P/E band chart of Tsingtao Brewery

HK$ HK$ 90 70 42x 85 65 80 75 36x 60 The P/E peak post 46x merger was higher 70 55 than the previous Completed merger peak 65 with Heineken China 40x 30x 50 on 29 Apr 2019 60 55 45 35x 50 24x 40 30x 45 35 40 18x 24x 35 30 30 25 25 The P/E trough during epidemic was the 20 The P/E trough 20 same as the previous during epidemic was higher than the 15 trough 15 previous trough 10

10

Jul-16 Jul-20 Jul-14 Jul-15 Jul-17 Jul-18 Jul-19

Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19 Oct-20 Apr-14 Oct-14 Apr-15 Oct-15 Oct-19 Apr-20

Jan-17 Jan-18 Jan-19 Jan-20 Jan-14 Jan-15 Jan-16

Jun-16 Jun-17 Jun-19 Jun-20 Jun-18

Mar-18 Mar-16 Mar-17 Mar-19 Mar-20

Sep-15 Sep-16 Dec-16 Dec-17 Sep-18 Sep-19 Dec-19 Sep-17 Dec-18 Sep-20 Dec-15 Source: CMBIS estimates, Bloomberg, Company data Source: CMBIS estimates, Bloomberg, Company data

Figure 69: Peers valuation Mkt cap P/B ROAE FY0-3 Stock (HK$/US$/ P/E (x) EPS growth (%) (x) (%) EPS FY2 code Rating Price RMBmn) FY1 FY2 FY3 FY1 FY2 FY3 FY1 FY1 cagr PEG Budweiser Brewing 1876 HK NR 22.55 298,639 60.6 34.2 28.8 (36) 77 19 3.8 6.4 10.4 3.3 CR Beer 291 HK Buy 48.85 158,478 48.5 36.3 29.7 2 34 22 6.5 14.0 18.5 2.0 Tsingdao Beer 168 HK Buy 62.40 107,823 26.4 22.5 19.8 12 17 14 3.6 11.1 14.2 1.6 H share beer sector 45.2 31.0 26.1 (7) 43 18 5 11 14.4 2.3

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1 Haitian Flavouring 603288 CH NR 169.90 550,551 83.8 70.4 59.8 23 19 18 26.3 32.8 19.8 3.5 Yili 600887 CH Buy 38.88 236,515 32.0 27.0 23.5 6 18 15 8.3 27.1 13.0 2.1 Yonghui 601933 CH NR 8.07 76,796 31.2 24.9 19.8 56 25 26 3.6 15.4 34.9 0.7 C&S Paper 002511 CH NR 22.10 28,909 31.8 26.2 22.1 48 22 18 5.9 19.1 28.6 0.9 Shanghai Jahwa 600315 CH NR 43.14 28,958 68.0 53.5 41.3 (24) 27 30 4.4 6.5 7.9 6.7 A share segment leaders 48.9 40.1 33.6 19 22 19 9.6 20.5 21.3 2.1

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Chongqing Brewery 600132 CH NR 107.00 51,785 88.9 76.5 66.7 (11) 16 15 35.0 31.1 17.5 2.1 Yanjing Brewery 000729 CH NR 8.29 23,366 156.4 85.5 72.1 (34) 83 19 1.8 32.8 19.8 3.5 Zhujiang Beer 002461 CH NR 9.82 21,735 39.3 34.6 30.3 14 14 14 2.5 27.1 13.0 2.1 A share beer sector 83.5 59.6 51.5 (5) 33 15 11.1 25.5 16.1 2.7

Asahi 2502 JP NR 3616.00 17,724 20.9 12.8 11.3 (45) 63 14 1.2 6.4 0.4 31.5 Kirin 2503 JP NR 1985.00 17,540 21.4 14.7 13.1 (71) 46 12 1.9 8.7 (21.8) (0.7) Carlsberg CARLB DC NR 854.60 20,573 21.7 19.0 16.8 (4) 14 13 2.9 13.4 7.5 2.5 Heineken NV HEIA NA NR 81.82 55,833 39.2 23.6 20.2 (52) 66 17 2.9 7.2 (2.6) (9.1) Budweiser BUD US NR 56.22 113,522 28.4 17.6 15.8 (53) 61 12 1.4 3.5 (5.4) (3.2) Int'l beer sector 26.3 17.5 15.4 (45) 50 13 2.1 7.8 (4.4) 4.2 Int'l beer sector - excluding outliers 7.5 2.5 Source: CMBIS estimates, Bloomberg

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Company Overview

Company background CR Beer focuses on the manufacturing, sales and distribution of beer products. CR Snow Beer, established in 1993, is a wholly-owned subsidiary of CR Beer. In 2019, the Group completed the transaction and commenced the strategic relationship with Heineken. As at 31 Dec 2019, CR Beer had 74 brewery plants, which had a total capacity of 20.5mn kL, and had presence in 25 out of 34 regions/cities in China. Utilization rate based on designed capacity reached 55.8% in 2019.

Figure 70: Brewery plants capacity by province

Source: Company data

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Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E Revenue 31,867 33,190 32,072 36,584 39,158 Profit before tax 1,532 2,202 3,391 4,714 5,874 Cost of sales (20,669) (20,964) (19,595) (21,800) (22,773) D&A 1,654 1,724 1,825 1,818 1,808 Gross profit 11,198 12,226 12,477 14,784 16,384 Net finance cost (63) (44) (109) (145) (191) Change in working capital 542 75 638 153 441 Other income 784 741 910 972 1,039 Others 269 141 (737) (1,088) (1,438) Selling expenses (5,570) (5,925) (6,126) (6,988) (7,440) Operating cash flow 3,934 4,098 5,008 5,452 6,495 Administration expenses (3,140) (3,168) (3,279) (3,525) (3,701) EBIT 3,272 3,874 3,982 5,244 6,283 Capex (1,641) (1,490) (2,000) (2,000) (2,000) Acquisitions 0 (2,216) 0 0 0 Finance income, net 67 39 109 145 191 Others 627 938 304 353 427 Profit on disposals of FA 94 167 100 100 100 Investing cash flow (1,014) (2,768) (1,696) (1,647) (1,573) Impairment losses (1,301) (1,052) (700) (600) (550) Staff compensation (483) (826) (100) (75) (50) Change of borrowing (2,862) (241) (511) 0 0 One-off annuity provision (483) 0 0 0 0 Dividend paid (529) (494) (561) (1,612) (1,660) Pre-tax profit 1,532 2,202 3,391 4,814 5,974 Others (63) (143) (103) (86) (81) Income tax (547) (892) (949) (1,226) (1,498) Financing cash flow (3,454) (878) (1,175) (1,698) (1,741) Less: Minority interests (8) 2 (3) (3) (3) Net profit 977 1,312 2,438 3,485 4,373 Net change in cash (534) 452 2,138 2,107 3,180 Adjusted net profit 2,538 2,838 2,888 3,860 4,723 Cash at the beginning 2,361 1,858 2,340 4,478 6,585 Forex effect 31 30 0 0 0 Cash at the end 1,858 2,340 4,478 6,585 9,765

Balance sheet Key ratios YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec FY18A FY19A FY20E FY21E FY22E Non-current assets 30,821 31,816 31,991 32,173 32,365 P&L ratios (%) PPE 19,632 19,413 19,652 19,898 20,154 Gross margin 35.1 36.8 38.9 40.4 41.8 Goodwill and intangible assets 8,514 9,749 9,685 9,621 9,557 EBIT margin 10.3 11.7 12.4 14.3 16.0 Others 2,675 2,654 2,654 2,654 2,654 Net margin 3.1 4.0 7.6 9.5 11.2 Adjusted net margin 8.0 8.6 9.0 10.6 12.1 Current assets 8,450 9,775 11,473 14,474 18,129 Payout ratio 39.8 40.8 40.0 40.0 40.0 Inventories 5,379 6,018 5,625 6,228 6,506 Trade receivables 443 329 318 363 388 Balance sheet ratios Other receivables 463 671 648 740 792 Current ratio (x) 0.5 0.5 0.6 0.7 0.8 Others 307 417 417 417 417 Quick ratio (x) 0.2 0.2 0.3 0.4 0.5 Cash balance 1,858 2,340 4,465 6,726 10,026 A/C receivables days 6 4 4 3 3 A/C payables days 35 44 49 45 46 Current liabilities 18,370 19,856 19,902 21,107 22,150 Inventory days 99 99 108 99 103 Trade payables 2,340 2,713 2,536 2,808 2,933 Asset turnover (x) 0.8 0.8 0.7 0.8 0.8 Other payables 15,297 16,348 17,087 18,023 18,946 Net cash (RMB mn) 1,212 1,897 4,546 6,653 9,833 Bank borrowings 704 511 0 0 0 Others 29 284 280 275 271 Returns (%) Adjusted ROE 13.6 14.7 14.0 17.2 19.1 Non-current liabilities 1,991 2,008 1,968 1,933 1,901 Adjusted ROA 6.4 7.0 6.8 8.6 9.8 Borrowings 9 0 0 0 0 Others 1,583 1,330 1,290 1,255 1,223 Per share Deferred tax liabilities 399 678 678 678 678 Adj. EPS (RMB) 0.78 0.87 0.89 1.19 1.46 DPS (RMB) 0.12 0.17 0.30 0.43 0.54 Total net assets 18,910 19,727 21,595 23,608 26,443 BVPS (RMB) 5.81 6.06 6.64 7.22 8.06 Shareholders' equity 18,848 19,670 21,535 23,545 26,378 Non-controlling interests 62 57 60 63 66

Source: Company data, CMBIS estimates

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CMB International Securities | Equity Research | Company Initiation

Tsingtao Brewery (168 HK) Continuing premiumization and incentive scheme to drive growth BUY (Initiation)

Target Price HK$78.10 Tsingtao Beer is one of China’s most famous brands. We think continuing Up/Downside +25% premiumization and its first ever share incentive scheme are its major growth Current Price HK$62.40 drivers. Although its revenue ranked third among peers, its EBITDA margin was the lowest in FY19. We think the incentive scheme could drive operating efficiency improvement. We forecast the Company to deliver 14% EPS CAGR in China Beer Sector FY19-22E. We initiate coverage of Tsingtao Brewery with Buy rating and TP of HK$78.10. Albert Yip  Continuing premiumization. Tsingtao Beer is one of China’s top 10 famous (852) 3900 0838 trademarks and has good brand recognition in overseas. According to World [email protected] Brand Lab, its value ranked the first among Chinese beer brands in 2020. The Company had around 14.4% market share in premium and super-premium segment in 2018, behind Bud APAC but ahead of CR Snow Beer. The Stock Data Mkt Cap (RMB mn) 107,834 Company has launched certain specialized beer products in recent years and Avg 3 mths t/o (RMB$ mn) 210.27 sales volume mix of high-end Tsingtao beer increased from 14% in FY14 to 52w High/Low (RMB) 81.70/ 29.75 23% in FY19. The Company launched a super high-end new product in July, Total Issued Shares (mn) 1,351.0 Centennial Journey, which sets the new height of retail price of domestic high- Source: Bloomberg end beer to lift Tsingtao brand equity. Shareholding Structure  First ever share incentive scheme. The Company’s A share Incentive Plan Tsingtao Brewery Group 32.83% was approved in Jun 2020. We think its wide employee coverage (1.6% of Source: HKEx total staff) and attractive share award price at RMB21.18 (71% discount to Share Performance current price) could be effective to incentivize management team. Given that Absolute Relative its revenue ranked third among peers but its EBITDA margin was the lowest 1-mth -0.5% -7.9% in FY19, we think there is large room to improve operating efficiency and 3-mth -5.2% -7.4% margin. 6-mth 31.4% 22.1% Source: Bloomberg  Other growth strategies. The Company will increase its competitiveness through further development of the base market strategic belt and strategic 12-mth Price Performance (HK$) measures such as building large-scale and intelligent production bases as well 168 HK HSI (rebased) 80.0 as intelligent supply chains. It will continue to focus on sports marketing (CBA 70.0 and CSL), music marketing (Hua Chenyu endorsement and music festivals) 60.0 50.0 and experience marketing (Tsingtao 1903 bar chain) to enhance brand equity. 40.0 30.0  Initiate at Buy. We estimate the Company to post 14% adj. EPS CAGR from 20.0 FY19 to FY22E, led by 5% revenue CAGR and 3.0ppt EBIT margin expansion 10.0 0.0 driven by premiumization. Our TP of HK$78.10 is based on 36.0x FY21E adj. 11/2019 2/2020 5/2020 8/2020 11/2020

P/E, which represents historical 1-yr forward P/E plus 1 s.d.. Catalysts: Source: Bloomberg better-than-expected revenue and margins; Risks: costs pressure, food safety issues. Auditor: Da Hua

Earnings Summary

(YE 31 Dec) FY18A FY19A FY20E FY21E FY22E Revenue (RMB mn) 26,575 27,984 27,670 30,839 32,372 YoY growth (%) 1 5 -1 11 5 Net profit (RMB mn) 1,422 1,852 2,219 2,617 2,971 Adj. net profit (RMB mn) 1,569 1,973 2,219 2,617 2,971 Adjusted EPS (RMB) 1.162 1.461 1.635 1.918 2.178 YoY growth (%) 23 26 12 17 14 Consensus EPS (RMB) NA NA 1.589 1.893 2.170 Adjusted P/E (x) 45.4 38.3 33.7 28.7 25.3 P/B (x) 0.9 1.0 1.2 1.4 1.6 Yield (%) 4.0 3.9 3.6 3.4 3.1 Source: Company data, Bloomberg, CMBIS estimates

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Focus Charts Figure 71: Revenue to grow at 5% CAGR from FY19 Figure 72: Adjusted net profit to grow at 15% CAGR to FY22E from FY19 to F22E

(RMB mn) Tsingtao brand revenue Other brand revenue Others (RMB mn) Net profit Adj. NP 40,000 3,500

5% CAGR 2,971 2,971 35,000 15% CAGR 427 3,000 403 30,000 10,619 2,617 2,617 365 336 10,624 341 2,500 10,238 10,262 2,219 2,219 25,000 10,115 1,973 2,000 1,852 20,000 21,325 19,812 1,569 17,381 17,072 1,500 1,422 15,000 16,119

10,000 FY18 FY19 FY20E FY21E FY22E 1,000 FY18 FY19 FY20E FY21E FY22E Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 73: Margins expansion led by Figure 74: Overall volume/ASP to grow at 1%/4% CAGR premiumization and capacity optimization from FY19 to FY22E

45% GPM (LHS) Adj. NPM (RHS) （mn kL） Sales volume - Tsingtao brand Sales volume - other brand (RMB/kL) ASP - Tsingtao brand (RHS) ASP - Other brand (RHS) 5.00 5,000 40% 4,872 40.9% 41.7% 4.90 4,685 40.5% 4,441 4,500 37.7% 39.0% 4.80 4,291 35% 4,118 4,000 4.70 30% 4.60 3,500 4.50 2,710 3,000 2,592 2,657 4.38 25% 4.40 2,458 2,560 2,500 4.30 4.23 20% 2,000 4.20 4.12 4.05 15% 4.10 4.00 4.00 1,500 3.96 4.00 3.91 3.92 8.5% 9.2% 1,000 10% 7.1% 8.0% 3.90 3.84 5.9% 3.80 500 5% FY18 FY19 FY20E FY21E FY22E 3.70 0 FY18 FY19 FY20E FY21E FY22E Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 75: No.2 player in premium and super- Figure 76: Lower EBITDA margin than peers suggests premium segment in 2018 room for improvement

40% 38.4% Others 21.7% 35% 32.4% 29.2% 30% Budweiser Heineken APAC 25% 1.7% 46.6% 22.0% Carlsberg 20% 18.9% 4.6% 16.9% 15% 12.9% 12.1%

CR Snow

Budweiser Budweiser Carlsberg Zhujiang Tsingtao Tsingtao

Chongqing Chongqing

Heineken Heineken

Brewery CR Beer CR

Brewery Brewery

11.0% 10% Yanjing

APAC

Asia

Asia beer

Tsingtao 14.4% Source: GlobalData Source: Company data, CMBIS estimates

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Continuing premiumization Tsingtao beer is one of China’s top 10 famous trademarks. It has strong brand power in China and good brand recognition in overseas. According to World Brand Lab, Tsingtao beer brand, valued at RMB179.3bn in 2020, ranked the first among Chinese beer brands. Tsingtao beer has a long history and its origin can be traced to 1903 when a brewery was established in Tsingtao city by German and British businessmen. Tsingtao beer has received a lot of awards domestically and overseas.

No.2 player in premium and super-premium segment According to GlobalData, the Company sold 1.16mL premium and super-premium beer in China in 2018, taking 14.4% market share in premium and super-premium segment. The Company is the second largest player in the segment, behind Bud APAC (46.6% market share) but ahead of CR Snow Beer (11.0% market share).

Figure 77: Market share in premium and super-premium segment by Company in 2018

Others 21.7%

Budweiser Heineken APAC 1.7% 46.6% Carlsberg 4.6%

CR Snow 11.0%

Tsingtao 14.4% Source: GlobalData

Brand upgrading strategy The Company emphasizes its brand strategy of “Tsingtao beer as tier 1 brand and Laoshan beer as tier 2 brand” and aims at catering demand of consumption upgrade such as premiumization, diversification and specialization.

Tsingtao beer’s positioning is high quality, high price and high visibility. Through promotion in key markets and sponsorship in sports, music, food and cultural events, it enhanced the brand equity of Tsingtao beer. The Company has launched certain specialized beer products in recent years such as Augerta, Hong Yun Dong Tao, Classic 1903 and draft beer to accelerate its premiumization. From FY14 to FY19, sales volume mix of Tsingtao brand-high-end increased from 18% to 23%, while sales mix of other brands (25.5% GPM vs group’s 39.0% in FY19), mainly Laoshan brand, decreased from 51% to 50%.

Regarding brand upgrading, the Company will remain focusing on sports marketing, music marketing and experience marketing to enhance the brand equity through internationalization, youth and fashion concept.

It will develop differentiated products and accelerate the upgrade transformation to more high value-added products like canned beer and craft beer, with a view to maintaining its leading position in domestic mid to high-end market.

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Figure 78: Sales volume mix by positioning in 2014 Figure 79: Sales volume mix by positioning in 2019

Tsingtao brand - high-end Tsingtao brand - 18.1% high-end 23.1%

Other brands Other brands 50.8% 49.7%

Tsingtao brand - others Tsingtao brand - 31.0% others 27.3%

Source: Company data Source: Company data

Centennial Journey sets new height of domestic high-end beers

The Company launched a super high-end new product called Centennial Journey (“百年之 旅”) in July 2020. The beer is produced by traditional brewing methodologies, scarce and selective barley and hops. The first bottle of the beer was auctioned at ~RMB480,000. Its retail price at official flagship store is set at RMB289/bottle, which sets the new height of retail price of domestic high-end beers. The launch of this new product is to lift the high- end brand image of Tsingtao.

Figure 80: Product portfolio by positioning Price Tsingtao positioning Super premium

Mainstream Source: Tmall

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Restricted share award scheme to incentivize key employees On 8 Jun 2020, shareholders approved Tsingtao Brewery’s restricted A share Incentive Plan. The Plan stated to grant 13.5mn shares, equivalent to 1% of issued shares, to 638 employees. The share award price is RMB21.73, at 50% discount to average closing price of 30 trading days before the release of the draft of the Plan. The Board approved 29 Jun 2020 as the grant date of the first batch of restricted shares. The number of employees to be awarded first batch of restricted shares was reduced to 627 and share award price is lowered to RMB21.18. These shares will be restricted for sale in three lots within 24/36/48 months since the date of grant, with each lot representing one-third of granted shares.

Apart from specific NP and ROE requirements in FY20-22E, the share award scheme also compares Tsingtao Brewery’s NP increase from base (average of FY16-18 NP) and ROE to its six A-share peers.

Figure 81: KPI requirements for the award of restricted shares

The increase of net profit Beer Restriction Requirements Net profit ROE ROE compared from base not less than business of sale for financial growth requirement to specified peer the sum of that amount of revenue mix period year (vs base) (%) group specified peer group (%) 1st FY20 >=50% Yes >=8.1 >=75percentile >=90% 2nd FY21 >=70% Yes >=8.3 >=75percentile >=90% 3rd FY22 >=90% Yes >=8.5 >=75percentile >=90% Source: Company data Net profit base equals to average of FY16-18 NP

Figure 82: Average NP in FY16-18 and FY19 ROE of specified peer group

FY16-18 FY19 Company Stock code average NP ROE (%) (RMBmn) Yanjing Brewery 000729 SZ 218 1.8 Tibet Galaxy Science 000752 SZ (119) (164.9) Lanzhou Huanghe 000929 SZ (26) 2.3 Zhujiang Brewery 002461 SZ 222 5.9 Chongqing Brewery 600132 SH 305 51.3 Huiquan Brewery 600573 SH (4) 1.8 Tsingtao Brewery 168 HK 1,243 10.0 Source: Company data

Better align the interests of management and shareholders This is the first time the Company launches an incentive scheme for employees. This should better align the interests of management and shareholders. We select CR Beer, Yanjing Brewery, Chongqing Brewery, Zhujiang Brewery, Bud APAC, Heineken Asia, Carlsberg Asia as major peers of Tsingtao Brewery. In FY19, we observed that EBITDA margin of the Company was lower than its major peers. Given that its revenue ranked third in the same year, we think there is room to improve the operating efficiency of the Company, and the incentive scheme should be an effective tool to unlock its potential.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 44 9 Nov 2020

Figure 83: Revenue of Tsingtao Brewery ranked third Figure 84: EBITDA margin of Tsingtao Brewery was among major peers in FY19 the lowest among major peers in FY19

40% 38.4% (US$mn) 7,000 6,546 35% 32.4% 6,000 4,803 29.2% 5,000 30% 4,049 4,000 3,584 25% 2,761 22.0% 3,000 2,000 1,660 20% 18.9%

16.9% 1,000 614 518

Chongqing beer Chongqing

Carlsberg Asia Carlsberg

Tsingtao Brewery Tsingtao Asia Heineken Brewery Zhujiang

CR Beer CR Budweiser APACBudweiser 15% 0 Yanjing Brewery

12.9% 12.1%

Budweiser Budweiser Carlsberg Zhujiang Tsingtao Tsingtao

Chongqing Chongqing

Heineken Heineken

Brewery CR Beer CR

Brewery Brewery

10% Yanjing

APAC

Asia

Asia beer

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Share price surged after the scheme unveiled Tsingtao Brewery’s H/A share price surged 18%/10% on 24 Mar 2020 after the restricted share award scheme was unveiled. We think there were two major reasons for the share price jump: (1) this is the first time the Company to have share incentive scheme; (2) The NP target in FY20E for the release of restriction of sale period represents 1% NP growth in FY20E, which is much better than market expectation amid COVID-19.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 45 9 Nov 2020

Other growth strategies

The Company will uphold its capability to support the brands to lead the Company’s development strategy. Based on the six strategic guidelines "brand leadership, innovation- driven, quality first, synergies priority, structural optimization and coordinated development", the Company will increase its competitiveness through further development of the base market strategic belt, accelerating product structure upgrades, enhancing brand equity, accelerating the expansion of international markets, strategic measures such as building large-scale and intelligent production bases, and building efficient and intelligent supply chains.

Brand upgrading Regarding brand upgrading, the Company will remain focusing on sports marketing, music marketing and experience marketing to enhance the brand equity through internationalization, youth and fashion concept.

In sports, Laoshan beer focuses on sponsoring popular men’s sports events like CBA and Chinese Super League. Tsingtao Beer joined the Official Sponsors of Beijing 2022 Winter Olymipics.

Figure 85: Laoshan Beer sponsors CBA Figure 86: Official partners of 2020 CSL

Source: website Source: CSL website

In music, Tsingtao beer endorsed pop singer Hua Chenyu as spokesperson. The fans of Hua Chenyu are young music lovers. The brand launches its high-end draft beer with Hua’ portrait on the packing to target young consumers. The Company also organizes music festival to promote its beer combining with music and food.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 46 9 Nov 2020

Figure 87: The second Linyi music festival Figure 88: Hua Chenyu promotes draft beer

Source: website Source: CSL website

Tsingtao 1903 bar to promote mix and match of beer and food News reported the Tsingtao 1903 is a leading nationwide bar chain in China with over 100 bars covering 52 cities. The bar chain promotes the Company’s high-end beer portfolio like IPA, Pearson Beer, black beer, craft beer, Augerta beer, etc. by providing fresh made beer and delicious food (incl. special dishes cooked with beer) for consumers. We think this could be seen as a marketing strategy to accelerate its beer premiumization.

Figure 89: Tsingtao 1903 bar Figure 90: Mix and match of beer and food

Source: website Source: website

Enhanced e-commerce and community sales Amid sales decline due to COVID-19, the Company proactively implements new marketing initiatives such as “community marketing promotion and contactless distribution” , strengthening online sales distribution structure and improving the dimensional “online supermarket + official online flagship store + authorized franchise store + wechat mall” e- commerce distribution structure to satisfy consumers’ various convenient and efficient purchasing needs and recover its sales growth.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 47 9 Nov 2020

New product categories The Company launched a healthy drink called “Prince seaweed soda water” in Jul 2019. The product is jointly developed by its Tsingtao Brewrey Bio-fermentation Engineering State Key Laboratory and Qingdao Marine Biomedicine Research Institute. The product is produced by combining 180m underground mineral water and seaweed essence extracted by modern marine technology. The selling point of the product is the anti-oxidation nature of seaweed essence.

In Apr 2020, the Company launched another new product called “Hanstation light zero soda sparkling water” to enter the rising sparkling water segment. This fruit taste beverage product is a healthy drink emphasizing no sugar, no fat and no calorie.

In Feb 2020, the Company announced to change its Articles of Association to include whisky and distilled wine as business area. We think the Company could upgrade its production facilities or acquire third party businesses to enter the new segment. The background of this move is to diversify its product portfolio.

Figure 91: Prince seaweed soda water Figure 92: Hanstation soda sparkling water

Source: website Source: website

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 48 9 Nov 2020

Earnings forecast 9M20 NP +15% Revenue fell 2% led by 4% drop of sales volume due to epidemic, but partly offset by 2% growth of ASP. As catering channel is recovering, 3Q20 revenue rose 5%, driven by 3% sales volume growth and 2% ASP growth. The Company proactively accelerated development of canned beer and craft beer so as to enhance product mix. In 9M20, GPM widened 1.8ppt to 42.0% in 9M20, led by ASP growth and drop of barley cost. SG&A expenses ratio reduced by 0.7ppt to 21.5% driven by savings of social insurance and advertising costs. EBIT rose 15% with 2.3ppt EBIT margin expansion to 15.4%.

14% adjusted EPS CAGR from FY19 to FY22E We estimate revenue growth to improve to 5% in 2H20E as sales growth further recovers. In FY21E, we forecast revenue growth to accelerate to 11% on 5% growth each on volume (low base in 1H20) and ASP (continuing premiumization). Looking into FY22E, we estimate 5% revenue growth led by 4% ASP growth.

We forecast EBIT margin to expand from 8.1% in FY19 to 11.1% in FY22E, led by 2.7ppt GPM expansion. Continuing premiumization and efficiency optimization are growth drivers of GPM.

Figure 93: CMBIS estimates vs consensus CMBIS Consensus Diff (%) US$ mn FY20E FY21E FY22E FY20E FY21E FY22E FY20E FY21E FY22E Revenue 27,670 30,839 32,372 27,679 29,770 31,403 0% 4% 3% Gross Profit 11,214 12,615 13,505 11,016 12,027 12,924 2% 5% 4% EBIT 2,649 3,170 3,590 2,468 2,970 3,392 7% 7% 6% Adjusted net profit 2,219 2,617 2,971 2,171 2,609 3,006 2% 0% -1% Gross Margin 40.5% 40.9% 41.7% 39.8% 40.4% 41.2% +0.7ppt +0.5ppt +0.5ppt EBIT 9.6% 10.3% 11.1% 8.9% 10.0% 10.8% +0.7ppt +0.3ppt +0.3ppt Adjusted net margin 8.0% 8.5% 9.2% 7.8% 8.8% 9.6% +0.2ppt -0.3ppt -0.4ppt Source: CMBIS estimates, Bloomberg

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 49 9 Nov 2020

Figure 94: P&L assumptions (RMBmn) FY18 FY19 FY20E FY21E FY22E Revenue 26,575 27,984 27,670 30,839 32,372 growth (%) 1.1% 5.3% -1.1% 11.5% 5.0%

Tsingtao brand revenue 16,119 17,381 17,072 19,812 21,325 growth (%) 2.7% 7.8% -1.8% 16.1% 7.6% GPM (%) 46.0% 46.8% 48.5% 48.9% 49.5%

- sales volume (mn kL) 3.91 4.05 3.84 4.23 4.38 growth (%) 4.0% 3.5% -5.1% 10.0% 3.5%

Other brand revenue 10,115 10,238 10,262 10,624 10,619 growth (%) -1.7% 1.2% 0.2% 3.5% 0.0% GPM (%) 24.5% 25.5% 27.4% 26.2% 26.2%

- sales volume (mn kL) 4.12 4.00 3.96 4.00 3.92 growth (%) -2.1% -2.8% -1.0% 1.0% -2.0%

Other revenue 341 365 336 403 427 growth (%) 16.8% 7.1% -8.0% 20.0% 6.0% GPM (%) 37.7% 40.4% 37.5% 37.5% 37.5%

GPM (%) 37.7% 39.0% 40.5% 40.9% 41.7%

Other income 523 603 572 609 649 % rev (%) 2.0% 2.2% 2.1% 2.0% 2.0%

Selling expenses 4,869 5,925 6,126 6,988 7,440 % rev (%) 18.3% 21.2% 22.1% 22.7% 23.0%

Admin expenses 1,386 3,168 3,279 3,525 3,701 % rev (%) 5.2% 11.3% 11.9% 11.4% 11.4%

Tax and surchages 2,327 2,313 2,232 2,358 2,387 % rev (%) 8.8% 8.3% 8.1% 7.6% 7.4%

Other income 59 67 62 65 67 % rev (%) 0.2% 0.2% 0.2% 0.2% 0.2%

EBIT 2,001 2,254 2,649 3,170 3,590 % of rev (%) 7.5% 8.1% 9.6% 10.3% 11.1% Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 50 9 Nov 2020

Valuation

We have a Buy rating for H-share but a Hold rating for A-share We set our TP of H-share at HK$78.10, based on 36.0x FY21E P/E, representing historical 1-yr forward P/E plus 1 s.d. Continuing premiumization and efficiency optimization are earnings growth drivers of the Company. We have a Buy rating on H-share.

For cross-checking, our TP implied a 2.5x FY21E PEG, which is still lower than Bud APAC (3.3x) and in line with international beer peers (2.5x).

We also set our TP of A-share at RMB78.7, based on 41.0x FY21E P/E, representing 14% premium on H-share target P/E of 36.0x. From 2004 to now, A-share 1-year forward P/E trades at 14% premium to H-share’s on average. We have a Hold rating on A-share because we think its upside potential is limited compared to H-share.

Figure 95: Ratio of A-share 1-year forward P/E to H-share’s

1-yr forward P/E (x) 2.0 1.9 1.8 1.7 1.6 1.5

1.4 +1s.d. 1.33x 1.3 1.2 1.1 average 1.14x 1.0 0.9 0.8 -1s.d. 0.95x 0.7

0.6

Jan-05 Jan-06 Jan-10 Jan-11 Jan-12 Jan-17 Jan-18 Jan-19 Jan-20 Jan-04 Jan-07 Jan-08 Jan-09 Jan-13 Jan-14 Jan-15 Jan-16

Sep-08 Sep-09 Sep-10 Sep-11 Sep-16 Sep-17 Sep-04 Sep-05 Sep-06 Sep-07 Sep-12 Sep-13 Sep-14 Sep-15 Sep-18 Sep-19 Sep-20

May-04 May-08 May-09 May-10 May-11 May-16 May-17 May-18 May-19 May-05 May-06 May-07 May-12 May-13 May-14 May-15 May-20

Source: CMBIS estimates, Bloomberg, Company data

Figure 96: P/E band chart of H-share Figure 97: P/E band chart of A-share

HK$ RMB 90 100 42x 85 95 54x 90 80 85 75 36x 80 46x 70 75 65 30x 70 60 65 38x 55 60 50 24x 55 45 50 30x 40 18x 45 35 40 22x 30 35 25 The P/E trough during 30 epidemic was the 25 20 same as the previous 15 trough 20 15 10

10

Jul-16 Jul-20 Jul-14 Jul-15 Jul-17 Jul-18 Jul-19

Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19 Oct-20 Apr-14 Oct-14 Apr-15 Oct-15 Oct-19 Apr-20

Jan-17 Jan-18 Jan-19 Jan-20 Jan-14 Jan-15 Jan-16

Jul-15 Jul-16 Jul-19 Jul-20 Jul-14 Jul-17 Jul-18

Oct-14 Oct-15 Oct-17 Oct-18 Oct-19 Oct-16 Oct-20

Apr-16 Apr-17 Apr-18 Apr-20 Apr-14 Apr-15 Apr-19

Jan-14 Jan-17 Jan-18 Jan-16 Jan-19 Jan-20 Jan-15 Source: CMBIS estimates, Bloomberg, Company data Source: CMBIS estimates, Bloomberg, Company data

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 51 9 Nov 2020

Figure 98: Peers valuation Mkt cap P/B ROAE FY0-3 Stock (HK$/US$/ P/E (x) EPS growth (%) (x) (%) EPS FY2 code Rating Price RMBmn) FY1 FY2 FY3 FY1 FY2 FY3 FY1 FY1 cagr PEG Budweiser Brewing 1876 HK NR 22.55 298,639 60.6 34.2 28.8 (36) 77 19 3.8 6.4 10.4 3.3 CR Beer 291 HK Buy 48.85 158,478 48.5 36.3 29.7 2 34 22 6.5 14.0 18.5 2.0 Tsingdao Beer 168 HK Buy 62.40 107,823 26.4 22.5 19.8 12 17 14 3.6 11.1 14.2 1.6 H share beer sector 45.2 31.0 26.1 (7) 43 18 5 11 14.4 2.3

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1 Haitian Flavouring 603288 CH NR 169.90 550,551 83.8 70.4 59.8 23 19 18 26.3 32.8 19.8 3.5 Yili 600887 CH Buy 38.88 236,515 32.0 27.0 23.5 6 18 15 8.3 27.1 13.0 2.1 Yonghui 601933 CH NR 8.07 76,796 31.2 24.9 19.8 56 25 26 3.6 15.4 34.9 0.7 C&S Paper 002511 CH NR 22.10 28,909 31.8 26.2 22.1 48 22 18 5.9 19.1 28.6 0.9 Shanghai Jahwa 600315 CH NR 43.14 28,958 68.0 53.5 41.3 (24) 27 30 4.4 6.5 7.9 6.7 A share segment leaders 48.9 40.1 33.6 19 22 19 9.6 20.5 21.3 2.1

Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 5.3 11.1 14.2 3.0 Chongqing Brewery 600132 CH NR 107.00 51,785 88.9 76.5 66.7 (11) 16 15 35.0 31.1 17.5 2.1 Yanjing Brewery 000729 CH NR 8.29 23,366 156.4 85.5 72.1 (34) 83 19 1.8 32.8 19.8 3.5 Zhujiang Beer 002461 CH NR 9.82 21,735 39.3 34.6 30.3 14 14 14 2.5 27.1 13.0 2.1 A share beer sector 83.5 59.6 51.5 (5) 33 15 11.1 25.5 16.1 2.7

Asahi 2502 JP NR 3616.00 17,724 20.9 12.8 11.3 (45) 63 14 1.2 6.4 0.4 31.5 Kirin 2503 JP NR 1985.00 17,540 21.4 14.7 13.1 (71) 46 12 1.9 8.7 (21.8) (0.7) Carlsberg CARLB DC NR 854.60 20,573 21.7 19.0 16.8 (4) 14 13 2.9 13.4 7.5 2.5 Heineken NV HEIA NA NR 81.82 55,833 39.2 23.6 20.2 (52) 66 17 2.9 7.2 (2.6) (9.1) Budweiser BUD US NR 56.22 113,522 28.4 17.6 15.8 (53) 61 12 1.4 3.5 (5.4) (3.2) Int'l beer sector 26.3 17.5 15.4 (45) 50 13 2.1 7.8 (4.4) 4.2 Int'l beer sector - excluding outliers 7.5 2.5 Source: CMBIS estimates, Bloomberg

Company Overview

Company background The Company produces beer, beverages, whiskey and distilled spirits and sell them in more than 100 countries and regions around the world. It is the earliest brewery in China, which can trace its root back to 1903 when its predecessor, the state-owned Tsingtao Brewery Factory, was established. The Company was registered, established and then listed on HKEx in 1993. It is the first domestic SOE listed on an overseas stock exchange.

The Company currently operates 60 wholly-owned and controlling breweries and two associated and joint-investment breweries in 20 provinces, municipalities and autonomous regions in China. As at 31 Dec 2019, total designed capacity reached 13.6mn kL. Utilization rate was around 59.4% in FY19.

Figure 99: Tsingtao Brewery’s diversified product portfolio

Source: Tmall

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 52 9 Nov 2020

Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E Revenue 26,575 27,984 27,670 30,839 32,372 Profit before tax 1,561 1,929 2,284 2,692 3,050 Beer 26,234 27,618 27,334 30,435 31,945 Investment income (21) (25) (21) (24) (25) Others 341 365 336 403 427 D&A 1,153 1,138 1,124 1,099 1,075 Cost of sales (16,556) (17,080) (16,456) (18,224) (18,867) Net finance income (513) (356) (477) (515) (590) Gross profit 10,019 10,903 11,214 12,615 13,505 Change in working capital 1,816 1,601 85 (254) (104) Others (5) (271) 690 (55) (55) Other income 523 603 572 609 649 Operating cash flow 3,992 4,017 3,685 2,943 3,350 Selling expenses (4,869) (5,104) (4,981) (5,613) (5,989) Admin expenses (1,386) (1,881) (1,966) (2,123) (2,229) Capex (762) (1,155) (731) (731) (731) R&D expenses (20) (21) (22) (25) (26) Interest received 537 515 515 551 627 Tax & surcharges (2,327) (2,313) (2,232) (2,358) (2,387) Others (592) 293 572 609 649 EBIT 1,941 2,187 2,586 3,106 3,523 Investing cash flow (817) (348) 356 430 546

Finance income, net 497 484 477 515 590 Change of borrowings (0) (33) 0 0 0 Others (134) (33) 0 25 25 Dividend paid (40) (31) (38) (36) (37) JV & asso 17 21 18 21 22 Interest paid (639) (711) (743) (887) (1,047) Pre-tax profit 2,320 2,660 3,081 3,667 4,160 Others 38 6 (19) (18) (17) (819) (798) (860) (1,039) (1,178) (641) (769) (800) (942) (1,101) Income tax Financing cash flow Less: Minority interests (139) (77) (65) (75) (79) Net profit 1,363 1,785 2,156 2,552 2,904 Net change in cash 2,535 2,900 3,241 2,431 2,795 Adj net profit 1,569 1,973 2,219 2,617 2,971 Cash at the beginning 9,102 11,653 14,557 17,799 20,230 Exchange difference 17 4 0 0 0 Cash at the end 11,653 14,557 17,799 20,230 23,024

Balance sheet Key ratios YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec FY18A FY19A FY20E FY21E FY22E Non-current assets 16,315 16,311 15,950 15,618 15,310 Sales mix (%) PPE 10,735 10,505 10,320 10,152 9,997 Beer 98.7 98.7 98.8 98.7 98.7 Intangible assets and gdwill 3,907 3,866 3,669 3,483 3,305 Others 1.3 1.3 1.2 1.3 1.3 JV and asso 370 377 395 415 437 1,566 1,568 1,570 Others 1,303 1,564 P&L ratios (%) Gross margin 37.7 39.0 40.5 40.9 41.7 Current assets 17,760 21,002 23,515 26,411 29,461 EBIT margin 7.5 8.1 9.6 10.3 11.1 Inventories 2,651 3,182 3,146 3,506 3,681 Net margin 5.4 6.6 8.0 8.5 9.2 Trade receivables 165 226 224 249 262 Adj. net margin 5.9 7.1 8.0 8.5 9.2 Other receivables 471 203 201 224 235 Payout ratio 45.6 40.1 40.0 40.0 40.0 Others 1,937 2,088 2,145 2,202 2,259 Cash 12,536 15,302 17,799 20,230 23,024 Balance sheet ratios Current ratio (x) 1.5 1.6 1.7 1.8 1.9 Current liabilities 12,087 13,354 13,981 14,640 15,332 Quick ratio (x) 1.3 1.3 1.5 1.6 1.7 Trade payables 2,572 2,388 2,507 2,633 2,764 A/C receivables days 2 3 3 3 3 Other payables 8,527 10,159 10,667 11,201 11,761 A/C payables days 55 53 54 51 52 Borrowings 296 271 271 271 271 Inventory days 56 62 70 67 70 Others 692 536 536 536 536 Net cash (RMB mn) 12,239 15,031 17,528 19,959 22,753

Non-current liabilities 3,298 4,045 4,029 4,130 4,177 Returns (%) Borrowings 1 0 0 0 0 Adj. ROE 8.9 10.6 11.1 12.2 12.7 Deferred income 2,344 2,520 2,520 2,520 2,520 Adj. ROA 5.3 5.7 5.9 6.6 7.0 Others 749 1,341 1,325 1,426 1,473 Deferred tax liabilities 205 184 184 184 184 Per share EPS (RMB) 1.16 1.46 1.64 1.92 2.18 Total net assets 18,690 19,913 21,454 23,259 25,262 DPS (RMB) 0.48 0.55 0.65 0.77 0.87 Shareholders' equity 17,970 19,172 20,647 22,377 24,301 BVPS (RMB) 13.30 14.19 15.14 16.40 17.81 Non-controlling interests 719 742 807 883 962

Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 53 9 Nov 2020

CMB International Securities | Equity Research | Company Initiation

Kweichow Moutai (600519 CH) Unrivalled market leader; price hike the next BUY (Initiation) catalyst Target Price RMB2,153.30 The Company is the white wine market leader in terms of brand equity, market Up/Downside +27% share and retail price. Moutai liquor has investment attributes because of its Current Price RMB1,700.62 limited supply and quality. The wide price spread between wholesale price and ex-factory price certainly offers the Company opportunities to raise ex-factory China White Wine Sector price, the next catalyst in our view. We initiate coverage of Kweichow Moutai with Buy rating and TP of RMB2,153.30. Albert Yip  Price hike could happen in 1Q21. We assume the Company would raise ex- (852) 3900 0838 factory price to distributor from RMB969 to RMB1,199 in 1Q21. Currently, the [email protected] price spread between wholesale price and ex-factory price (~RMB1,890), an indicator of distributor’s profitability, is much greater than the Company’s (ex- factory price of RMB969 x GPM). Historically, price hike usually happened in Stock Data first year of FYP and 1Q. We believe the Company might raise its ex-factory Mkt Cap (RMB mn) 2,136,315 price in 1Q21 at the earliest to have a good start in the 14th FYP. Avg 3 mths t/o (RMB mn) 5,053.21 52w High/Low (RMB) 1828.00/  Central Commission for Discipline Inspection’s article will not block 960.10 price hike. On 22 Sept, the Commission posted an article to alert the recent Total Issued Shares (mn) 1,256.2 tide of price hikes of high-end white wines might bring back corruption and Source: Bloomberg

improper publicly-funded dining. In July 2017, we saw the Commission posted Shareholding Structure an article to alert government officials’ consumption of Moutai and Wuliangye Guizhou Moutai Group 58.0% through business banquets with private companies owners and by public- Source: Company funding. That said, the Company still raised price in Jan 2018. Share Performance  Perceived national wine brand prestige. Moutai liquor is called one of the Absolute Relative world’s top three distilled wines. Also, it had been served in China’s national 1-mth 3.2% 0.0% banquet. Moutai liquor won 20 times during international wine competition and 3-mth 3.2% 5.0% was awarded “National Famous Wine” five times in the National Wine 6-mth 36.0% 17.2% Appraisal. In addition to various marketing campaigns, such as time reporting Source: Bloomberg ad in CCTV, consumers have perceived Moutai as “National Wine”. 12-mth Price Performance (RMB)  Channel diversification to enhance growth. Since 2019, the Company has 600519 CH shcomp (rebased) 2,000 expanded its direct sales to retailers including supermarkets, e-commerce 1,800 1,600 platforms and tobacco and wine chains. The ex-factory price is set at 1,400 RMB1,299 or RMB1,399, which is higher than ex-factory price to distributor. 1,200 1,000 Looking forward, we expect volume growth would be led by this segment and 800 600 B2C. This should enhance ASP and GPM of Moutai sales. 400 200 0  Initiate at Buy. We forecast the Company to post 18% EPS CAGR from 11/2019 2/2020 5/2020 8/2020 11/2020 FY19-22E. Our TP is set at RMB2,153.30, representing 46.8x FY21E P/E, at 15% premium on other segment leaders’ average of 40.7x. Catalysts: ex- Source: Bloomberg factory price increase or planned sales volume beat. Auditor: Sichuan Huaxin Earnings Summary

(YE 31 Dec) FY18A FY19A FY20E FY21E FY22E Revenue (RMB mn) 73,639 85,430 95,142 116,842 133,183 YoY growth (%) 26 16 11 23 14

Net income (RMB mn) 35,204 41,206 46,146 57,799 66,861 EPS (RMB) 28.02 32.80 36.73 46.01 53.23 YoY growth (%) 30 17 12 25 16 Consensus EPS (RMB) NA NA 37.48 45.01 53.08 P/E (x) 60.7 51.8 46.3 37.0 32.0 P/B (x) 16.0 14.1 11.9 9.9 8.3 Yield (%) 1.0 1.1 1.2 1.6 1.8 ROAE (%) 34.5 33.1 31.1 32.5 31.4 Net cash (RMB mn) 100,602 119,581 139,278 169,933 206,684 Source: Company data, Bloomberg, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 54 MORE REPORTS FROM BLOOMBERG: RESP CMBR AND http://www.cmbi.com.hk 9 Nov 2020

Focus Charts Figure 100: 16% revenue CAGR from FY19-22E Figure 101: 18% NP CAGR from FY19-22E (RMBmn) Moutai revenue Series wine revenue Others (RMBmn) 150,000 70,000 140,000 65,000 18% CAGR 107 130,000 16% CAGR 12,108 60,000 120,000 99 55,000 110,000 11,527 50,000 100,000 45,000 92 66,861 90,000 9,924 40,000 85 120,968 57,799 9,542 80,000 105,216 35,000 74 46,146 41,206 70,000 8,077 85,126 30,000 75,802 35,204 60,000 65,487 25,000 50,000 20,000 FY18 FY19 FY20E FY21E FY22E FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 102: GPM expansion Figure 103: Sector-leading GPM in FY19

100% GPM - Company GPM - Moutai GPM - Series wine 91.3% 100% 90% 80.6% 93.7% 93.8% 93.8% 94.3% 94.4% 80% 76.7% 74.5% 95% 72.8% 71.9% 71.9% 71.4% 70% 60.7% 92.2% 90% 91.1% 91.3% 91.4% 92.6% 60% 85% 50% 40% 36.2% 80%

30%

Lujiao Laojiao Lujiao

Jiangsu King's King's Jiangsu

Swellfun

Jiangsu Jiangsu

Kweichou Kweichou Wuliangye

Jinhui Liquor Jinhui

Anhui Anhui Gujing Shanxi Fen

Sichuan Sichuan Shunxin Yanghe

75% 20% Beijing Moutai

74.8% Wine

73.8% Luck 70% 72.2% 71.1% 71.8% 65% FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 104: White wine sector has large room for Figure 105: No. of above-scale white wine industry consolidation enterprises is decreasing as small players exited

1,800 CR10 40.0% 26.6% 1,563 1,578 1,593 0.8% 1,600 1,498 Kouzi Distillery 0.6% 1,445 0.9% 1,400 King's Luck 0.5% 1.5% 1,176 Lang Jiu 0.9% 1,200 1.8% Shunxin Agriculture 1.1% 1,000 Anhui Gujing 1.9% 2019 1.2% 800 Shanxi Fen Wine 2.1% 2017 1.1% 600 Luzhou Laojiao 2.8% 1.8% 400 Yanghe 4.1% 3.5% 200 Wuliangye 8.9%

5.3%

2015 2016 2018 2019 2017 15.2% 0 2014 Moutai 10.3% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

Source: Langjiu prospectus, CMBIS Source: National Statistics Bureau, CMBIS

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 55 9 Nov 2020

National wine brand prestige Various honors and awards

Moutai liquor is called one of the world’s top three distilled wines, together with French brandy and Scotch whisky. Also, it had been served in China’s national banquet. For example, the liquor was served in the national banquet when US President Nixon visited China in 1972. In 1975, Chinese Vice Prime Minister Wang Zhen said Moutai is the national liquor at the National Food Work Conference. According to the Company, Moutai liquor had won a lot awards during international spirits competitions and was awarded “National Famous Wine” five times in the National Wine Appraisal held in 1953, 1963, 1979, 1984 and 1989.

Figure 106: International awards and honors

Year Award 1915 Gold Award in 1915 American “Panama World's Fair” 1985 Golden Laurel Leave Prize of International Food and Tourism Contest 1986 Gold Award of the 12th International Food Fair in Paris, France 1986 Hong Kong “Star of Asia” Packaging Award First Prize of the 3rd World Advertisement Convention China Import and Export 1987 Advertisement in Hong Kong 1989 Gold prize of the 1st Beijing International Fair 1991 Gold prize of the 2nd Beijing International Fair 1992 Gold Prize of the 1st International Famous Liquor Contest in the US 1992 Supreme Gold Prize of Hong Kong International Food Fair 1992 Gold Prize of the 4th World Famous Liquor Fair in Tokyo, Japan “Star of the World” International Packaging Supreme Prize for the package of 1992 “Emperor Handi Moutai” in Paris, France 1993 Special Award of Bordeaux Wine and Liquor Fair “Feitian” and Five-Star” series of Moutai won Gold Prize of the 5th Asia-Pacific 1994 International Trade Fair No.1 in Special Gold Prize of (US) “Famous Liquor Appraisal in Commemoration 1994 of the 80th Anniversary of Panama World's Fair” 2005 International Outstanding Contribution Award in Water Resource Protection Awarded "Excellent Management Organization" by the International 2005 Certification Network and China Quality Certification Center 2012 Gold Award of the 9th World Spirits Competition 2013 Global Performance Excellence Award 2014 Gold Medal in 2014 Spirits Selection by Concours Mondial de Bruxelles 2015 Grand Gold medal in 2015 Spirits Selection by Concours Mondial de Bruxelles November 12 was designated as Kweichow Moutai day in the City and County 2015 of San Francisco, the US Source: Company data, CMBIS

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 56 9 Nov 2020

Figure 107: Winners of the National Wine Appraisal

Year Session List of winners 1952 1st Moutai, Fenjiu, Xi Feng Liquor, Luzhou Laojiao Tequ 1963 2nd Moutai, Wuliangye, Gujing Gongjiu, Luzhou Laojiao Tequ, Quanxing Daqujiu, Xi Feng Liquor, Fenjiu, Dongjiu 1979 3rd Moutai, Fenjiu, Wuliangye, Jian Nan Chun Chiew, Gujing Gongjiu, Yanghe Daqu, Dongjiu, Luzhou Laojiao Tequ 1984 4th Moutai, Fenjiu, Wuliangye, Yanghe Daqu, Jian Nan Chun Chiew, Gujing Gongjiu, Dongjiu, Xi Feng Liquor, Luzhou Laojiao Tequ, Quanxing Daqu, Shuanggou Daqu, Yellow Crane Tower Liquor, Langjiu 1989 5th Moutai, Fenjiu, Wuliangye, Yanghe Daqu, Jian Nan Chun Chiew, Gujing Gongjiu, Dongjiu, Xi Feng Liquorjiu, Luzhou Laojiao Tequ, Quanxing Daqu, Shuanggou Daqu, Yellow Crane Tower Liquor, Langjiu, Wulingjiu, Baofengjiu, Songheliangye, Tuopaiqujiu Source: Internet

Perceived “National Wine” brand prestige

News said Moutai had filed applications for the use of “National Wine” trademark for several times since 2001 but were rejected. In Aug 2018, Moutai finally retreated its appeal and stopped the use of “National Wine” trademark.

In fact, the Company had been promoting Moutai as “National Wine Moutai” (“国酒茅台”) for a long time. For examples:

Time reporting advertisements in CCTV. According to our searches on internet, Moutai had bid the time reporting advertisements for many years beginning 2003. For example, Moutai had successfully joined “CCTV’s National Brands Plan” (“CCTV 国家品牌计划”) in 2017 and 2018 and won the time reporting advertisement before the joint news broadcast of CCTV channels at 19:00 (“国酒茅台为您报时”). These advertisements had successfully brainwashed consumers that Moutai is “National Wine”.

Specialty stores. Specialty stores were named “National Wine Moutai” stores.

CSL sponsorship. In 2012, Moutai sponsored Chinese Super League Club Guizhou Renhe and “National Wine Moutai” was labeled on the front side of the team jersey.

IPO prospectus. In 2001, the Company had mentioned its national wine brand image in its prospectus.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 57 9 Nov 2020

Figure 108: Time reporting advertisement before the Figure 109: Moutai is promoted as “National Wine” joint news broadcast by CCTV channels in advertisement

Source: internet Source: internet

Figure 110: Specialty stores were named “National Figure 111: Moutai sponsored Guizhou Renhe Wine Moutai” stores Football Club

Source: internet Source: internet

Scarcity nature due to tight supply Unique geographical environment

Maotai county (茅台镇) is located in the northwest of Guizhou Province, on the bank of the middle reaches of the Chishui River (赤水河中游河畔). It has a sloping canyon landform, mainly low and middle mountains and hills. The unique climate conditions of the river valley, which is warm in winter and hot in summer, less rain and less wind, and long sunshine time are conducive to the plantation of special sorghum for liquor making and the reproduction and growth of brewing microorganisms. The soil in Maotai county is mostly purple sand shale and fine sandstone. The good soil permeability filters surface water and groundwater provides premium source of water for brewing. All these geomorphology, climate, plants and water source have created a unique and irreplicable geographical advantage of Maotai county’s brewing Moutai liquor.

In addition, the red tassel sorghum planted in Maotai county is used to produce Moutai liquor. This sorghum is different from sorghum in the northeast and other regions in that it has solid, full, and uniform grains, small and thick skins, and amylopectin content of more than 88%. It is said that only this sorghum can be used to produce Moutai liquor, which requires nine times of cooking, eight times of fermentation, and seven times of wine extraction.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 58 9 Nov 2020

Figure 112: The red tassel sorghum planted in Maotai county

Source: Internet

Complicated production process: combination of science and art

The production process of Moutai is divided into two parts: koji making and wine making. The koji production process uses high-quality wheat as raw materials. After crushing, adding water, adding mother koji, stepping koji, cultivating and storing for a certain period of time, it can be grinded into powder before being placed into wine production. The production process uses high-temperature koji and sorghum as raw materials. After two rounds of feeding, nine rounds of steaming and cooking, eight rounds of cooling, addition of koji and stacking, eight rounds of fermentation, seven rounds of wine extracting and storage for three years. Then, different base wines are selected to blended and stored for one year. Finally, the production of Moutai is finished after a total of five years.

Figure 113: The complicated production process of Moutai

Source: Internet

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 59 9 Nov 2020

Production cycle longer than other white wines

The production cycle of Moutai liquor, a type of sauce-flavored liquor (酱香型), is the longest among all liquor-flavor types. The production of Moutai liquor is mainly composed of feeding, fermentation and storage. The entire production process of Moutai liquor from feeding to finished liquor requires about five years in total.

On the contrast, the production cycle of Wuliangye, a kind of strong-flavored liquor (濃香 型), is around two years. The production cycle of light-flavored liquor such as Fen Jiu is around one year.

Limited capacity

In 2019, the previous Chairman of the Company, Mr. Li Baofang, the carrying capacity of the ecological environment restricts the expansion of Moutai liquor. According to the atmospheric environment of Maotai county, the water quality and flow rate of Chishui River and the current area of the factory area, the core liquor production area is about 15 sq km. Based on scientific demonstration and comprehensive evaluation of various factors, Moutai liquor’s production capacity will be capped at 56,000 tons.

Quality of Moutai liquor cannot be replicated outside Maotai county?

On 9 Dec 1974, the Zunyi Revolutionary Committee issued the "Notice regarding the newly built "Moutai Liquor Exchanging Pilot Plant" 《关于新建"茅台酒易地试验厂"的通知》, it was decided to establish the "Kweichow Moutai Relocation Test Factory" in the northern suburb of Zunyi City and begin the trial test. This location was thoroughly selected to simulate the geomorphology and climate.

The liquor production test was done by 28 technical elites headed by Zheng Guangxian, the former Head of Moutai brewery. The pit stone, mud, raw materials and equipment were also brought from the brewery in Moutai county.

After 10 years of hard work, 9 cycles, 63 rounds, more than 3000 analytical tests, in 1985, the quality of the test liquor was rated close to Moutai liquor level but its taste was a bit different from Moutai liquor, according to the evaluated by a committee of liquor experts. The pilot plant was named as Guizhou Zhenjiu Plant in 1986. We think this pilot test suggested that the quality of Moutai liquor cannot be replicated outside Maotai County.

Figure 114: The testing Moutai wine was approved by Figure 115: The testing Moutai wine is called the committee of experts Zhenjiu now

Source: Internet Source: Internet

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 60 9 Nov 2020

Large room to increase ex-factory price Investment attributes of Moutai liquor

Apart from its “National Wine” image, we think Moutai liquor’s scarcity and storage of value strengthen its investment attributes. Firstly, the long production cycle and limited production capacity defined Moutai liquor’s scarcity. Secondly, the quality of Moutai liquor will become better and its value will appreciate as time passes by. However, the flavor of strong-flavored liquor and light-flavored liquor does not change much as time passes by.

Certain peers lifted prices recently

In June and July, news reported that Qinghua, Guojiao 1573 and Langjiu increased ex- factory prices and retail prices. In August, many regional brands such as Jiannanchun, Xi Feng Liquor, Jinhui Jiu and Wuling Spirit also increased their prices. Guojiao 1573 announced to raise settlement price by RMB40 to RMB890, in line to Wuliangye’s ex- factory price RMB889. Both prices are close to Moutai’s ex-factory price of RMB969.

Figure 116: Certain peers lifted prices in June and July Product Remarks 52% alcohol Guojiao Raised official suggested retail price by 27% to 1573 RMB1,399. Settlement price increased by 5% to RMB890 Ex-factory price increased by RMB100. The Company 53% alcohol Qinghua also increases retail price and wholesale price to maintain 30 distributors and POS profitability 53% alcohol Hongyun Ex-factory price increased by RMB199 Langjiu Source: Internet

Large gap between ex-factory price and wholesale price

Because of scarcity, brand image and investment demand, the wholesale price of Moutai liquor increased from more than RMB1,000 in 2H16 to currently ~RMB2,950. On the other hand, ex-factory price has been lifted from RMB819 to RMB969 since 28 Dec 2017. The price spread (wholesale price minus ex-factory price) of distributor is much greater than the Company’s gross profit (ex-factory price x GPM). According to our sources of channel check, while Moutai’s retail price trades at above its official suggested retail price, the retail prices of the other two high-end white wine brands, Wuliangye and Guojiao 1573, trade below its official suggested retail price. The price gap between ex-factory price and wholesale price of Moutai is large at ~RMB1,831, which is much higher than Wuliangye’s price gap (RMB71). The strong wholesale and retail prices of Moutai are a reflection of its brand power, in our view.

Figure 117: Current prices of top three high-end white wines Official Ex-factory Wholesale (RMB) Retail price suggested price price retail price 53% alcohol Moutai - distributor channel 969 2800 2950 1499 - direct sales channel 1299/1399 na 1499 * 1499 52% alcohol Wuliangye 889 960 1000 1399 52% alcohol Guojiao 1573 890 850 900 1399 Source: CMBIS channel checks (2 Nov 2020) *JD.com

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 61 9 Nov 2020

Price hike usually happened in first year of FYP and 1Q historically

If we look at the past nine times of price increases, we can see two interest findings: (1) the Company usually raised prices during the first year of FYP, namely 2001, 2006 and 2011; (2) six of them happened in 1Q. Because year 2020 is set as “Year of Fundamental Foundation” (基础建设年), we believe the Company might raise its ex-factory price in 1Q21 2021 at the earliest to have a good start in the 14th FYP (实现良好开局). Therefore, we assume the Company would increase its ex-factory price to distributor by 24% to RMB1,199 in Jan 2021 in our forecast.

Figure 118: History of ex-factory price increase of Moutai liqour Date RMB 10/8/2001 218 1/10/2003 268 10/2/2006 308 1/3/2007 358 11/1/2008 438 1/1/2010 499 1/1/2011 619 1/9/2012 819 1/1/2018 969 Source: Wind, Company data

Channel diversification to enhance growth Volume sold thorugh traditional distributor would be relatively stable

We believe the volume sold to traditional distributors was around 17,000 tonnes in 2019. Looking forward, we think the sales volume to distributors would be relatively stable and the volume increase could come from direct sales (self-operated specialty stores and group purchase), e-commerce platform, supermarket channels, self-operated e-commerce platform and new channels. Because the retail prices/ex-factory prices in such channels are greater than ex-factory price to traditional distributors, we think the Company’s channel diversification strategy could enhance ASP and GPM.

Expand e-commerce platform and supermarket channels

Since 2019, the Company has expanded its distribution channel by cooperating with supermarkets, e-commerce platforms and tobacco and wine retail chains. News reported that, in Jun 2019, three national supermarket operators (CR Vanguard, Wumart and RT- mart) and three Guizhou supermarket operators became the first batch of supermarket operators to sell Moutai. In Sep 2019, Tmall and Suning were selected as e-commerce distributors. In Jan 2020, news reported the Company would sell Moutai at another 19 regional supermarket operators and JD.com. In Jun 2020, 16 regional supermarket operators, four e-commerce wine operators as well as two tobacco and wine retail chains were authorized to sell Moutai. In Oct 2020, news said that four e-commerce platforms (Xiaomi Youpin, Netease (you.163.com), sfbest.com and Gome Online) will sell Moutai on 2020 Singles’ Day. As a whole, we think the channel diversification process is continuing.

The ex-factory price to e-commerce platform and supermarket channel is RMB1,299 or RMB1,399. Such price is greater than the ex-factor price to distributor (RMB969). The

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 62 9 Nov 2020 expanded volume supply of Moutai to these new sales channels could increase ASP and GPM of Moutai sales.

Figure 119: E-commerce and supermarket channels participants Channel type Number Vendor Coverage 1 China Resources Vanguard 2 Yonghui Superstores Whole China 3 RT-Mart 4 Hefei Department Store Anhui 5 Homeful Supermarket 6 Beijing Hualian Group Beijing 7 Wangfujing Department Store 8 Wumart Beijing and Hebei 9 New Huadu Supercenter Fujian 10 Seashine Group 11 Walmart Guangdong 12 Rainbow Department Store 13 Ren Ren Le Guangdong and Shaanxi 14 Guizhou Heli Guizhou 15 Guizhou Xingli Department Store Supermarket 16 Dennis Henan 17 Dazhang Group 18 Changchun Eurasia Group Jilin 19 Wenfeng Great World Chain Jiangsu 20 Golden Eagle Retail Group Jiangsu 21 Dashang Group Liaoning 22 Yinchuan Xin Hua Ningxia 23 Shandong Inzone Shandong 24 Zhenhua Group 25 Carrefour Shanghai 26 Bailian Group 27 Chengdu Ito Yokado Sichuan 28 Bailun Group 29 Xinjiang Wuika Times Xinjiang 30 Chongqing Department Store Chongqing 31 Tmall 32 JD.com E-commerce Whole China 33 Suning.com 34 1919.cn Source: Internet

Increasing sales volume at B2C

In FY19, the Company recorded 2,652 tonnes sales at B2C (or called direct sales channel - specialty stores in provincial capital cities and group purchase), increasing 12% YoY. The selling price at B2C is set at RMB1,499 (recommended retail price), higher than ex-factory price to distributor, e-commerce platform and supermarket. Because the supply of Moutai wine in the market is in shortage, evidenced by high retail price at ~RMB2,960, we expect the Company would gradually increase sales volume in such channel to improve profitability and meet consumers’ demand.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 63 9 Nov 2020

The impact of CCP Central Commission for Discipline Inspection’s article Factors supporting price hike still valid

On 22 Sep, CCP Central Commission for Discipline Inspection (“中纪委”) posted an article 《警惕高端白酒涨价引发不正之风回潮》to alert the recent tide of price hikes of high-end white wines might bring back corruption and improper publicly-funded dining. The article reported certain corruption cases of about government officials receiving Moutai as gifts. The corruption cases are about officials receiving Moutai as gift, which cannot be controlled by the Company. The Company’s staff are not involved in such corruption cases. According to our channel checks, wholesale price of Moutai has just decreased mildly since the article was published.

We think the factors supporting price hike of Moutai are still valid including: (1) large price spread between its wholesale price and ex-factory price, (2) since Moutai’s suggested retail price was lifted to RMB1,499 in Dec 2017, other high-end competitors (such as Guojiao 1573, Wuliangye, Qinghua Langjiu, Jinnanchun Dongfanghong) have also raised suggested retail prices to around RMB1,400 in 2019 and 2020.

Price still raised on 1 Jan 2018 despite CCP Central Commission for Discipline Inspection issued article in Jul 2017

On 24 Jul 2017, the Commission published an article 《整治“潜入地下”的公款吃喝》 to alert government officials’ consumption of Moutai and Wuliangye through business banquets with private companies owners and by public-funding. Furthermore, in Aug 2017, we saw certain local governments issued 《关于开展违规公款购买消费高档白酒问题集中 排查整治工作的通知》to inspect violations of government officials’ using public-funding to consume high-end white wines. That said, the Company still raised ex-factory price to RMB969 on 1 Jan 2018.

High quality development and battle against poverty in Guizhou

When the Communist Party Secretary of Guizhou Province visited and studied Maotai Group in Jul 2020, he mentioned Maotai Group should follow five unswerving (“五個堅定 不移”) strategies including deeply restructuring, strictly management, environmental protection, high quality development and strictly govern the party. On 2 Sep 2020, Maotai Group discussed the draft of the 14th Five-Year Plan. The Chairman said the 14th FYP is set for the high quality development of the Group after reaching RMB100bn revenue. Therefore, we think “high quality development” could mean continuing revenue and net profit growth of Maotai Group, which is underpinned by both volume and price growth of Moutai.

Moreover, Maotai Group is a very important enterprise in Guizhou and has a key role in the battle against poverty in Guizhou. On 1 July 2020, the Communist Party Secretary of Guizhou Province emphasized the importance of battling against poverty in Guizhou. On 11 Sep 2020, the Chairman of Maotai Group said the Group will proactively participate in the revolution of rural industries, including establishing premium raw materials supplying bases for the production of Moutai, to increase income level of farmers in Guizhou. In 2018, the Company contributed 85% and 94% of revenue and PBT of Moutai Group, respectively. Therefore, we think the growth of revenue and net profit of the Company and dividend payment to Guizhou government would help the province to battle against poverty.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 64 9 Nov 2020

Therefore, we think the article could delay the timing of price hike of Moutai, but the Company would still increase price of Moutai because the supporting factors exist and high quality development of the Company can help the battle against poverty in Guizhou.

Based on the past nine times of ex-factory price adjustment, we observed that six adjustments happened between Jan and Mar, while the remaining three adjustments happened between Aug and Oct. Therefore, we believe the timing for the next ex-factory may be between Jan and Mar 2021. Earnings forecast 9M20 NP climbed 11% despite epidemic

In 9M20, revenue rose 10% led by 12% Moutai wine revenue growth, while series wine revenue growth was flat. By channel, direct sales revenue jumped 172% while wholesale revenue only increased 2%. Because recommended retail price of RMB1,499 is much higher than ex-factory price of RMB969, the shift to direct sales channel could enhance revenue and GPM. GPM slightly dropped 0.2ppt to 91.3%, driven by accounting treatment change which realigned transportation expenses from selling expenses to COGS. 3Q20 GPM reversed down trend and increased 0.3ppt to 91.1% led by 7ppt increase of direct sales mix to 14%. Selling expenses ratio declined 1.7ppt to 2.6% as the Company reduced advertising expenses and changed accounting treatment. Tax & surcharges expenses ratio increased 0.9ppt to 14.0%.

We forecast the Company to post 18% EPS CAGR from FY19 to FY22E

In FY20E, we forecast the Company to record 11% revenue growth, meeting its 10% growth target. In FY21E, we forecast the Company to deliver 23% revenue growth by assuming 24% increase of ex-factory price of Moutai from RMB969 to RMB1,199 in 1Q21. In FY22E, we forecast a 14% revenue growth led by 10% volume growth of Moutai and 5% ASP growth.

We estimate EBIT margin to increase from 69.1% in FY19 to 71.7% in FY22E, driven by 1.3ppt GPM expansion and 1.8ppt decline of operating expenses ratio.

Figure 120: CMBIS estimates vs consensus CMBIS Consensus Diff (%) US$ mn FY20E FY21E FY22E FY20E FY21E FY22E FY20E FY21E FY22E Revenue 95,142 116,842 133,183 98,891 116,625 135,568 -4% 0% -2% Gross Profit 86,995 107,749 123,275 90,782 107,995 125,807 -4% 0% -2% EBIT 65,986 82,491 95,478 66,050 80,726 97,152 0% 2% -2% Net profit 46,146 57,799 66,861 47,037 56,527 67,167 -2% 2% 0% Gross Margin 91.4% 92.2% 92.6% 91.8% 92.6% 92.8% -0.4ppt -0.4ppt -0.2ppt EBIT Margin 69.4% 70.6% 71.7% 66.8% 69.2% 71.7% +2.6ppt +1.4ppt flat Net Margin 48.5% 49.5% 50.2% 47.6% 48.5% 49.5% +0.9ppt +1.0ppt +0.7ppt Source: Company data, CMBIS estimates, Bloomberg estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 65 9 Nov 2020

Figure 121: P&L assumptions (RMBmn) FY18 FY19 FY20E FY21E FY22E Revenue 73,639 85,430 95,142 116,842 133,183 growth (%) 26.5% 16.0% 11.4% 22.8% 14.0%

Moutai brand rev 65,487 75,802 85,126 105,216 120,968 growth (%) 25.0% 15.8% 12.3% 23.6% 15.0% GPM (%) 93.7% 93.8% 93.8% 94.3% 94.4%

- sales volume (tonne) 32,464 34,562 34,908 38,050 41,855 growth (%) 7.5% 6.5% 1.0% 9.0% 10.0%

Series wine rev 8,077 9,542 9,924 11,527 12,108 growth (%) 39.9% 18.1% 4.0% 16.2% 5.0% GPM (%) 71.1% 72.2% 71.8% 73.8% 74.8%

- sales volume (tonne) 29,774 30,083 30,083 30,384 30,688 growth (%) -0.4% 1.0% 0.0% 1.0% 1.0%

Others 74 85 92 99 107 growth (%) 50.6% 14.6% 8.0% 8.0% 8.0% GPM (%) -16.0% 23.3% 23.3% 23.3% 23.3%

GPM (%) 91.1% 91.3% 91.4% 92.2% 92.6%

Other income 3,434 3,284 3,513 4,484 5,822 % rev (%) 4.7% 3.8% 3.7% 3.8% 4.4%

Selling expenses 2,572 3,279 2,510 3,239 3,664 % rev (%) 3.5% 3.8% 2.6% 2.8% 2.8%

Admin expenses 5,326 6,168 6,815 7,839 8,682 % rev (%) 7.2% 7.2% 7.2% 6.7% 6.5%

Tax & surcharges 11,289 12,733 15,116 18,565 21,162 % rev (%) 15.3% 14.9% 15.9% 15.9% 15.9%

Other expenses 23 54 81 98 112 % rev (%) 0.0% 0.1% 0.1% 0.1% 0.1%

EBIT 51,339 59,049 65,986 82,491 95,478 % of rev (%) 69.7% 69.1% 69.4% 70.6% 71.7% Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 66 9 Nov 2020

Valuation

Valuation undemanding compared to other consumer staples’ segment leaders and international wine and luxury goods peers

The stock trades at 37.4x FY21E P/E, less than other segment leaders’ average of 40.8x. We forecast the Company to post 18% EPS CAGR from FY19-22E, which is in line with peers’ average of 20%. In terms of PEG, the Company’s 2.1x is below peers’ average 2.8x.

Amid epidemic, the Company still delivered positive growth rates of revenue and NP in 1H20, suggesting its resilient business nature. The Company also has strong brand power, product scarcity nature and high ROAE (32.5% vs. segment leaders’ average of 18.9% in FY21E), so we think it deserves to trade at premium to other segment leaders. We set our TP at RMB2,153.30, representing 46.8x FY21E P/E, at 15% premium on other segment leaders’ average of 40.7x. Our TP’s PEG of 2.7x is less than segment leaders’ average of 2.8x.

To cross-check, we compare the Company’s valuation to international wine sector and luxury goods sector. (1) International wine sector: the Company’s 18% EPS CAGR from FY19-22E is stronger than international wine sector (9%). Our TP’s PEG of 2.7x is less than international wine sector’s 4.0x.

(2) International luxury goods sector: We also compare the Company to international luxury goods sector because of the common attributes of scarcity nature and investment attribute for Moutai and limited editions of luxury goods such as Hermes Birkin bag and Ferrari cars. The Company’s 18% EPS CAGR from FY19-22E is also faster than international luxury goods sector (9%). Our TP represents 2.7x FY21E PEG, which is also below the average of international luxury sector (6.0x). Therefore, we think our TP is not aggressive.

Figure 122: Peers’ valuation table Mkt cap P/B ROAE FY0-3 Stock (RMB/ P/E (x) EPS growth (%) (x) (%) EPS FY2 code Rating Price US$mn) FY1 FY2 FY3 FY1 FY2 FY3 FY1 FY1 cagr PEG Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1

Haitian Flavouring 603288 CH NR 169.90 550,551 83.8 70.4 59.8 23 19 18 26.3 32.8 19.8 3.5 Yili 600887 CH Buy 38.88 236,515 32.0 27.0 23.5 6 18 15 8.3 27.1 13.0 2.1 Tsingtao Brewery 600600 CH Hold 80.61 92,063 49.3 42.0 37.0 12 17 14 4.7 11.1 14.2 3.0 Yonghui 601933 CH NR 8.07 76,796 31.2 24.9 19.8 56 25 26 3.6 11.5 34.9 0.7 C&S Paper 002511 CH NR 22.10 28,909 31.8 26.2 22.1 48 22 18 5.9 19.1 28.6 0.9 Shanghai Jahwa 600315 CH NR 43.14 28,958 68.0 53.5 41.3 (24) 27 30 4.4 6.5 7.9 6.7 Segment leaders 49.3 40.7 33.9 20 21 20 8.9 18.0 19.7 2.8

Wuliangye 000858 CH Buy 259.30 1,006,501 49.2 39.9 33.2 17 24 20 11.7 25.5 20.3 2.0 Jiangsu Yanghe 002304 CH NR 174.06 262,306 34.4 30.4 26.8 3 13 13 6.5 19.1 9.9 3.1 Luzhou Laojiao 000568 CH NR 182.80 267,757 47.2 38.7 32.5 22 22 19 11.7 25.4 21.0 1.8 Shanxi Fen Wine 600809 CH NR 234.74 204,583 77.4 60.7 49.1 36 27 24 22.1 29.5 28.9 2.1 Anhui Gujing 000596 CH NR 222.50 94,859 52.2 40.8 33.9 2 28 20 10.7 20.2 16.4 2.5 Sichuan Swellfun 600779 CH NR 72.50 35,420 49.1 37.2 31.4 (13) 32 18 15.0 30.0 10.9 3.4 Jiangsu King's Luck 603369 CH NR 48.67 61,057 37.9 30.6 24.7 11 24 24 7.3 19.3 19.2 1.6 Beijing Shunxin 000860 CH NR 54.31 40,285 43.5 32.6 26.1 14 33 25 4.8 11.0 24.0 1.4 Anhui Kouzi 603589 CH NR 60.12 36,072 24.9 20.8 18.0 (16) 20 16 4.7 18.3 5.3 3.9 White wine sector 46.2 36.8 30.6 9 25 20 10.5 22.0 17.3 2.4

Diageo DGE LN NR 2635.00 80,982 24.1 23.9 21.0 (16) 1 14 10.0 18.6 (1.4) (16.8) Remy Cointreau RCO FP NR 149.20 8,927 62.3 48.1 41.5 (4) 29 16 5.1 8.3 13.0 3.7 Pernod Ricard RI FP NR 147.00 45,606 27.6 26.9 23.4 (14) 3 15 2.5 8.5 0.3 100.9 Brown-Forman BF/B US NR 75.11 35,044 42.4 39.5 36.3 3 7 9 14.4 39.2 6.4 6.2 Constellation STZ US NR 183.48 35,569 19.7 18.3 15.8 2 8 16 2.7 14.4 8.5 2.2 Int'l wine sector 35.2 31.3 27.6 (6) 10 14 6.9 17.8 5.3 19.2 Int'l wine sector - excluidng outliers 9.3 4.0

LVMH MC FP NR 437.05 261,320 52.9 31.4 27.2 (42) 68 16 5.7 11.2 4.2 7.5 Hermes RMS FP NR 844.60 105,633 79.2 56.5 48.9 (27) 40 15 12.4 16.3 5.9 9.6 Richemont CFR SW NR 70.12 44,637 59.5 30.7 24.8 (36) 93 24 2.3 3.5 15.2 2.0 Kering KER FP NR 568.10 84,990 35.5 24.4 21.1 (37) 45 15 6.3 18.3 1.6 14.9 Ferrari RACE IM NR 173.90 40,161 62.0 43.2 36.5 (25) 44 18 18.6 29.5 8.6 5.0 Prada 1913 HK Buy 33.30 10,991 na 54.9 38.2 (117) (488) 44 3.4 (1.4) (1.7) (32.4) Int'l luxury goods sector 57.8 40.2 32.8 (47) (33) 22 8.1 12.9 5.6 1.1 Int'l luxury goods sector - excluding outliers 8.5 6.0 Source: Bloomberg estimates, CMBIS estimates

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Figure 123: P/E band chart

RMB 2400 52x

2200

2000 41x 1800

1600

1400 30x

1200

1000 19x 800

600 8x 400

200

0

Jul-12 Jul-13 Jul-19 Jul-20 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18

Apr-12 Oct-12 Apr-13 Oct-13 Apr-19 Oct-19 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-20 Oct-20

Jan-14 Jan-15 Jan-17 Jan-12 Jan-13 Jan-16 Jan-18 Jan-19 Jan-20

Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 68 9 Nov 2020

Company Overview

Company background The Company has strong core competitiveness underpinned by renowned brand, excellent product quality, long culture and heritage, unique environment and special craftsmanship.

The development history of the liquor industry proves that the brewing of high-quality liquor is inseparable from its unique natural conditions. Maotai county (茅台鎮) is located in the northwest of Guizhou Province, on the bank of the middle reaches of the Chishui River (赤 水河中游河畔). It has a sloping canyon landform, mainly low and middle mountains and hills. The unique climate conditions of the river valley, which is warm in winter and hot in summer, less rain and less wind, and long sunshine time are conducive to the plantation of special sorghum for liquor making and the reproduction and growth of brewing microorganisms. The soil in Maotai county is mostly purple sand shale and fine sandstone. The good soil permeability filters surface water and groundwater provides premium source of water for brewing. All these geomorphology, climate, plants and water source have created a unique and unrepeatable geographical advantage of Maotai county’s brewing Moutai. Maotai county is known as "China's No. 1 Wine Town". In Mar 2001, Kweichow Moutai wine was awarded the geographical indication product protection (地理标志产品保 护) and the production area is in Maotai county, Renhuai City, Guizhou.

53% alcohol content Moutai liquor is the flagship product of the Company. Other products include Moutai Wangzi liquor, Moutai Yingbin liquor and Laimao liquor. In FY19, sales of Moutai liquor reached RMB75.8bn, representing 89% of total revenue. Sales of other series wine reached RMB9.5bn, equivalent to 11% of total revenue.

Figure 124: Product portfolio of Kweichow Moutai Product 53% alcohol content Moutai (15 years) Moutai (Entrando Series Moutai (Year of Roaster) Moutai (Year of Dog) Moutai (Year of Rat) Moutai Italia-Milano) High-end Moutai

Retail price (RMB) 1,499 4,999 6,299 3,329 3,238 3,699 Product Moutai Wangzijiu Moutai Yingbin Lai Mao Jiu Han Jiang Jiu Guizhou Da Qu Wang Mao Series wine

Retail price (RMB) 264 168 408 498 198 799

Source: Tmall

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Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E Revenue 73,639 85,430 95,142 116,842 133,183 Profit after tax 37,830 43,970 49,158 61,504 71,218 Liquor 73,565 85,345 95,050 116,743 133,076 D&A 1,175 1,243 1,304 1,373 1,442 Others 74 85 92 99 107 Net finance cost 0 0 7 7 7 Cost of sales (6,523) (7,430) (8,147) (9,093) (9,907) Change in working capital 2,377 (23) (1,623) (2,194) (2,233) 67,116 78,000 86,995 107,749 123,275 3 20 0 0 0 Gross profit Others Net cash from operating 41,385 45,211 48,847 60,690 70,435 Other income 3,434 3,284 3,513 4,484 5,822 Selling expenses (2,572) (3,279) (2,510) (3,239) (3,664) Capex (1,607) (3,149) (5,575) (4,225) (1,825) Admin expenses (5,326) (6,168) (6,815) (7,839) (8,682) Others (22) (17) (306) 21 21 (22) (49) (76) (93) (107) (1,629) (3,166) (5,881) (4,204) (1,804) R&D expenses Net cash from investing Tax & surcharges (11,289) (12,733) (15,116) (18,565) (21,162) Others (1) (5) (5) (5) (5) Interest paid (0) (0) (28) (28) (28) 51,339 59,049 65,986 82,491 95,478 (16,441) (20,117) (23,240) (25,803) (31,851) EBIT Dividend paid Others 0 833 0 0 0 Finance costs, net 4 (7) (7) (7) (7) Net cash from financing (16,441) (19,284) (23,268) (25,831) (31,879) Non-operating items (515) (259) (259) (259) (259) Profit before tax 50,828 58,783 65,720 82,224 95,212 Net change in cash 23,315 22,761 19,698 30,654 36,751 Income tax (12,998) (14,813) (16,561) (20,721) (23,993) Cash at the beginning 74,928 98,243 121,004 140,701 171,356 Non-controlling interests (2,626) (2,764) (3,012) (3,705) (4,357) Exchange difference 0 0 0 0 0 Net profit 35,204 41,206 46,146 57,799 66,861 Cash at the end 98,243 121,004 140,701 171,356 208,107

Balance sheet Key ratios YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec FY18A FY19A FY20E FY21E FY22E Non-current assets 21,985 24,018 28,616 31,468 31,850 Sales mix (%) PPE 17,203 17,663 21,854 24,630 24,941 Liquor 99.9 99.9 99.9 99.9 99.9 Intangible assets 3,499 4,728 4,818 4,904 4,986 Others 0.1 0.1 0.1 0.1 0.1 Loans and advances 36 49 49 49 49 1,247 1,578 1,895 1,884 1,874 Other non-current assets Margin & ratios (%) Gross margin 91.1 91.3 91.4 92.2 92.6 Current assets 137,862 159,024 181,602 215,822 256,223 EBIT margin 69.7 69.1 69.4 70.6 71.7 Inventories 23,507 25,285 27,813 30,595 33,654 Net margin 47.8 48.2 48.5 49.5 50.2 Trade receivables 564 1,463 1,629 2,001 2,281 Payout ratio 51.9 51.9 51.9 51.9 51.9 Others 1,716 1,647 1,832 2,245 2,556 Placement with inst. 103,009 117,378 123,247 129,409 135,879 Balance sheet ratios Cash balance 9,066 13,252 27,080 51,572 81,853 Current ratio (x) 3.2 3.9 4.3 4.9 5.7 Quick ratio (x) 2.7 3.3 3.6 4.2 4.9 Current liabilities 42,438 41,093 42,350 43,722 45,139 A/C receivables days 4 4 6 6 6 Trade payables 1,178 1,514 1,660 1,853 2,018 A/C payables days 61 66 71 70 71 Other payables 5,439 6,035 6,459 6,916 7,410 Inventory turnover days 1,275 1,198 1189 1172 1183 Customer deposits 13,577 13,740 14,427 15,149 15,906 Net cash (RMB mn) 100,602 119,581 139,278 169,933 206,684 Others 22,244 19,805 19,805 19,805 19,805 Returns (%) Non-current liabilities 0 73 73 73 73 ROAE 34.5 33.1 31.1 32.5 31.4 Deferred tax liabilities 0 73 73 73 73 ROAA 25.7 25.6 25.0 26.9 26.6

Total net assets 117,408 141,876 167,794 203,495 242,862 Per share Shareholders' equity 112,839 136,010 160,770 194,619 231,482 EPS (RMB) 28.02 32.80 36.73 46.01 53.23 Minority Interest 4,570 5,866 7,025 8,876 11,380 DPS (RMB) 14.54 17.03 19.07 23.88 27.62 BVPS (RMB) 89.83 108.27 127.98 154.93 184.27

Source: Company data, CMBIS estimates

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CMB International Securities | Equity Research | Company Initiation

Wuliangye (000858 CH)

Reform to roll back glory days BUY (Initiation)

Target Price RMB307.80 The Company initiated reform measures to roll back glory days. To enhance Up/Downside +19% brand value, it will launch super high-end 501 Wuliangye (leveraging on scarcity Current Price RMB259.30 and history of its mud cellars), and would gradually extend storage period of base wine to three years. It also initiated channel reform such as flattening, developing corporate group purchase channel and adopting code scanning systems to China White Wine Sector accelerate sales growth. We initiate coverage of Wuliangye with Buy rating and TP of RMB307.80. Albert Yip (852) 3900 0838  Former leader of white wine sector. The Company was once the sector [email protected] leader in terms of revenue and ex-factory price. Moutai’s ex-factory price took the lead in Sep 2012 and its revenue surpassed the Company in FY13. On the one hand, the rising of Moutai was driven by its enhancing national wine Stock Data image and growing production capacity. On the other hand, the up and down Mkt Cap (RMB mn) 1,006,501 of Wuliangye’s ex-factory price in 2013 and 2014 amid downcycle had hurt Avg 3 mths t/o (RMB mn) 4,720.27 distributors’ confidence and continuous expansion of series wines brand 52w High/Low (RMB) 261.20/ 98.63 portfolio had caused dilution of Wuliangye’s brand value. Total Issued Shares (mn) 3,881.6 Source: Bloomberg  Reform to enhance brand equity. The Chairman Mr. Li kicked off “second entrepreneurship” in 2017 aiming at the return to glory days. The Company Shareholding Structure has eliminated many series wine brands, and now focuses on core Wuliangye Yibin City State-owned Asset 35.21% brand “1+3” and four national series wine brands to ensure the brands have a Management Limited clear hierarchy. Two high-end products, super high-end 501 Wuliangye and Yibin Wuliangye Group 19.63% Classic Edition Wuliangye, which are produced from limited mud cellars Source: HKEx

established in Ming and Qing Dynasty, are used to raise brand equity. Also, Share Performance the Company would gradually extend its storage period before available for Absolute Relative sale of base wine to three years to enhance product quality and value (vs 1-mth 17.4% 13.8% Moutai’s four years). 3-mth 19.3% 21.3% 6-mth 91.1% 64.6%  Channel reform to accelerate sales growth. In 2019, the Company Source: Bloomberg reformed its brand business unit by decentralizing more power to frontline staff to further penetrate into lower tier cities. Code scanning systems were 12-mth Price Performance (RMB) installed to better monitor channel sales and inventory level to control 000858 CH shcomp (rebased) 300

wholesale price, laying a solid foundation for realizing both volume and ASP 250

growth. Amid epidemic, the Company began to develop corporate group 200

purchase channel by partnering with distributors in 2020. 150  Initiate at Buy. We forecast the Company to post 20% EPS CAGR in FY19- 100 22E. Our TP is set at RMB307.80, representing 47.3x FY21E P/E, at 1.01x to 50 0 our target P/E for Moutai. Catalysts: ex-factory price increase or FY21E 11/2019 2/2020 5/2020 8/2020 11/2020

guidance beat. Source: Bloomberg

Earnings Summary Auditor: Sichuan Huaxin (YE 31 Dec) FY18A FY19A FY20E FY21E FY22E

Revenue (RMB mn) 40,030 50,118 57,714 68,755 79,488

YoY growth (%) 33 25 15 19 16

Net income (RMB mn) 13,384 17,402 20,439 25,257 30,278 EPS (RMB) 3.448 4.483 5.266 6.507 7.800 YoY growth (%) 38 30 17 24 20 Consensus EPS (RMB) NA NA 5.26 6.38 7.59 P/E (x) 75.2 57.8 49.2 39.9 33.2 P/B (x) 13.4 12.2 10.5 8.9 7.6 Yield (%) 0.8 0.9 1.1 1.4 1.6 ROE (%) 22.9 25.3 25.5 26.9 27.4 Net cash (RMBmn) 48,960 63,239 71,961 82,952 96,701 Source: Company data, Bloomberg, CMBIS estimates

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Focus Charts Figure 125: 17% revenue CAGR from FY19-22E Figure 126: 20% NP CAGR from FY19-22E (RMBmn) High-end liquor revenue low to mid-end liquor revenue Others (RMBmn) 90,000 35,000

80,000 17% CAGR 7,406 30,000 20% CAGR 70,000 6,440 10,658 25,000 60,000 5,152 9,272 50,000 3,816 7,878 20,000 30,278 6,631 61,424 25,257 40,000 2,278 53,043 15,000 20,439 7,563 44,684 30,000 39,671 17,402 30,189 13,384 20,000 10,000 FY18 FY19 FY20E FY21E FY22E FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 128: Revenue comparison between Moutai and Figure 127: GPM expansion Wuliangye

GPM - Company GPM - high-end liquor (RMB mn) Moutai revenue Wuliangye revenue GPM - low to mid-end liquor GPM - others 90,000 90% 85% 80,000 87.7% 89.0% 80% 84.3% 84.6% 86.5% 75% 70,000 76.2% 70% 73.8% 74.5% 75.2% 77.4% 65% 60,000 60% 50,000 55% 58.5% 50% 55.0% 57.0% 40,000 45% 50.8% 52.2% 40% 30,000 35% 30% 20,000 25% 20% 10,000 15% 11.1% 9.0% 9.0% 9.0% 7.8% 0 10% FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY 5% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 FY18 FY19 FY20E FY21E FY22E

Source: Company data, CMBIS estimates Source: Bloomberg, CMBIS

Figure 130: The Company’s forward P/E usually Figure 129: Ex-factory price comparison between traded at greater discount to Moutai’s when prices Moutai and Wuliangye were “inverted”

(RMB) 1-yr forward P/E Ex-factor price of Moutai Ex-factory price of Wuliangye 1.4 ratio (x) 1,200.00 1.3

1,000.00 1.2

1.1 800.00 +1s.d. 1.01x 1.0 600.00 0.9 average 0.90x 400.00 0.8 -1s.d. 0.79x 0.7 Wuliangye Wuliangye Wuliangye initiated 200.00 wholesale price wholesale price channel reform, Wuliangye 0.6 below ex-factory below ex-factory inventory control wholesale price price price and profit sharing below ex- 0.00 to channel 0.5 factory price

Source: Wind, CMBIS Source: Company data, Bloomberg, CMBIS estimates

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The former leader of white wine sector

Former leader in terms of revenue and ex-factory price

Wuliangye was once the leader of Chinese white wine sector in terms of revenue and ex- factory price. Moutai’s ex-factory price began to challenge Wuliangye’s in Jan 2008 and took the lead in Sep 2012. Moutai’s revenue then surpassed Wuliangye’s in FY13.

Since Moutai was listed in 2004, revenue of Wuliangye had been greater than Moutai’s. However, Moutai’s revenue exceeded Wuliangye’s in 2013. On the one hand, the rising of Moutai was driven by its enhancing brand equity and production capacity. On the other hand, the up and down of ex-factory price in 2013 and 2014 had hurt distributors’ confidence and continuous expansion of series wines brand portfolio had caused dilution of Wuliangye’s brand value. In 2012, the government banned public-funded consumption and banquet caused reduction of demand for the sector and decrease of wholesale prices of high-end white wine. While Moutai held firm on its ex-factory price, Wuliangye raised ex- factory price by 11% to RMB729 in Mar 2013. But the weak demand made its wholesale price fall below ex-factory price. Wulianye then cut its ex-factory to RMB609 in May 2014. Such changes of ex-factory prices had hurt distributors’ confidence and caused sales volume to slump 21% in 2014.

Figure 131: Ex-factory price comparison between Figure 132: Revenue of Kweichow Moutai has Moutai and Wuliangye surpassed Wuliangye since 2013

(RMB) (RMB mn) Ex-factor price of Moutai Ex-factory price of Wuliangye Moutai revenue Wuliangye revenue 90,000 1,200.00

80,000 1,000.00 70,000

800.00 60,000

50,000 600.00 40,000 400.00 30,000

200.00 20,000

10,000 0.00 0 FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: Wind, CMBIS Source: Bloomberg, CMBIS

Core competence underpinned by six unique comparative advantages

The Company has six unique comparative advantages: (1) The unique natural ecological environment makes Wuliangye unique; (2) since the early Ming Dynasty (more than 600 years ago), the reproduction of the microbial community in the ancient mud cellars has never stopped; (3) the Company uses unique five kinds of crops formulas to brew white wine with world-class quality; (4) its unique brewing technique has formed a unique microbiome above Wuliangye’s production base in Yibin, Sichuan; (5) the unique harmonious quality that makes Wuliangye a typical representative of Chinese culture; and (6) the unique "Ten Miles Wine City" – the base area of the Wuliangye Group is large at 10 square miles.

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Reform measures aiming at return to the glory days In Mar 2017, Mr. Li Shuguang, became the Chairman of Wuliangye Group, a major shareholder of the Company, and initiated the reform of the Company to kick off “second entrepreneurship” (“二次创业”) aiming at taking back the leader position in terms of brand equity, market and market capitalization .

Restructure brand portfolio to enhance brand equity

The Company changed its brand strategy from “1+3+5” and “5+N” to “1+3” and “4+4” in 2017 to reduce number of brands and avoid dilution of core brand Wuliangye’s brand equity. In 2019, the Company eliminated a total of 129 series wine brands and refined its “4+4” strategy to mainly focus on 4 key national brands “五粮春、五粮醇、五粮特曲、尖庄”. We think the new brand strategy could ensure that the brands’ images have a clear hierarchy and the price band is in order.

Core brand “1” represents 52% alcohol content Wuliangye. In 2019, this core brand was successfully upgraded to the 8th generation with better quality, packing and anti- counterfeiting features. Also, ex-factory price was increased from RMB789 to RMB889.

The “3” brands are 501 Wuliangye, classic edition of Wuliangye and 39% alcohol content Wuliangye, which are high-end products of the Company. (1) 501 Wuliangye (明池) (清池) is the most high end brand given that the wine is fermented in limited mud cellars established in Ming Dynasty and Qing Dynasty. Annual production volume might be around 501 bottles. The scarcity and history of these mud cellars should support a premium price for the wine, and enhance the brand equity of Wuliangye. (2) Classic Edition Wuliangye is made from wine stored for at least 10 years and blended with certain wine made from mud cellars established in Ming Dynasty and Qing Dynasty to support its premium value. The Company relaunched its “drum bottle”, which was used between 1960s-1990s, for the Classic Edition Wuliangye. According to our channel checks, Classic Edition of Wuliangye was launched at ex-factory price of RMB1,499 and retail price of RMB2,699 in Oct 2020. The Company targets annual sales volume of around 1,000 tonnes (around 4% of its high end wine volume in FY19) in future. The high ex-factory price could enhance GPM of the Company. (3) The Company is undergoing packaging upgrade for 39% alcohol content Wuliangye, which is preferred by young consumers because of lower alcohol content.

The four key national brands are “五粮春、五粮醇、五粮特曲、尖庄”, mainly are low to mid-end products. Also, there are four regional brands called “五粮人家、百家宴、友酒、 火爆”. The optimization of series wine brands is to avoid equity dilution of core brand Wuliangye. For example, in Apr 2019, the Company ended the cooperation with four brands (“VVV” “五粮 PTVIP” “东方娇子” “壹玖壹捌 1918” ) and asked its distributors and specialty stores to offload these products.

The Company is also strengthening its brand story to narrow its gap between Moutai. Wuliangye Culture Research Institute was established in Dec 2019 to promote its brand culture. The brand image is positioned as “Chinese Strong-flavored Wine and King of Wine” (“大国浓香 中国酒王”). The wine is presented as the “Essence of Sky and Land; National Spirit and Wonderful World” (“天地精华、民族精神、世界精彩”). Furthermore, the mud cellar advantages, technological advantages and formula advantages are emphasized as the core elements of Wuliangye.

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Figure 133: “1+3” and four national brands Products 8th generation Wuliangye 501 Wuliangye Ming Dynasty 501 Wuliangye Qing Dynasty Classic Edition 39% alcohol content (52% alcohol content) Wuliangye Wuliangye High-end

Retail price (RMB) 1,399 na na 2,699 799 Products Wuliangchun Wuliangtequ Wuliangchun Mian Rou Jian Zhuang Low to mid-end

Retail price (RMB) 299 208 178 62 Source: Tmall, CMBIS

Gradually extend storage period of base wine to three years

To improve product quality and emphasize scarcity nature of Wuliangye, the Company mentioned to gradually extend storage period of base wine before available for sale to three years. Because the quality and value of white wine would be enhanced after a longer storage period, such strategy could enhance its competitiveness in high-end white wine segment and could narrow the gap between Wuliangye and Moutai (whose base wine is stored for four years before available for sale).

Digital certificate to enhance storage value

In Mar 2020, the Company cooperated with Sina Group to provide Wuliangye digital wine certificate project. ZhenJiuBlockchain (“ 臻 久 网 ” ) is a classic wine digital asset management service platform invested by Sina Group. It is an official digital wine certificate operating platform specified by the Company. The digital wine certificate utilizes block chain technology to provide anti-counterfeit verification of Wuliangye for the transportation process from origin of product to smart warehouse. The brand reputation of both companies reduces consumers’ risks of purchasing counterfeit wine products and enhances the storage value of Wuliangye.

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Figure 134: A digital certificate issued by Figure 135: ZhenJiuBlockchain a classic wine digital ZhenJiuBlockchain asset management service platform invested by Sina

Source: internet Source: Tencent

Channel reform to accelerate sales growth Channel management refinement to further penetrate

In 2017, the Company launched “Hundred Cities Thousand Counties Ten Thousand Stores” (“百城千县万店”) work plan and established more than 7,000 POS to penetrate into unfilled areas.

In 2019, the Company reformed its brand business unit by the concept of “Vertically flattened, horizontally specialized” (“纵向扁平化、横向专业化”). It refined its national distribution network management by refining its seven distribution centers (“七大营销中心”) into 21 distribution regions (“营销战区”), which were further divided into 60 distribution bases (“ 营销基地”). At the same time, the Company decentralized more power to distribution bases, and expanded its marketing and distribution team to meet the needs of the new distribution organization. This should help the Company further penetrate into lower tier cities.

In 2019, the three series wines operating subsidiaries were integrated into Yibin Wuliang Nongxiang Series Wine Co Ltd (“宜宾五粮浓香系列酒有限公司“) to consolidate the resources as well as lead and coordinate the development of series wines. Businesses decision making now is more to close to market through regional organization flattening. We think this reform would be better than that each series wine brand worked individually. In 1H20, the Company completed the upgrade of new products of “五粮醇、五粮特曲、尖 庄”and revenue of these brands recorded 10%-150% YoY growth in 1H20.

O2O integration

The new retail operating subsidiary commenced operation in Jul 2020. It will actively build a vertical ecological empowerment platform containing brand promotion platform, product sales platform, consumers interaction platform and online sales management platform.

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Kicked off corporate group purchase channel

To diversify from traditional distributors channel, the Company began to develop corporate group purchase channel this year. Arranged and led by the Company, distributors have visited several thousand corporate customers and secured around 10,000 orders this year. For certain large corporate customers like Huawei, the Company will arrange direct sales to such customers. The successful development of corporate group purchase channel has enhanced sales this year as sales to distributors was hit by COVID-19.

Channel inventory management by bar code

In 2019, the Company installed bar code scanning systems from factory to distributors and then to 70,000 POS when it upgraded its 8th generation of 52% alcohol content Wuliangye. The system enables the Company to closely monitor retail sales, better control channel inventory and control wholesale price, which could lay a solid foundation to realize increases of both sales volume and ASP.

Reform of salary management

The Company initiated “Measures for Performance Appraisal and Salary Management of Deputy Senior Managers” (“副职高级管理人员业绩考核暨薪酬管理办法”) in Apr 2020. The income package of senior management is composed of annual salary and incentive income. The amount of incentive income is tied to the KPIs and appraisal of the employee. We think the reform should better incentivize senior management.

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Earnings forecast 9M20 NP +16%, outstanding among peers

In 9M20, revenue rose 15%. 3Q19 revenue growth accelerated to 18% from 13% in 1H20 as the sector recovered. Amid COVID-19, the Company expanded corporate group purchase and online sales to offset impact from traditional channel. 9M20 GPM widened 0.7ppt to 74.5%. Selling expenses ratio increased 0.6ppt to 11.5% as the Company invested in brand promotion to promote sales recovery. SG&A expenses ratio slightly increased 0.2ppt to 15.9%.

Despite COVID-19, the Company still managed to achieve 15% revenue growth and 16% NP growth in 9M20. We think this set of results was outstanding compared to white wine peers, showing its strong execution skills and brand equity.

Figure 136: White wine sector 1H20 results snapshot 1H19 1H20 NP 9M19 9M20 NP Company revenue growth revenue growth growth YoY YoY growth YoY YoY Wuliangye 13% 16% 15% 16% Beijing Shunxin 13% -15% 12% -35% Kweichou Moutai 11% 13% 12% 11% Shanxi Fen Wine 8% 33% 13% 44% Jiangsu King's Luck -5% -5% 2% 2% Luzhou Laojiao -5% 17% 1% 27% Anhui Gujing -8% -18% -2% -12% Jinhui Liquor -13% -11% -6% -2% Jiangsu Yanghe -16% -3% -10% 1% Sichuan Swellfun -52% -70% -27% -21% Average -5% -4% 1% 3% Source: Bloomberg, Company data

We forecast the Company to post 20% EPS CAGR from FY19 to FY22E

We expect revenue growth to improve from 13% in 1H20 to 17% in 2H20E as sales growth further recovers. In FY21E, we forecast the Company to deliver 19% revenue growth driven by 11% blended ASP growth and 7% volume growth. In FY22E, we forecast a 16% revenue growth led by 10% blended ASP growth and 5% volume growth. We assume Moutai would raise its ex-factory price by 24% to RMB1,199 in FY21E and Wuliangye would follow by lifting ex-factory price 7% and 6% to RMB949 an RMB999 in FY21E and FY22E, respectively.

Figure 137: CMBIS estimates vs consensus CMBIS Consensus Diff (%) US$ mn FY20E FY21E FY22E FY20E FY22E FY22E FY20E FY21E FY22E Revenue 57,714 68,755 79,488 57,231 67,457 78,096 1% 2% 2% Gross Profit 43,427 52,402 61,559 43,122 51,544 60,368 1% 2% 2% EBIT 26,714 33,091 39,655 26,480 32,201 38,336 1% 3% 3% Net profit 20,439 25,257 30,278 20,399 24,841 29,526 0% 2% 3% Gross Margin 75.2% 76.2% 77.4% 75.3% 76.4% 77.3% -0.1ppt -0.2ppt +0.1ppt EBIT 46.3% 48.1% 49.9% 46.3% 47.7% 49.1% flat +0.4ppt +0.8ppt Net Margin 35.4% 36.7% 38.1% 35.6% 36.8% 37.8% -0.2ppt -0.1ppt +0.3ppt Source: Company data, CMBIS estimates, Bloomberg estimates

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Figure 138: P&L assumptions (RMBmn) FY18 FY19 FY20E FY21E FY22E Revenue 40,030 50,118 57,714 68,755 79,488 growth (%) 32.6% 25.2% 15.2% 19.1% 15.6%

High-end liquor rev 30,189 39,671 44,684 53,043 61,424 growth (%) 41.1% 31.4% 12.6% 18.7% 15.8% GPM (%) 84.3% 84.6% 86.5% 87.7% 89.0%

Low to mid-end liquor rev 7,563 6,631 7,878 9,272 10,658 growth (%) 12.9% -12.3% 18.8% 17.7% 15.0% GPM (%) 50.8% 52.2% 55.0% 57.0% 58.5%

Total sales volume (tonne) 191,596 165,411 177,864 190,314 199,317 growth (%) 6.4% -13.7% 7.5% 7.0% 4.7%

Others 2,278 3,816 5,152 6,440 7,406 growth (%) 8.8% 67.5% 35.0% 25.0% 15.0% GPM (%) 11.1% 7.8% 9.0% 9.0% 9.0%

GPM (%) 73.8% 74.5% 75.2% 76.2% 77.4%

Other income 106 160 160 160 160 % rev (%) 0.3% 0.3% 0.3% 0.2% 0.2%

Selling expenses 3,778 4,986 6,061 6,950 7,862 % rev (%) 9.4% 9.9% 10.5% 10.1% 9.9%

Admin expenses 2,340 2,655 2,854 3,180 3,482 % rev (%) 5.8% 5.3% 4.9% 4.6% 4.4%

Tax & surcharges 5,908 6,984 7,907 9,282 10,651 % rev (%) 14.8% 13.9% 13.7% 13.5% 13.4%

Other expenses 95 131 51 60 69 % rev (%) 0.2% 0.3% 0.1% 0.1% 0.1%

EBIT 17,527 22,720 26,714 33,091 39,655 % of rev (%) 43.8% 45.3% 46.3% 48.1% 49.9% Source: Company data, CMBIS estimates

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Valuation

We value the Company at RMB307.80, 47.3x FY21E P/E

The stock trades at 39.9x FY21E P/E, 9% above white wine peers’ average of 36.8x. We forecast the Company to deliver 20% EPS CAGR in FY19-22E, above peers’ average of 17%. In terms of PEG, the Company trades at 2.0x, below peers’ average of 2.4x.

The Company reported 13% revenue growth and 16% NP growth in 1H20, showing the business was resilient amid epidemic. The Company is the number two player in high-end white wine segment. Therefore, we think the valuation comparison between the Company and Moutai is meaningful.

As we mentioned above, Moutai became market leader in terms of revenue in FY13. We compared the Company’s 1-yr forward P/E to Moutai’s and found the Company’s 1-yr forward P/E trading at 10% discount to Moutai’s on average. The standard deviation of such ratio was low at 0.11x. According to our channel checks, wholesale price had sometimes traded below ex-factory price when consumer demand weakened between 2013 and 2018. In Mar 2020, certain regions saw wholesale price below ex-factory price due to epidemic. The Company’s forward P/E usually traded at greater discount to Moutai’s when prices were “inverted” (“倒挂”). The Company completed channel reform, inventory control and profit sharing to channel (“控盘分利”) in 1H19 and this improved distributors’ confidence. Amid epidemic, the Company quickly reduced quotas in certain distributors and developed corporate group purchase channel successfully to stabilize wholesale price. Coupled with brand portfolio restructuring to enhance brand equity, we think these measures should help to lift Wuliangye wholesale price gradually.

We think these reform measures and new sales channel development could help reduce the likelihood of “inverted prices”, which should support the Company’s 1-yr forward P/E to Moutai to be justified to trade at above historical average. We set the Company’s 1-yr forward P/E at 1.01x of Moutai’s (hist. avg. +1 s.d.). Given that we value Moutai at 46.8x FY21E P/E, we set our TP of the Company at RMB307.80, based on 47.3x FY21E P/E (1.01x to Moutai’s target FY21E P/E).

Figure 139: The Company’s 1-yr forward P/E traded at greater discount to Moutai’s 1-yr forward P/E when its wholesale price was below ex-factory price

1-yr forward P/E 1.4 ratio (x) 1.3

1.2

1.1 +1s.d. 1.01x 1.0

0.9 average 0.90x 0.8 -1s.d. 0.79x 0.7 Wuliangye Wuliangye Wuliangye initiated wholesale price wholesale price channel reform, Wuliangye 0.6 below ex-factory below ex-factory inventory control wholesale price price price and profit sharing below ex- to channel 0.5 factory price

Source: Bloomberg, Company data, CMBIS estimates

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Figure 140: Peers’ valuation table P/B ROAE FY0-3 Stock Mkt cap P/E (x) EPS growth (%) (x) (%) EPS FY2 code Rating Price (RMBmn) FY1 FY2 FY3 FY1 FY2 FY3 FY1 FY1 cagr PEG Wuliangye 000858 CH Buy 259.30 1,006,501 49.2 39.9 33.2 17 24 20 11.7 25.5 20.3 2.0

Kweichou Moutai 600519 CH Buy 1700.62 2,136,315 46.3 37.0 32.0 12 25 16 13.3 31.1 17.5 2.1 Jiangsu Yanghe 002304 CH NR 174.06 262,306 34.4 30.4 26.8 3 13 13 6.5 19.1 9.9 3.1 Luzhou Laojiao 000568 CH NR 182.80 267,757 47.2 38.7 32.5 22 22 19 11.7 25.4 21.0 1.8 Shanxi Fen Wine 600809 CH NR 234.74 204,583 77.4 60.7 49.1 36 27 24 22.1 29.5 28.9 2.1 Anhui Gujing 000596 CH NR 222.50 94,859 52.2 40.8 33.9 2 28 20 10.7 20.2 16.4 2.5 Sichuan Swellfun 600779 CH NR 72.50 35,420 49.1 37.2 31.4 (13) 32 18 15.0 30.0 10.9 3.4 Jiangsu King's Luck 603369 CH NR 48.67 61,057 37.9 30.6 24.7 11 24 24 7.3 19.3 19.2 1.6 Beijing Shunxin 000860 CH NR 54.31 40,285 43.5 32.6 26.1 14 33 25 4.8 11.0 24.0 1.4 Anhui Kouzi 603589 CH NR 60.12 36,072 24.9 20.8 18.0 (16) 20 16 4.7 18.3 5.3 3.9 White wine sector 45.9 36.5 30.5 8 25 19 10.7 22.7 17.0 2.4 Source: Bloomberg estimates, CMBIS estimates

Figure 141: P/E band chart

RMB 300 50x

280

260 40x

240

220

200

180 30x 160

140

120 20x

100

80

60 10x 40

20

0

Jul-14 Jul-17 Jul-18 Jul-15 Jul-16 Jul-19 Jul-20

Apr-15 Oct-15 Apr-16 Oct-16 Oct-19 Apr-20 Oct-20 Apr-14 Oct-14 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19

Jan-14 Jan-15 Jan-18 Jan-19 Jan-16 Jan-17 Jan-20

Source: Company data, CMBIS estimates, Bloomberg

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Company Overview

Company background The Company was listed in 1998. As a China renowned brand, Wuliangye has remained true to its original aspiration and kept its mission firmly in mind. Sichuan Yibin, a city built over 2,200 years ago. The local liquor can be dated back over 4,000 years ago. Yibin sits on land that is rated as “the most suitable region for the production of high-quality genuine distilled liquor at the same latitude in the world” by UNESCO and FAO.

The cellar is in the core of liquor production, and the mud in the cellars plays a fundamental role in fermentation. Wuliangye’s cellar cluster was built in 1368 in the Ming Dynasty using the weak acid yellow stick soil which is unique to Yibin. Due to its rich nutrients and other essential ingredients, the soil has facilitated the selection and metabolism of liquor production-related microorganism that finally developed into unique microbial communities and aromatic substances. The more aged the cellar is, the more harmonious and stable the microbial communities are, which generate more aromatic compounds and bring out richer fragrance. Therefore, Wuliangye strong-flavored liquor is renowned for its unique aroma and flavor.

52% alcohol content Wuliangye liquor is the flagship product of the Company. Other products include 501 Wuliangye, Classic Edition Wuliangye and 39% alcohol content Wuliangye. The “4+4” series wine brands include four national brands “五粮春、五粮醇、 五粮头特曲、尖庄” and four regional brands “五粮人家、百家宴、友酒、火爆”. In FY19, sales of high-end liquor (price inclusive of tax >RMB120) and low to mid-end liquor reached RMB39.7bn and RMB6.6bn, representing 79.2% and 13.2% of total revenue, respectively.

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Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E Revenue 40,030 50,118 57,714 68,755 79,488 Profit after tax 14,039 18,228 21,347 26,347 31,532 Liquor 37,752 46,302 52,562 62,316 72,082 JV & associates (101) (93) (83) (96) (105) Others 2,278 3,816 5,152 6,440 7,406 D&A 563 490 530 560 598 Cost of sales (10,487) (12,802) (14,286) (16,353) (17,929) Change in working capital (2,176) 4,482 (2,987) (4,239) (4,331) 29,543 37,316 43,427 52,402 61,559 (8) 5 (0) (0) 1 Gross profit Others Net cash from operating 12,317 23,112 18,807 22,571 27,695 Other income 106 160 160 160 160 Selling expenses (3,778) (4,986) (6,061) (6,950) (7,862) Capex (381) (1,699) (1,052) (1,052) (1,052) Admin expenses (2,340) (2,655) (2,854) (3,180) (3,482) Others 50 82 160 160 160 (84) (126) (46) (55) (64) (332) (1,616) (892) (892) (892) R&D expenses Net cash from investing Tax & surcharges (5,908) (6,984) (7,907) (9,282) (10,651) Others (11) (4) (5) (5) (5) Equity raised 1,814 0 0 0 0 17,527 22,720 26,714 33,091 39,655 (5,410) (7,252) (9,192) (10,688) (13,054) EBIT Dividend paid Others (22) 0 0 0 0 Finance income, net 1,085 1,431 1,655 1,896 2,200 Net cash fr. financing act. (3,618) (7,252) (9,192) (10,688) (13,054) Others (106) (137) (140) (140) (140) JV & associates 101 93 83 96 105 Net change in cash 8,368 14,244 8,722 10,991 13,749 Profit before tax 18,607 24,106 28,312 34,943 41,820 Cash at the beginning of the year 40,592 48,960 63,204 71,926 82,917 Income tax (4,568) (5,878) (6,965) (8,596) (10,288) Exchange difference 0 0 0 0 0 Non-controlling interests (654) (826) (909) (1,090) (1,254) Cash at the end of the year 48,960 63,204 71,926 82,917 96,666 Net profit 13,384 17,402 20,439 25,257 30,278

Balance sheet Key ratios YE 31 Dec (RMB mn) FY18A FY19A FY20E FY21E FY22E YE 31 Dec FY18A FY19A FY20E FY21E FY22E Non-current assets 7,984 9,770 10,375 10,963 11,522 Sales mix (%) PPE 5,614 6,921 7,463 7,975 8,449 Liquor 94.3 92.4 91.1 90.6 90.7 Intangible assets 414 412 412 412 412 Others 5.7 7.6 8.9 9.4 9.3 JV & associates 919 1,022 1,105 1,201 1,306 1,036 1,415 1,395 1,375 1,355 Other non-current assets Margin & ratios (%) Gross margin 73.8 74.5 75.2 76.2 77.4 Current assets 78,110 96,627 109,704 126,542 146,166 EBIT margin 43.8 45.3 46.3 48.1 49.9 Inventories 11,795 13,680 15,048 16,552 18,208 Net margin 33.4 34.7 35.4 36.7 38.1 Trade receivables 13,992 14,778 17,017 20,273 23,437 Payout ratio 49.3 49.1 49.1 49.1 49.1 Other receivables 3,362 4,931 5,678 6,764 7,820 48,960 63,239 71,961 82,952 96,701 Cash balance Balance sheet ratios Current ratio (x) 3.8 3.2 3.5 3.8 4.2 Current liabilities 20,708 30,035 31,562 33,329 35,034 Quick ratio (x) 3.2 2.8 3.0 3.3 3.7 Trade payables 3,566 3,677 4,103 4,697 5,150 A/C receivables days 115 105 101 99 100 Other payables 12,061 18,418 19,519 20,693 21,945 A/C payables days 128 103 99 98 100 Others 5,080 7,939 7,939 7,939 7,939 Inventory turnover days 389 363 367 353 354 Net cash (RMB mn) 48,960 63,239 71,961 82,952 96,701 Non-current liabilities 267 266 266 266 266 Borrowings 0 0 0 0 0 Returns (%) Deferred income 267 266 266 266 266 ROAE 22.9 25.3 25.5 26.9 27.4 ROAA 17.9 18.9 18.9 20.5 21.4 Total net assets 65,119 76,096 88,251 103,909 122,388 Shareholders' equity 63,487 74,291 86,190 101,411 119,288 Per share Minority Interest 1,632 1,805 2,061 2,499 3,100 EPS (RMB) 3.45 4.48 5.27 6.51 7.80 DPS (RMB) 1.70 2.20 2.59 3.19 3.83 BVPS (RMB) 16.36 19.14 22.20 26.13 30.73

Source: Company data, CMBIS estimates

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Disclosures & Disclaimers Analyst Certification The research analyst who is primary responsible for the content of this research report, in whole or in part, certifies that with respect to the securities or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject securities or issuer; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by that analyst in this report. Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the stock(s) covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the stock(s) covered in this research report 3 business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong listed companies covered in this report; and (4) have any financial interests in the Hong Kong listed companies covered in this report.

CMBIS Ratings BUY : Stock with potential return of over 15% over next 12 months HOLD : Stock with potential return of +15% to -10% over next 12 months SELL : Stock with potential loss of over 10% over next 12 months NOT RATED : Stock is not rated by CMBIS

OUTPERFORM : Industry expected to outperform the relevant broad market benchmark over next 12 months MARKET-PERFORM : Industry expected to perform in-line with the relevant broad market benchmark over next 12 months UNDERPERFORM : Industry expected to underperform the relevant broad market benchmark over next 12 months

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