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Morningstar | Premium Liquor Blue of Dream Fuels Yanghe's 1H Profits, up 28%; Shares Look Attractive

Thanks to strong sales volume growth of its premium liquor, Blue of Dream, wide-moat Jiangsu Yanghe Brewery JSC’s CNY 5 billion net profit, up 28% year on year, in the first half of 2018 was ahead of our forecast. Revenue grew 26% to CNY 14.5 billion, stemming from promising 30% top-line growth outside of Jiangsu, as a positive outcome of its "new Jiangsu" market expansion strategy. The home market of Jiangsu Province also accomplished impressive revenue growth, with sales rising 20% from the year-ago period. Operating profit margin lifted 85 basis points owing to favorable mix toward higher-end products and moderate price hikes, along with effective cost reductions.

We increase our fair value estimate to CNY 160 per share from CNY 155 after taking into account higher 2018 full-year profit forecast of CNY 8.4 billion, implying 26% growth versus our 18% prior forecast, as we believe the robust growth will persist in the second half. We now project Yanghe’s revenue and net profit will increase at compound annual growth rates of 13.6% and 15%, respectively, for the next five years, with operating margin averaging 46% compared with a 44.2% average for the past three years. In our geographic revenue assumptions, we anticipate the revenue growth from the Jiangsu and non-Jiangsu markets will be 9% and 18%, respectively. We think the recent weakness of the shares, which have dropped 22% since June 12, offers a good entry point for the second most profitable baijiu company, given that the shares are trading at a 27% discount to our fair value estimate.

The Blue series, as known as an innovative soft (mianrou) type of baijiu, contributed over 75% of total sales and played a key profit driver for the company. Thanks to strong demand, the premium liquor, Blue of Dream, saw tremendous 50%-60% sales growth, based on our estimate, while subpremium liquor Blue of Sky and midrange liquor Blue of Ocean increased in double digits constantly. We expect the contribution from Blue of Dream and Sky will continue to increase in light of the firm’s leading position in the subpremium baijiu market amid the ongoing premiumization trend, as well as the company’s prudent distribution expansion plan.

In contrast to Kweichow Moutai and Wuliangye Yibin, Yanghe’s advancement payment from distributors was up 40% to CNY 2.06 billion from the first quarter, possibly owing to the distributors' intent to lock in the purchase price before the ex-factory price effective in July. This reaffirms our view that demand for Yanghe will remain robust in the second half.