In a recent article, Mr. Ross Givens laid out his thesis on a basket of Chinese spirit stocks. I agree with his conclusion, but I think he missed the best one out there - Kweichow Moutai, which has a wider moat than other Chinese spirits stocks in China and is trading at similar discount.
Below is a recap of Mr.Givens’ thesis:
“The three stocks of our focus are Wuliangye Yibin Co. Ltd. (SZSE:000858), Luzhou Lao Jiao Co. Ltd. (SZSE:000568) and Yantai Changyu Pioneer Wine Co. Ltd. (SZSE:000869).
Together, these three firms represent a ¥106.7 billion market capitalization ($17.18 billion USD) and combined annual sales are $12.6 billion. Compare this with global giant Diageo's (DEO) $17.3 billion in sales and the significance is more apparent. But for the additional 37% of sales generated by Diageo, you'll have to pay an additonal 369% for the stock.
But these stocks are not buys based on low price to sales multiples alone. All three have clean balance sheets with zero long-term debt. They are also carrying substantial cash positions representing 33% (SZSE:000858), 27% (SZSE:000568) and 9.2% (SZSE:000869) of their stock prices. It would take both reckless management and severe economic hardship to send any of the three into insolvency.
DIVIDENDS
As if the rock-bottom discounts weren't enticing enough, each of these companies pays a healthy dividend.
- Wuliangye Yibin Co Ltd (SZSE:000858) 4.11% yield
- Yantai Changyu Pioneer (SZSE:000869) 3.96% yield
- Luzhou Lao Jiao Co Ltd (SZSE:000568) 9.88% yield
These yields blow away the 1.81% average of the S&P 500.
WHY THE DISCOUNT?
Like every out-of-favor industry, there is a reason for the discounted nature of these securities. In our case, the price declines are tied to a political shift in China. President Xi Jinping has led an anticorruption drive designed to reduce excessive spending by both government officials and consultants attempting to woo federal contracts.
Make no mistake, sales are declining. These stocks are not falling based solely on speculative fear. Revenues are down on the year, but nowhere near to the extent of company stock prices. These three stocks are down 52%, 62% and 71% over the past 24 months even though revenue and profits have been effected far less severely. This is an over exaggeration, and Mr. Market is saying, "Stocks are on sale!"
While Wuliangye Yibin Co. Ltd. (SZSE:000858), Luzhou Lao Jiao Co. Ltd. (SZSE:000568) and Yantai Changyu Pioneer Wine Co. Ltd. (SZSE:000869) are all great brands, if we want to talk about Chinese spirits, we cannot leave out the best of the best - Kweichow Moutai.
Before I get into Moutai’s wide moat, let’s compare Moutai against the other three and we’ll throw in Diageo as well. If you want to know more about the businesses, you may want to use gurufocus's Asia market feature as the annual reports for these Chinese comapneis are in Chinese only unfortunately.
| Â | Moutai | Wuliangye | Luzhou Lao Jiao | Changyu | Diageo |
| Gross Margin | 93% | 73% | 57% | 69% | 61% |
| Op Margin | 70% | 46% | 45% | 31% | 30% |
| Net Margin | 49% | 32% | 33% | 24% | 22% |
| ROE | 35.5% | 22.1% | 32.5% | 16.88% | 35.32 |
| PE | 10.4 | 9.6 | 8.3 | 18.4 | 18.6 |
| Dividend Yield | 3.76% | 4.19% | 10.04% | 4.05% | 2.50% |
You can tell a lot about the moat differential from the above numbers. Moutai has the highest gross margin, operating margin, net margin and return on equity. It is only slightly more expensive than Wuliangye and Luzhou Lao Jiao and is a bargain compared to Changyu and Diageo.
Any time we come across a great business, we want to ask ourselves why. In this case, Wuliangye and Luzhou Lao Jiao are by any measure great businesses, but Moutai is far better in most aspects. It will take me a few articles to fully explain Moutai’s moat because it has so many layers. Instead of burden the readers with the details, I will only discuss the essence of Moutai’s moat.
In my opinion, Moutai’s moat mainly comes from its history and what it represents. For those of you who think Jack Daniel’s got a pretty old history, you may want to know that the original Moutai was first produced more than 2000 years ago in what is now Guizhou Province of China during the Han Dynasty. Throughout these 2000 years, people in Moutai continued to improve and perfect Moutai’s flavor. If you study China’s history, you will easily find out that bai jiu (Chinese spirits) has been part of China’s culture for a very very long time. From the Great Confucius to Chairman Mao, the Chinese loved bai jiu. And there is no other brands as history-rich, culture-rich and flavor-rich as Moutai. If you ask someone what comes to his or her mind when it comes to carbonated drinks, he or she will most likely say Coca Cola. Similarly, if you ask a Chinese what comes to his mind when it comes to bai jiu, he will tell you Moutai. This is the essence of Moutai’s moat. It takes thousand of years to build and even if you tell me to sell Coca Cola and use the all the money to buy another Maotai, I can’t do it. I doubt any person can.
Now you may wonder, of all the bai jiu, why is Moutai so unique? Is there any other reason in addition to the historical and cultural factors?
Well, it turns out the flavor of Moutai is only made possible due to a combination of soil condition and the climate of the town of Moutai. Moutai Bai Jiu contains only the natural grown sorghum ( a unique type of grain only growable in that area) of the local valleys and water from the Chishui River. The unique climate of this region along with the a few other unique geological factors, combined with a culture that has been existed for thousands of years, created this magical liquor.
As a matter of fact, the Chinese government has tried many times to brew Moutai in other parts of China because the supply can never meet the demand. Of course they failed every single time they tried even though they follow the exact fermentation and brewing procedures.
Moreover, Moutai needs a higher temperature for the fermentation process than all other bai jiu. Moutai’s fermentation process takes place in temperatures up to 63 ℃, 10-15℃ higher than any other bai jiu products. Maotai’s distilling process also requires a 10-20 ℃ higher temperature than other bai jiu.
Because of the more rigorous production standards, it takes longer to produce a bottle of Moutai. According to Moutai’s website, the average production cycle for a bottle of Moutai is 5 years.
If I haven’t convinced you Moutai has a wide moat, you can ask any of your Chinese friends what Moutai stands for. The Pavlovian bell will ring.
So to sum up, we have a great business with one of the highest margins and ROEs on earth, located in the most populated and most drinking-prone nation on earth, selling at 10 times earnings due to fears of adverse impact on Moutai from government crackdown on corruption. The 2014 result is not going to be pretty but we can be reasonably sure that in 5 years, the average Chinese family will be more wealthy than they are today. We can also be reasonably sure that the bai jiu culture that has been a huge part of the Chinese culture, is going to prosper in not only the next 5 years, but the next centuries.
Unfortunately, Moutai is off limits for non-Chinese retail investors as the shares are only listed on Shanghai Stock Exchange. My half-jokingly suggestion to non-Chinese investors - buy a bottle of Moutai, make some Chinese friends and form a mini joint venture.
