In June of 2014, I wrote an article called Take a Sip at This Iconic Brand, in which I outlined the case for Kweichow Moutai (SZSE:600519, Financial), which had a gross margin of 93% and net margin of 49% and was trading at a P/E of 10.4. Earlier this year, Kweichow Maotai overtook Diageo (DEO, Financial) to become most-valuable liquor company (precisely on April 7) and has continued to be the world’s most valuable liquor company. As of the most recent close, Kweichow Maotai’s market cap is $131 billion while Diegeo’s market cap is $85 billion. Diageo (DEO) owns many of the most renowned liquor brands in the world such as Johnny Walker, Smirnoff, Captain Morgan, Bailey’s and Crown Royal. Kweichow Maotai, on the other hand, only has the Maotai brand, and the 53 degree Feitian Maotai accounts for the majority of revenue and profits. Does it make sense that Kweichow Maotai, with effectively only one brand, is more valuable than Diageo (DEO) which owns a collection of wonderful global brands?
We shall explore.
First of all, let’s look at the numbers. According to a recent research by Goldman Sachs' Gao Hua China, Kweichow Maotai has the highest gross margin, net margin, ROE and CROCI among all major publicly traded spirits companies in the world. Kweichow Maotai’s gross margin is 91% versus Diageo’s 61%; net margin 44% versus 23%; ROE 29% versus 24%; CROCI 31% versus 12%. Maotai beats Diageo in every single metric.
What the heck? Why is Kweichow Maotai’s margin so much higher than everybody?
If I have to name the key difference between Kweichow Maotai and Diageo that makes Kweichow Maotai that makes Kweichow Maotai superior, it would be pricing power. Maotai has increased its out-of-factory price at an effective CAGR of more than 10% for the past 10, 15 and 20 years. This double-digit pricing power is almost like pharmaceutical companies except Maotai doesn’t have the problem of patent expiration. The retail price has increased at roughly 12% since 2006, according to Goldman Sachs.
Diageo, on the other hand, has had very limited pricing power over the past 10 and 15 years. According to JPMorgan, in Diageo’s most important market, the U.S., the price/mix growth has been much muted, even in the super-premium category.
Why is Maotai’s pricing power much stronger than Diageo, and is it sustainable? I think so. Maotai has almost no substitute in China in the high end market while Diageo’s brands all have substitutes. This is the fundamental difference, which makes Maotai’s moat much wider than Diageo’s moat.
Regarding Volume, Maotai is also better positioned than Diageo, as the demand for high-end baijiu rises along with income growth. According to Goldman Sachs, China’s urban worker’s monthly income has been increasing at a CAGR of 12%. This has resulted in double-digit volume growth for Maotai. Diageo, on the other hand, has struggled on the organic volume growth rate, as it faces intense competition in two of the most important categories, whisky and vodka, especially in North America, Diageo’s most important market.
It looks obvious that Kweichow Maotai will continue to have better pricing power and volume growth than Diageo for many years to come, which means Kweichow Maotai will grow its revenue faster and continue to improve its margins with minimum need in capital expenditures and marketing expenses. Diageo, on the other hand, will continue to face fierce competition in whiskey and vodka.
Conclusion
At 36 times earnings, it certainly looks a little expensive compared to Diageo at 22 times earnings. But the rare combination of superior pricing power and inevitable volume growth makes Kweichow Maotai one of the widest moat companies on earth, and I view Kweichow Maotai the best publicly traded spirit companies for the long term.
As a side story, I purchased Maotai for my family in 2014 at an average cost of about RMB 140 per share. Back then, I actually did not do much research on the Chinese baijiu industry and global spirit industry. It was just a fat pitch. I sold Maotai shares between RMB 300 and 400 per share and felt good without doing further research. Had I done more research on the Chinese baijiu industry and had I appreciated the merit of holding on to the truly wonderful businesses, I would not have sold those shares. As embarrassing as it is (believe me), I’m glad I made this mistake, though, as now I have a much better appreciation fir the importance of building a circle of competence and what it means to be a true long-term holder.
Disclosure: No position in Kweichow Maotai or Diageo.
