Jiangsu Yanghe Hurdles and Moutai Support Inflection

Leading Independent Investment Research, Morningstar, Inc.

Morningstar

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Equity Bottom-Up

Jiangsu Yanghe Brewery A / Equity Bottom-Up

We are initiating coverage of <a href="https://www.smartkarma.com/entities/1275" target="_blank" data-smartkarma-citation="entities:1275:1">Jiangsu Yanghe Brewery A (002304 CH)</a> with wide moat and stable moat trend ratings and a fair value estimate of CNY 155 per share, implying a 2018 adjusted P/E ratio of 30 and enterprise value/EBITDA of 19.5.Yanghe has transformed from a second-tier regional baijiu maker into the third-largest distillery by revenue since its IPO in 2009. Its revenue reached CNY 20 billion in 2017, behind Moutai and Wuliangye’s CNY 58 billion and CNY 30 billion, respectively. Thanks to its strong brand equity and solid management execution, Yanghe has become the leader in the midrange to premium segment and enjoys the second-best profitability among peers.Yanghe’s wide economic moat stems from its intangible assets. Unlike Moutai and Wuliangye’s focus on the super-premium market, Yanghe focuses more on the mid- to highend segment, and its product mix is more diversified. With strong innovation capabilities, Yanghe differentiated itself by launching its successful Blue Classic series in 2003, a smooth, soft-tasting baijiu that has been popularized and is embraced by younger drinkers. The innovative Blue Classic series has become the primary sales driver, accounting for 75% of total sales.The retail price of Yanghe’s high-end flagship product, Blue of the Dream, is among the highest among sub-premium baijiu products and about 3.3 times higher than the industry average. We believe the firm’s pricing power is demonstrated by its 43.1% trailing five-year average operating margin, which is much higher than the industry’s 20%.Given its dominance in its home market, we believe the catalyst will come from revenue growth outside of Jiangsu amid the accelerating premiumization trend. In 2014, Yanghe initiated a new campaign, the "new Jiangsu market," that was designed to penetrate other provinces around Jiangsu, where there are large populations, above-average economic growth, and a lack of dominant local midto upper-range baijiu brands. This strategy has started to bear fruit, as sales from outside Jiangsu increased at a 22% CAGR for the past three years, while sales in Jiangsu grew only 3.4% annually.We believe Yanghe will continue to outperform the baijiu sector and gain market share on the back of its strong brand power and extensive distribution network. We anticipate the firm’s revenue to grow at a CAGR of 14% for the next five years, driven by robust sales growth from the "new Jiangsu market" (including Henan, Anhui, Shandong, Zhejiang, and Hubei), growing at 19.3% annually, while revenue in Jiangsu Province increases at 8.4%. We also think the firm’s improving profitability is likely to persist over 2018-22, driven by further product mix improvement and price hikes, and forecast operating margin to average at 45.8% versus the 44.2% average for the past three years.Analyst: Allen Cheng

We are initiating coverage of Jiangsu Yanghe Brewery A (002304 CH) with wide moat and stable moat trend ratings and a fair value estimate of CNY 155 per share, implying a 2018 adjusted P/E ratio of 30 and enterprise value/EBITDA of 19.5.Yanghe has transformed from a second-tier regional baijiu maker into the third-largest distillery by revenue since its IPO in 2009. Its revenue reached CNY 20 billion in 2017, behind Moutai and Wuliangye’s CNY 58 billion and CNY 30 billion, respectively. Thanks to its strong brand equity and solid management execution, Yanghe has become the leader in the midrange to premium segment and enjoys the second-best profitability among peers.Yanghe’s wide economic moat stems from its intangible assets. Unlike Moutai and Wuliangye’s focus on the super-premium market, Yanghe focuses more on the mid- to highend segment, and its product mix is more diversified. With strong innovation capabilities, Yanghe differentiated itself by launching its successful Blue Classic series in 2003, a smooth, soft-tasting baijiu that has been popularized and is embraced by younger drinkers. The innovative Blue Classic series has become the primary sales driver, accounting for 75% of total sales.The retail price of Yanghe’s high-end flagship product, Blue of the Dream, is among the highest among sub-premium baijiu products and about 3.3 times higher than the industry average. We believe the firm’s pricing power is demonstrated by its 43.1% trailing five-year average operating margin, which is much higher than the industry’s 20%.Given its dominance in its home market, we believe the catalyst will come from revenue growth outside of Jiangsu amid the accelerating premiumization trend. In 2014, Yanghe initiated a new campaign, the "new Jiangsu market," that was designed to penetrate other provinces around Jiangsu, where there are large populations, above-average economic growth, and a lack of dominant local midto upper-range baijiu brands. This strategy has started to bear fruit, as sales from outside Jiangsu increased at a 22% CAGR for the past three years, while sales in Jiangsu grew only 3.4% annually.We believe Yanghe will continue to outperform the baijiu sector and gain market share on the back of its strong brand power and extensive distribution network. We anticipate the firm’s revenue to grow at a CAGR of 14% for the next five years, driven by robust sales growth from the "new Jiangsu market" (including Henan, Anhui, Shandong, Zhejiang, and Hubei), growing at 19.3% annually, while revenue in Jiangsu Province increases at 8.4%. We also think the firm’s improving profitability is likely to persist over 2018-22, driven by further product mix improvement and price hikes, and forecast operating margin to average at 45.8% versus the 44.2% average for the past three years.Analyst: Allen Cheng

Initiating Coverage of Jiangsu Yanghe With CNY 155 FVE and Wide Moat and Stable Trend Ratings