EUR 850.00 For Business Accounts Only

Morningstar | Moutai Will Improve Profitability From Structural Sales Channel Reform; Raising Our FVE to CNY 750. See Updated Analyst Note from 20 Mar 2019

We are increasing our fair value estimate for wide-moat Kweichow Moutai to CNY 750 per share from CNY 670, as we increase our earnings forecasts to reflect the positive impact from the company’s structural sales channel reform. We now project Kweichow Moutai’s revenue and net profits to grow at CAGRs of 14.7% and 13.9%, respectively, through 2022, with operating margin averaging 60.5%. Following a strong rally year to date, we view the shares as fairly valued at current levels.

Moutai is a sauce-aroma type of baijiu, with the fermentation process taking one year of production and four years of aging before it can become a bottle of liquor. For example, the produced base liquor in 2012 was available to sell in 2017 after maturation. Note that the quantity of Moutai liquor is about 85% of the base liquor production five years ago, in theory.

Based on the historical production numbers of base liquor, we expect sales volume to increase slightly in 2019 but to drop significantly in 2020, due to 17% year-on-year base liquor production volume decrease in 2015. However, salable volume should increase again in 2021 onward, as production picked up 22% and 9% year on year, respectively, in 2016 and 2017.

The company has implemented several strategies, including raising ex-factory prices, increasing direct sales (higher selling price versus that through distributors), and improving product mix by launching more nonstandardized high-end products, to mitigate the impact of lower volume of salable liquor for 2019 and 2020.

In December 2018, Kweichow Moutai has decided to implement sales distribution reform. It plans to freeze the quotas for the distributor channel, as it will deliver only 17,000 metric tons of Moutai liquors to its distributors in 2019, which is about 6,000 metric tons short from last year. This will account for 55% of the total 31,000 metric tons target shipments, which is much lower than the historical average of 80% over the past decade. The remaining 14,000 metric tons of Moutai liquor will be shipped to the direct sales channels, such as self-owned stores, customized products sold to group accounts, supermarkets, and online sales platforms. Moreover, the company will not add distributors or franchisees stores, according to management. We think this will be a structural change for the firm's sales distribution network and expect to see more sales volume shifting to the direct sales channel. While we believe the distributor channel will remain the major sales network for Kweichow Moutai, sales via the direct channel are expected to gradually increase to around 50% thorough 2022.

We believe Kweichow Moutai's profits will benefit from the sales channel reform, given the price gap between the retail price and ex-factory price will boost the revenue and profits from the higher margins. Based on our estimates, the average selling price in the direct sales channel was 78% higher than in the distributor channel in the past three years. We forecast the average selling price will be driven by incremental sales volume from direct sales channel and from nonstandardized products, although the company does not intend to raise its ex-factory price in 2019, which we think seems to be a more efficient strategy to improve its profitability, since margins are still thick enough for distributors and retailers. It would not make any sense for the company to not raise its ex-factory prices going forward.