Description

Yanghe is a Chinese baijiu (“white alcohol”) company.  Over the past decade, Yanghe has experienced huge growth.  From 2006 to 2012 total revenues compounded at a 59% (!) CAGR.  Then, the corruption crackdown hit.  Revenues declined 13% in 2013 and 2% in 2014.  Revenue growth resumed in 2015, growing 9%.  In 2016, revenue grew 7%.  In 2016, Yanghe generated US$2.6 bn of revenues.

Today, government consumption has been cleared out and what remains is a healthy consumer franchise.  Yanghe's prices for most of its offerings are in the ordinary consumption range, 100-400 RMB, far lower than the thousands of RMB charged by super-premium competitors Moutai and Wuliangye.

Baijiu is a huge industry in China.  In 2015, total baijiu sales volume in China was 13 mm tons, with total sales value of US$84 bn.  Nationally, Yanghe was #4 with 1 mm tons of sales volume and 8% market share.  In Jiangsu, where Yanghe is dominant, Yanghe has 23% market share by value. 

Baijiu is a very good business – brand matters more than price as baijiu is not bought on price.  There is also a jewelry-like effect where higher price causes buyers to ascribe more value to the product.  For Yanghe, even with its much lower ASPs vs. Moutai and Wuliangye, gross margins are 60%+ and operating margins are 40%+.  Despite significant inventory aging requirements, Yanghe generates a 20% ROIC.

Yanghe has a good brand, especially in its most important “blue” category that accounts for 70% of revenue (key lines: Blue of the Ocean, Blue of the Sky, Blue of the Dream).  It is known for its attractive blue packaging (http://www.yangheglobal.com/PRODUCTS) and for its smooth texture in the mouth (“kougan”).  As one former manager told me, “the smooth texture is a big difference.  You’re not used to cheaper baijiu after you drink the more expensive one.”  Yanghe was a leader in emphasizing the texture and the concept really took off.

Yanghe has also done really well in distribution, far surpassing its competitors in Jiangsu.  Yanghe has a strategy of deep control into end points of sale, allowing it to monitor sales more closely than its peers.  Yanghe has 6000 sales reps who visit points of sale regularly.  Yanghe was also very early in deepening penetration to lower-tier cities.

Yanghe is based in Jiangsu province, which geographically is directly north of Shanghai and incorporates the large cities Suzhou and Nanjing.  In Jiangsu, Yanghe has dominant market share and is #1 by far with weak competition.  Yanghe has about 23% value share, a steady increase from 15% in 2006.  Though Jiangsu is mature, Yanghe should continue to grow with consumption.

The opportunity now is for Yanghe to expand outside Jiangsu.  Sales outside Jiangsu comprised 45% of Yanghe sales in 2016 and has consistently been growing at 20%+.  Management is focusing on growing in provinces directly adjacent to Jiangsu: Henan, Shandong, Anhui.  Competition is fierce and there are already local competitors in those markets, but Yanghe has continued to make significant share gains.  

Valuation

Putting these trends together, I expect revenue to CAGR in the low teens going forward as Yanghe continues to penetrate the markets adjacent to Jiangsu.  Because of operating leverage (62% GM vs. 42% OPM), margins should continue to expand at a reasonable rate.  Add in a couple points of yield from cash generation, and you can see a high teens IRR.

Today Yanghe trades at 22x NTM earnings – a very reasonable valuation for a premium, branded spirits company with a prospective high teens IRR. 

Disclaimer: This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation.  This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Sales growth outside Jiangsu