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Will investors at last drown their sorrows over baijiu? By Keane Hoo, 2012-6-21
THE baijiu sector was one of the few sectors which attracted great investor interest last year on the back of rising demand, limited production capacity, and the emergence of baijiu as an asset class for investment. We have seen how once buoyant sectors corrected after huge gains were made over a short period of time. Investors are now wondering if we will see a repeat of the boom and bust cycle in the Chinese baijiu sector.
The Chinese baijiu sector witnessed a series of price hikes in 2011. Kweichow Moutai raised ex-factory prices by an average 20 percent on January 1 last year, while Wuliangye Yibin hiked prices by 20 percent to 30 percent last September, according to company filings.
The price hikes significantly boosted earnings. Kweichow Moutai posted a 57.6 percent year-on-year rise in 2012 first quarter net profit to 2.97 billion yuan (US$471 million) on a 42.5 percent increase in revenue to 6.02 billion yuan. Wuliangye Yibin recorded a 46.5 percent increase in first quarter earnings to 3.05 billion yuan, while revenue rose 31.8 percent to 8.2 billion yuan.
Shareholders shared in the benefits of the stellar earnings, with Kweichow Moutai announcing on April 11 cash dividends of 39.97 yuan for every 10 shares held, the highest dividend payment in the history of China's A share market. Based on total equity at the end of 2011, the earnings distribution will cost the company up to 4.15 billion yuan.
Other baijiu makers also paid out big dividends. According to CapitalVue data, the dividend payout ratios last year for Jiangsu Yanghe Brewery Joint-Stock, Wuliangye Yibin and Shanxi Xinghuacun Fen Wine Factory were 33.6 percent, 30.8 percent, and 27.7 percent, respectively.
In addition, shareholders benefited from rising stock prices due to the bullish sentiments. At the close of trade on 15 June, shares of Tuopai Liquor, Jiugui Liquor, and Huzhu Barley Wine have respectively risen 108, 93.8, and 90.4 percent year-to-date. Kweichow Moutai was up 31.4 percent, while Wuliangye Yibin chalked up gains of 5.3 percent.
Rising tide
A rising tide lifts all boats. Smaller baijiu producers also reaped the benefits of growing investor interest, raising funds to ease cash flow pressures. According to a Xinhua report in March, Lu Zhou Lao Jiao partnered with China Minsheng Banking Corp to roll out a baijiu-based investment product. The product, which provides investors with annual returns of 4.2 percent, was sold out in half a day and raised 200 million yuan. The success of the securitization partly reflects excessive liquidity in China chasing too few investment targets. Investors could also speculate on baijiu prices following the launch of baijiu trading on the online Jinmajia Equity Platform operated by the Beijing Equity Exchange.
The high profitability has led to foreign distilleries making a beeline to China's baijiu sector. The most recent acquisition was undertaken by Diageo Highlands Holding, which won regulatory approval last year to up its stake in Sichuan Chengdu Quanxing Group from 49 to 53 percent. Quanxing Group controlled Sichuan Swellfun, which owns the baijiu brand Shui Jing Fang. Diageo has since launched Shui Jing Fang in seven countries and at duty-free shops in 40 airports worldwide. In line with regulations, Diageo launched a mandatory tender offer to all shareholders, excluding Quanxing Group, in March.
Double-edged sword
The entry of foreign spirits makers into the Chinese baijiu market is a double-edged sword for local baijiu makers. Although competition will intensify, possibly leading to an erosion of profit margins, the pie may be significantly enlarged if the foreign distilleries manage to successfully introduce baijiu to the uninitiated in international markets.
It will not be easy for foreign distilleries to displace the likes of Moutai and Wuliangye as the preferred tipple of choice in China. According to the 2011 Hurun Report, luxury consumers in China rated Moutai as the preferred baijiu brand. Other than brand loyalty and recognition, one reason for the dominance of Moutai is that baijiu production is located in the town of Maotai, which is acknowledged as having the best environment for baijiu production. Geographical limits thus hamper the ability of foreign distilleries to compete in the high-end segment of the market.
The boom will not be threatened by the entry of foreign players. Instead, the bursting of the baijiu bubble may have been precipitated by the pledge made by Premier Wen Jiabao in March to ban the use of public funds to buy high-end alcohol amid widespread public anger over the misuse of government funds. If strictly enforced, this will deal a huge blow to the baijiu industry, which has been greatly dependent on purchases by government agencies. Following the comments by Wen, prices of some top-end Moutai brands dropped from a peak of 2,000 yuan last year to about 1,400 yuan per bottle, while the wholesale price of Wuliangye dropped from 1,000 yuan per bottle during the peak season to about 750 yuan per bottle.
Slowing economy
The slowing domestic economy is another drag on the sector as the huge expense accounts of corporations are squeezed, directly affecting baijiu demand and increasing inventory levels. The twin impact of lower demand from government agencies and the corporate sector, coupled with the threat posed by counterfeit baijiu, have exacted a toll on baijiu producers. According to a Chengdu Business Daily report on May 25, Lu Zhou Lao Jiao lowered the sales target for distributors in 2012, cutting the target for the high-end Guojiao 1573 by 1,500 tons to 4,500 tons.
The deteriorating industry fundamentals led to the share prices of Lu Zhou Lao Jiao, Jiugui Liquor, and Wuliangye Yibin declining by more than 10 percent in the past month.
Faced with strong headwinds, the domestic baijiu sector will have to go into overdrive and take remedial measures to ensure that the current market is just experiencing a healthy correction, and is not the prelude to a full-blown market crash. Failure to do so could lead to investors drowning their sorrows over baijiu purchased at inflated prices.
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