Sector Note Consumer Staples│China│October 20, 2020 China Food & Beverages Overweight (no change) Meeting upgrade preferences in lower-tier cities ■ We conducted a market survey with 1,057 consumers regarding China’s baijiu sector. Highlighted companies We found that COVID-19 has resulted in some weddings, banquets, etc. being Anhui Gujing Distillery postponed until 2H20F, which should benefit 2H20F baijiu consumption. ADD, TP Rmb273.0, Rmb206.9 close ■ In this report, we initiate coverage with Add ratings for three dominant regional Gujing is the market leader in Anhui Province. market baijiu players – Anhui Gujing, Shanxi Fen Wine and Jiangsu King’s Luck – We like Gujing because it has large margin ranked in that order. We also reiterate our Add ratings for the national super-premium improvement potential, as its home market is baijiu players: Moutai, Wuliangye and Luzhoulaojiao. in the harvest stage; its Cellar brand should help it gain market share. Overweight on the baijiu sector in 2H20F Jiangsu King's Luck Brewery According to feedback from the Autumn Food & Drinks Fair, just held in Qingdao, and ADD, TP Rmb57.00, Rmb47.10 close consumption data related to the Mid-Autumn Festival and National Day Holidays, super- premium liquor sales continue to be strong in 3Q20. Super-premium baijiu recovered King’s Luck is the second-largest liquor company in Jiangsu Province. Its high-end faster in 1H20 and we forecast that Moutai will maintain 10% yoy sales growth in 3Q20, product structure and strong resources in the vs 11% in 1H20, and that Wuliangye and Luzhou Laojiao will achieve 10–15% yoy sales corporate consumption channel should growth in 3Q20, vs 13% and -5% yoy in 1H20. It is also highly possible that Yanghe will continue to provide stable sales growth. achieve yoy positive sales growth in 3Q20. Because of a lot of weddings and banquets Shanxi Xinghuacun Fen Wine being postponed to 3Q20, we expect premium and regional leading baijiu players to have ADD, TP Rmb261.0, Rmb208.2 close stronger sales recovery than super-premium players in 3Q20. We expect Gujing and Fen Wine is China’s largest light fragrance King’s Luck to have solid sales growth in 3Q20. The recovery of mid-range liquor sales liquor play. Its unique taste and product was also significant, so we expect Fen Wine to achieve over double-digit sales growth in structure cater for the preferences of young 3Q20. In 4Q20 and FY21F, we expect the consumption atmosphere to continue to consumers. It just completed SOE reform, and recover, and leading regional players should have faster sales growth in 1H21F, given an incentive share plan will accelerate its their low base in 1H20. nationwide market penetration. COVID-19 to put off some baijiu consumption to 2H20F In our market survey, 55.9% of participants indicated COVID-19 had affected their baijiu Summary valuation metrics use, and 63.3% said they have put off baijiu purchases in relation to weddings, banquets, P/E (x) Dec-20F Dec-21F Dec-22F etc. to 2H20F, which should benefit baijiu sales growth in 2H20F. Only 42.9% of Anhui Gujing Distillery 48.18 38.12 30.48 Jiangsu King's Luck Brewery 38.53 31.13 24.72 participants said they would stock up on baijiu, and 41.1% said they would keep only a Shanxi Xinghuacun Fen Wine 76.61 59.30 46.84 month’s supply. We believe the current baijiu channel inventory is at a relatively low level. P/BV (x) Dec-20F Dec-21F Dec-22F Meeting the upgrade preferences in lower-tier cities Anhui Gujing Distillery 10.06 8.46 7.07 According to Euromonitor data, there is a clear mix upgrade trend in China’s baijiu sector. Jiangsu King's Luck Brewery 7.18 6.17 5.23 Super premium baijiu volume and value grew by an 11.4% and 11.6% CAGR in 2014–19, Shanxi Xinghuacun Fen Wine 20.10 16.30 13.18 and premium baijiu volume and value increased by a 6.6% and 9.0% CAGR, respectively, higher than the other low-end segments. The regionally dominant baijiu Dividend Yield Dec-20F Dec-21F Dec-22F Anhui Gujing Distillery 0.75% 0.94% 1.18% players, such as Gujing, Fen Wine and King’s Luck, have met the mix upgrade Jiangsu King's Luck Brewery 0.92% 1.13% 1.43% preferences in lower-tier cities, leveraging their dominant position in home markets and Shanxi Xinghuacun Fen Wine 0.53% 0.68% 0.86% strong distribution channels to expand into outside markets. Gujing has done particularly well in mix upgrading and has improved its GPM from 71% in FY15 to 77% in FY19, the Insert highest among the three regional players in FY19 (Fen Wine: 72%; King’s Luck: 73%). Distribution channel reform expected to expand to outside markets The three leading regional players are improving their distribution networks to penetrate into markets outside of home markets. Fen Wine achieved a strong sales CAGR of 29% in outside markets in 2014–19. Fen Wine’s sales contribution from outside markets has been improved from 43% in FY15 to 51% in FY19, the highest among three, vs. 28% for Gujing and 6% for King’s Luck. We expect the penetration of outside markets to be an important growth driver in the medium term, and these regional players will further gain market shares in the national market. Because of the COVID-19 pandemic, baijiu players started embracing online digital marketing earlier this year. Gujing is developing live- streaming campaigns to introduce its culture and processing techniques. Buying opportunity for regional leading players In the long term, we prefer national super premium baijiu players, like Moutai, Wuliangye and Luzhou Laojiao, given their strong brand power, superior market position, and potential to raise selling prices. But in 2H20F and 1H21F, we expect these regional leading players, like Gujing, Fen Wine and King’s Luck to deliver faster growth, since 1) they recover later than the national players in 1H20, 2) the delayed wedding and Analysts banquets to boost demand in 2H20F, and 3) low base effect for 1H21F. Therefore, we see buying opportunities for these leading regional players in 2H20F. Lei Yang T (86) 21 6162 9676 Gujing is our top pick, followed by Fen Wine E [email protected] Gujing is our top pick among the three regional baijiu players, followed by Fen Wine and Sun Feifei King’s Luck, because of its strong product mix upgrade and channel penetration T (86) 21 6162 5750 capability. We also like Fen Wine, owing to its employee motivation system and fast E [email protected] growth in 1H20. We believe Gujing’s valuation of about 40x FY21F P/E is relatively attractive. One risk is more intense competition in 2H20F. Powered by the EFA Platform Consumer Staples│China Food & Beverages│October 20, 2020 Meeting upgrade preferences in lower-tier cities Overweight on the baijiu sector in 2H20F According to feedback from the Autumn Food & Drinks Fair, just held in Qingdao, and consumption data related to the Mid-Autumn Festival and National Day Holidays, super-premium liquor sales continue to be strong in 3Q20. Super- premium baijiu recovered faster in 1H20 and we forecast that Moutai will maintain 10% yoy sales growth in 3Q20, vs 11% in 1H20, and that Wuliangye and Luzhou Laojiao will achieve 10–15% yoy sales growth in 3Q20, vs 13% and -5% yoy in 1H20. It is also highly possible that Yanghe will achieve yoy positive sales growth in 3Q20. Because of a lot of weddings and banquets being postponed to 3Q20, we expect premium and regional leading baijiu players to have stronger sales recovery than super-premium players in 3Q20. We expect Gujing and King’s Luck to have solid sales growth in 3Q20. The recovery of mid- range liquor sales was also significant, so we expect Fen Wine to achieve over double-digit sales growth in 3Q20. In 4Q20 and FY21F, we expect the consumption atmosphere to continue to recover, and leading regional players should have faster sales growth in 1H21F, given their low base in 1H20. In the long term, we prefer national super premium baijiu players, like Moutai, Wuliangye and Luzhou Laojiao, given their strong brand power, superior market position, and potential to raise selling prices. But in 2H20F and 1H21F, we expect these regional leading players, like Gujing, Fen Wine and King’s Luck to deliver faster growth, since 1) they recover later than the national players in 1H20, 2) the delayed wedding and banquets to boost demand in 2H20F, and 3) low base effect for 1H21F. Therefore, we see buying opportunities for these leading regional players in 2H20F. The retail selling price range for national super premium players is above Rmb600 per bottle. Moutai and Wuliangye’s core products have hit the retail prices of close to Rmb3,000 per bottle and over Rmb1,000 per bottle, respectively. While Luzhou Liaojiao’s Cellar 1573 is selling over Rmb900 per bottle in the market. The major consumption group for the super- premium baijiu is the business entertainment. For the regional leading players, most of their products are mid-end and premium segments, with retail prices of Rmb100-300 per bottle and Rmb300- 600 per bottle. The major consumption group of the premium baijiu is the group gathering and banquets eg: the weddings, family fest in Chinese New Year; Gujing’s Cellar Age brand, Fen Wine’s Qinghua brand and King’s Luck’ Guoyuan brand are quite popular for these consumption scenes. The individual consumption and small group gathering incline to choose the mid-range baijiu products, eg: Fen Wine’s Laobaifen brand.