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Morningstar | Subpremium baijiu leader Yanghe will benefit from the accelerating premiumization trend.

Jiangsu Yanghe Brewery has transformed from a second-tier regional baijiu maker into the third-largest distillery by revenue since its IPO in 2009, with revenue reaching CNY 20 billion in 2017. 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--its 43% historical five-year average operating margin is much higher than the 20% industry average.With strong innovation capabilities, Yanghe has differentiated itself by launching its successful Blue Classic series in 2003, a smooth, soft-tasting baijiu that has gained popularity and been embraced by younger drinkers. The innovative Blue Classic series has become the primary sales driver, accounting for 75% of total sales. Although Yanghe grew rapidly over the past decade, it was not immune to the crackdown of the anticorruption measures, while both the top and bottom lines saw negative growth in 2013-14. However, we believe the baijiu industry, particularly the premium segment, has resumed growth since 2015, as mass demand from the private sector has replaced the public sector in driving business growth on the back of rising disposable income per capita.Given the firm’s dominance in its home market, we believe the catalyst will come from the revenue growth outside of Jiangsu amid the accelerating premiumization trend. In 2014, Yanghe initiated a new campaign, the "new Jiangsu market," which was designed to penetrate other provinces around Jiangsu, where there are large populations, above-average economic growth, and a lack of dominant local mid- to upper-range baijiu brands. This strategy has started to bear fruit, as sales from outside Jiangsu increased at a 22% CAGR over the past three years while sales in Jiangsu grew only 3.4% annually. The sales percentage from the non-Jiangsu market rose to 47% in 2017 from 35% in 2014.We believe Yanghe will outstrip the baijiu sector due to its strong competitive advantages, underpinned by its intangible assets, and will benefit from the ongoing consolidation of the premium baijiu segment and gain market share from other regional competitors.