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Morningstar | Raising Wuliangye’s FVE to CNY 80 Following Strong 2Q Results; Shares Are Undervalued. See Updated Analyst Note from 28 Aug 2018

While we maintain our wide moat and stable trend ratings for Wuliangye Yibin, we are raising our fair value estimate by 7% to CNY 80 per share from CNY 75 following its upbeat first-half 2018 result, mainly owing to a higher revenue growth forecast and the time value of money. We increase our five-year revenue CAGR forecast to 16.2% (from 15% previously), as we are more optimistic for the growth of the company’s premium liquors. Meanwhile, we lower our average operating profit margin slightly to 43.4% (from 43.6% previously), owing to a higher business tax rate. Given that shares are trading at a 20% discount to our new fair value estimate, we think Wuliangye is undervalued at current levels.

The company’s second-quarter results were ahead of the market’s and our expectations. Revenue came in strong at CNY 7.52 billion, up 38% year on year, which was higher than our 28% revenue growth projection. The promising revenue growth, stemming from strong volume growth, came from the strong demand for premium liquors and also benefited from the supply constraints of major rival Kweichow Moutai. Shipments for the premium Wuliangye liquor amounted to 12,000 metric tons in the first half, and management is confident that it can attain its full-year target of 20,000 metric tons, with 8,000 metric tons of supply in the second half. Advance payments from distributors, a key indicator for projecting sales growth, also painted a picture of weakening demand like that for Kweichow Moutai, as the balance dropped 23% to CNY 4.42 billion from the first quarter's CNY 5.77 billion. However, demand still looks robust in 2018, as the end channel's inventory level remains healthy, which should allow Wuliangye to achieve its full-year target of 20,000 metric tons.

Gross profit increased 35% year on year to CNY 5.43 billion, with gross margin sliding 1.5 percentage points from last year to 72.2%, attributable to product mix changes due to supply control on the premium liquors. On the cost front, while the business tax/sales ratio increased 2 percentage points from last year, the selling, general, and administrative expense ratio declined 5.6 percentage points, thanks to lower subsidies to distributors and effective control on marketing expenses. The higher business tax was due to new government policy on the consumption tax rate hikes, which started in May 2017. We believe the year-on-year negative impact will ease in second-half 2018. As a result, the operating profit grew 45% year on year to CNY 2.94 billion, with operating margin rising 2 percentage points year on year to 39%. Thanks to lower taxes, net profit surged 55% year on year to CNY 2.14 billion.