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Morningstar | Yanghe's 3Q Profit Slightly Short of Our Forecast; Cutting FVE to CNY 136 but Shares Are Attractive

Wide-moat Jiangsu Yanghe Brewery's third-quarter results slightly fell short of our forecasts, with revenue and net profit increasing 20.1% and 21.5% year on year, respectively. We attribute the decelerating top-line growth (versus the first half’s 26% year-on-year increase) to weaker-than-expected demand during the Mid-Autumn Festival and distributors stocking in advance (in the second quarter) before the ex-factory price hikes effective July 1. As the company intends to control shipments to ensure the inventory in the end channel is healthy, we expect its revenue to grow at 10% year on year in the fourth quarter.

We are trimming our fair value estimate to CNY 136 per share from CNY 160 as we lower our profit growth assumptions, given our concern that demand for premium baijiu will be curbed as the Chinese economy weakens. Industry leaders Kweichow Moutai's and Wuliangye Yibin’s worse-than-expected third-quarter results also painted a picture of weak demand for premium baijiu.

That said, we maintain our wide economic moat and stable moat trend ratings, as our long-term view for Jiangsu Yanghe remains positive. We expect the company’s revenue and net profit to grow at compound annual growth rate of 12.6% and 13.5%, respectively, through 2022, driven by the company’s "new Jiangsu" market expansion strategy and better product mix (increasing sales percentage from the premium liquor Blue of Dream). Management expects revenue contribution will be 50/50 from Jiangsu province/non-Jiangsu markets. We believe Jiangsu Yanghe’s short-term share price performance will remain soft as the market worries about weak future demand, but we think the current price provides a good entry point from a long-term perspective, as it is a 38% discount to our new fair value estimate.

Revenue was CNY 6.42 billion, up 20.1% year on year. The premium liquor Blue of Dream grew strongly at 50% in the third quarter, while subpremium liquor Blue of Sky and midrange liquor Blue of Ocean grew at a low teens pace. Profitability continued to see improvement in the quarter. Gross margin was slightly better than our expectation, thanks to price hikes and the product mix upgrade. The sales expense ratio was largely stable while the administrative expense ratio decreased 2.4 percentage points. As a result, operating profit margin and net margin improved 53 and 37 basis points, respectively, to 42.1% and 31.7%.