EUR 850.00 For Business Accounts Only

Morningstar | Despite Slow Progress in Direct Sales, Kweichow Moutai Profit Growth Remained Solid in 1H 2019

We maintain our fair value estimate for wide-moat Kweichow Moutai at CNY 880, after the official release of the interim results. Despite slow progress in direct sales, profit growth of 26.6% in the first half was ahead of our projection, because of the increasing mix of the higher margin nonstandardized Zodiac liquor. Earlier this year, Moutai initiated a sales reform, aiming to shift more shipments from the traditional dealers to the direct sales channels (including self-owned stores, customized products sold to group accounts, supermarkets, and online sales platforms), to drive revenue and profit growth, given the hefty price gap between the retail prices and ex-factory prices. Surprisingly, the sales proportion of direct sales did not increase as the company planned previously. In contrast, the sales mix fell from 6% in 2018 to 4% for first-half 2019. Given the company has not yet revealed further details about the development of the direct sales unit, we are not altering our forecasts to factor in the positive effect from the sales reform for the time being. Since the preliminary results were lower than the market consensus, the share prices saw some weaknesses recently. We now view the shares as fairly valued at current levels.

Despite demand for Moutai liquor remains strong, we expect the limited supply to curb top line growth in the short term, given the volume growth of the base liquor production was nearly flat in 2014 (requires four-year preservation before it can be on the market). We also don’t expect the company will take out too much of its finished goods inventory to the market this year, as the company will not have enough shipments to fulfill the demand for 2020, given the lower volume of base liquor production in 2015. As the mix will be normalizing in the second half 2019, we expect the sales growth will slightly decelerate compared with the first half. That said, the supply constraint issue will be resolved in the long term, as Moutai has increased its capacity quite significantly over the past three years, which expected to come online in 2021.

Operating margin in the first half was higher than we anticipated, mainly due to higher gross margin and lower selling, general, and administrative expenses/sales ratio, because the company lowered its marketing and advertising expenses for its series products in the first half. Another reason was because we previously expected the operating expense would increase for the increasing mix from direct sales, a lower margin channel. We already revised down the operating expense/sales ratio forecast to account for the different result.