www.ubssecurities.com This report has been prepared by UBS Securities Co. Limited. This is a translation of a Chinese research note published by UBS Securities Co Ltd on 30 October 2019. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 21. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. abc Global Research 31 October 2019 China Baijiu Sector Is a tipping point coming soon after a four-year industry upcycle? Autumn CFDF feedback indicated expectations are returning to rationality Last week, we hosted investors to attend the 2019 Autumn China Food & Drinks Fair (CFDF) in Tianjin, and had meetings with some industry experts. Feedback suggested investors and industry professionals’ expectations have been returning to rationality, primarily due to the healthy pull-back in premium baijiu prices as Moutai liquor supply gradually recovers. Previously, after the 2019 Spring CFDF (report), premium baijiu prices spiked sharply due to shrunken supply, boosting market sentiment. We think: 1) generally, despite rising economic uncertainties, increasing household consumption and leading producers’ healthy channel inventory suggest higher-end baijiu could achieve steady and sustainable growth over the next few years; and 2) unlike what some investors expect, there may be no cyclical tipping point for baijiu ahead. A low-growth, less-cyclical age: major brands could attain structural growth We think higher-end baijiu's steady growth since 2018 could have ushered in a new era for major baijiu companies’ structural growth amid consumption upgrades, with these industry characteristics: 1) slow growth and weak cyclicality, with continued market concentration towards major/higher-end baijiu brands (only about 1.5% market share in 2018 by sales volume); and 2) leading producers’ steady and structural growth, mainly driven by improving management, continuous product mix upgrades, solid regional/channel expansion and appropriate price hikes. These clearly differ from the high growth and the strong cyclicality before 2012 driven by government consumption. Competition likely to rise structurally; even major brands could diverge further Premium baijiu makers face limited competition in their respective price bands due to strong brands, with growth depending mainly on the economy and their risk-resisting ability. High-end baijiu companies face rising competition due to more competitors, despite their stronger sub-sector growth outlook. In recent years, regionally famous baijiu brand have upgraded their product mixes and brands amid premiumisation and are challenging nationwide high-end brands in their respective base markets. We agree with sector experts that the sector may see more M&A activities going forward. Valuation: growth visibility/long-term potential matter for premium/high-end Premium baijiu’s valuation premium comes mainly from their high growth visibility, while high-end baijiu’s long-term growth potential is a major driver of valuation upside, in our view. Among baijiu stocks we cover, our order of preference is: Jiangsu Yanghe, Kweichow Moutai, Wuliangye Yibin, Luzhou Laojiao and Sichuan Swellfun. Equities China Distillers & Brewers Brad Chen Analyst S1460516060001 brad-a.chen@ubssecurities.com +86-213-866 8985 Frank Su Associate frank.su@ubssecurities.com +86-213-866 8811 China Baijiu Sector 31 October 2019 abc 2 Contents UBS-S Research THESIS MAP ............................................................. 3 First meeting with experts: opinion leader Wang Zhaocheng on baijiu ................................................................................................. 4 Second meeting: an expert from a baijiu consulting firm ............ 8 Third meeting with experts: a Hunan baijiu distributor ............. 10 Fourth meeting with experts: a Henan baijiu distributor ........... 13 Fifth meeting with experts: a Fenjiu distributor based in Shandong........................................................................................ 18 Brad Chen Analyst S1460516060001 brad-a.chen@ubssecurities.com +86-213-866 8985 Frank Su Associate frank.su@ubssecurities.com +86-213-866 8811 China Baijiu Sector 31 October 2019 abc 3 China Baijiu Sector UBS-S Research THESIS MAP a guide to our thinking and what's where in this report MOST FAVORED LEAST FAVORED Jiangsu Yanghe, Kweichow Moutai, Wuliangye Yibin Swellfun, Luzhou Laojiao PIVOTAL QUESTIONS Q: Can rising household consumption bolster demand for higher-end baijiu in 2019-21 with the weaker economy impacting business-related consumption? Yes. We believe the continued healthy demand for and consumption upgrade to higher-end baijiu by households could sustain (retail) value growth in the higher-end seg...
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