December 11, 2018 Food & Beverages Gan Bei: low inventory to support growth HINA C ■ We believe the China baijiu sector’s short-term slowdown has been priced in, and we consider the sector’s current valuation to be attractive. ■ Positive on the long-term outlook on product mix upgrades and channel reforms. Current tight channel inventory supports volume growth in 1H19F ■ We initiate coverage on China’s baijiu sector with an Overweight rating. Our top pick is Moutai. We have an Add call on Yanghe and Hold on Wuliangye. AVIGATING AVIGATING N Analyst(s) Lei YANG, CFA T (86) 21 6162 9676 E [email protected] FeiFei SUN T (86) 21 6162 5750 E [email protected] IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE Powered by END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN THE UNITED STATES IT IS DISTRIBUTED BY CGS-CIMB the EFA SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. Platform Navigating China Consumer Staples │Food & Beverages │December 11, 2018 TABLE OF CONTENTS Sector summary ............................................................................................................................. 5 Our market survey finds younger generation has started to drink baijiu ....................................... 9 China Baijiu sector overview ....................................................................................................... 13 Comparison of major baijiu players ............................................................................................. 19 Valuation and stock recommendation ......................................................................................... 21 Sector, Company Briefs OR Appendices… ................................................................................. 27 2 INITIATION Sector Note Navigating China │Food & Beverages │December 11, 2018 China Food & Beverages Overweight Gan Bei: low inventory to support growth Highlighted Companies ■ We believe the China baijiu sector’s short-term slowdown has been priced in, Jiangsu Yanghe Brewery and we consider the sector’s current valuation to be attractive. ADD, TP Rmb120.0, Rmb99.4 close ■ Positive on the long-term outlook on product mix upgrades and channel Moutai is the king of the super-premium baijiu sector in China, with its strong reforms. Current tight channel inventory supports volume growth in 1H19F brand name and high collectable value. ■ We initiate coverage on China’s baijiu sector with an Overweight rating. Our We expect its Series brands to become top pick is Moutai. We have an Add call on Yanghe and Hold on Wuliangye. another sales growth driver for the future. Moutai is our top pick for the sector. Short-term slowdown has been largely priced in… Kwechow Moutai Co. Ltd Following their 3Q18 results announcements, baijiu companies’ share prices corrected ADD, TP Rmb720.0, Rmb583.0 close significantly due to the slowdown in sales growth. The SW Baijiu Index has dropped 24% Yanghe has a strong distribution network YTD. The current trailing P/E for the SW Baijiu Index is down to 20.6x, close to 1 s.d. and well-recognised brand. Thanks to its below its historical average P/E of 25.5x in Apr 2015-YTD 2018 (-1 s.d. is 20.1x). We expansion to new markets and further believe the baijiu sector’s short-term slowdown has been priced in, and we consider the penetration into its home market of Jiangsu, we expect a solid 17% sales sector’s valuation to be relatively cheap now. We do not expect the current slowdown to CAGR and 19% net profit CAGR over be as severe as in 2013-15, when the baijiu sector underwent a restructuring period. FY17-20F. … and we are positive on the long-term outlook Wuliangye Yibin We expect premiumisation and channel penetration to drive baijiu sales growth in the HOLD, TP Rmb55.00, Rmb52.82 close long run. Euromonitor forecasts China’s super premium (retail selling price of Wuliangye’s channel reform is currently >Rmb600/bottle) and premium baijiu segments (Rmb300-600/bottle) to post sales CAGR in progress. We expect these reforms and its series brands to drive a sales of 12% and 13%, respectively, in 2017-20F. We expect the tight channel inventory now CAGR of 17% over FY17-20F. to support baijiu companies’ sales growth. Our channel checks revealed Moutai’s channel inventory is c.1 month and Wuliangye’s is 1.0-1.5 months (vs. normalised 2-3 months). Summary Valuation Metrics Baijiu becoming more popular with the younger generation P/E (x) Dec-18F Dec-19F Dec-20F Traditionally, the main consumers of baijiu are aged 30-50 years. However, based on our Jiangsu Yanghe Brewery 18.32 15.99 13.28 market survey in Oct 2018, 45% of survey respondents aged 20-30 years indicated they Kwechow Moutai Co. Ltd 21.65 18.94 15.96 Wuliangye Yibin 16.25 14.24 12.28 habitually drink baijiu. Our survey also revealed that demand for baijiu is likely to be more resilient than for other alcoholic drinks. Around 62% of survey respondents said they P/BV (x) Dec-18F Dec-19F Dec-20F would increase baijiu consumption in the long run. Jiangsu Yanghe Brewery 4.42 3.89 3.38 Kwechow Moutai Co. Ltd 6.57 5.51 4.61 Wuliangye Yibin 3.45 3.09 2.76 We like Moutai’s brand name and Yanghe’s distribution network Moutai achieved sales CAGR of 7% during the last baijiu downturn (2013-15), when Dividend Yield Dec-18F Dec-19F Dec-20F industry sales contracted by 6% CAGR, reflecting Moutai’s superior market position. For Jiangsu Yanghe Brewery 3.17% 3.63% 4.37% Kwechow Moutai Co. Ltd 2.36% 2.69% 3.20% Yanghe, we think its unique “go to market” distribution model as a competitive advantage. Wuliangye Yibin 3.21% 3.66% 4.25% It has more than 5,000 sales personnel vs. Moutai’s 684 and Wuliangye’s 576 in FY17. Insert Initiate coverage on baijiu sector with Overweight We initiate on China’s baijiu sector with Overweight for its longer-term earnings growth potential. We have Add ratings on Moutai & Yanghe and Hold on Wuliangye. Catalysts: 1) government tax cuts and stimulus policies triggering domestic consumption recovery, Analyst(s) and 2) rise in weightage of China’s large-cap securities in MSCI to 20% from 5%. Figure 1: Moutai’s, Wuliangye’s and Yanghe’s relative share price performance vs. market index (rebased 31 Dec 2012 = 100) Share performance comparison ( rebase 31 Dec 2012 =100) 400 Baijiu industry adjustment cycle Baijiu industry recovery cycle Lei YANG, CFA 300 T (86) 21 6162 9676 E [email protected] 200 FeiFei SUN T (86) 21 6162 5750 100 E [email protected] 0 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 Moutai Wuliangye Yanghe Shanghai Stock Exchange Composite Index Shenzhen Stock Exchange Component Index SOURCES: CGS-CIMB RESEARCH, BLOOMBERG IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by EFA THE UNITED STATES IT IS DISTRIBUTED BY CGS-CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFACustomEntityStatement Platform Navigating China Food & Beverages │December 11, 2018 KEY CHARTS Short-term slowdown largely priced in… SW Baijiu Index trailing P/E Following their 3Q18 results announcements, baijiu Current trailing P/E(x): 20.6; Mean:25.5; +1std: 31.0; -1std: 20.1 companies’ share prices corrected significantly due to the 45 slowdown in sales growth. The Shenwan (SW) Baijiu The trailing P/E (x) on CSSW Baijiu Index Mean +1 std -1 std Index has dropped 24% YTD. The current trailing P/E for 40 the SW Baijiu Index is down to 20.6x, close to 1 s.d. below 35 its historical average P/E of 25.5x in Apr 2015-YTD 2018 (- 30 1 s.d. is 20.1x). The baijiu sector’s short-term slowdown 25 has been priced in and we consider the sector’s P/E 20 valuation to be attractive now. 15 Jun-15 Jun-17 Jun-18 Jun-16 Oct-16 Oct-15 Oct-17 Oct-18 Apr-18 Apr-15 Apr-16 Apr-17 Feb-17 Feb-16 Feb-18 Dec-15 Dec-16 Dec-17 Aug-15 Aug-16 Aug-17 Aug-18 … and we are positive on the industry’s long- China baijiu industry sales performance and forecast term prospects China baijiu industry cycle Adjustment period Recovery period New growth period sales value growth 2012-15 CAGR 2015-17 CAGR 2017-20F CAGR Euromonitor forecasts that China’s super premium (retail Low-end 10% 0% -8% selling price of >Rmb600/bottle) and premium baijiu Mid-range 7% 9% 9% Premium 1% 13% 13% segments (Rmb300-600/bottle) will achieve sales CAGR Super premium -11% 14% 12% of 12% and 13%, respectively, in 2017-20F. We also Total China Baijiu Industry -5% 12% 11% Note: Recovery period sales CAGR of 2015-17 is higher than the sales CAGR of the new growth expect the current tight channel inventory to support baijiu period of 2017-20F, due to a low base in 2015 (2015:Rmb729bn vs 2017: Rmb915bn) companies’ sales growth. Our market survey finds baijiu becoming Our survey revealed younger consumers are drinking baijiu more popular with the younger generation 100% Traditionally, the main consumers of baijiu are aged 30-50 years. However, based on our market survey in Oct 2018, 45% of survey respondents aged 20-30 years indicated they habitually drink baijiu. Our survey revealed that baijiu 50% is gaining popularity among consumers aged below 20 years. 0% < 20yrs old 20-30 yrs old 30-40 yrs old 40-50 yrs old > 50 yrs old Drink baijiu Don't drink Moutai is the most valuable baijiu brand; we Yanghe's number of sales personnel far exceeds Moutai’s and like Yanghe’s unique distribution network Wuliangye’s Moutai achieved 7% sales CAGR in 2012-15, when there No.