Wuliangye (SZSE:000858) (Global Value Fund II). Wuliangye is recognized as one of China’s premium baijiu (spirit) brands. Wuliangye literally translated means “five grains liquid,” as it is brewed by a unique formula that combines the flavor of five different grains. Wuliangye has a very strong brand within China due to its premium quality and 600+ years of history, enabling the company to have strong pricing power (70%+ gross margin, approximately 40% EBIT margin). Wuliangye’s strong brand is supported by its aged cellar and unique brewing techniques. In the baijiu industry, cellars with a longer history typically produce higher-quality liquor (more microbes for fermentation). Wuliangye has tens of thousands of cavern fermentation pits, dating back from the Ming Dynasty (650 years ago) to several decades ago, and it has the largest single brewing workshop in China.
According to Wall Street research, the significant growth in China’s premium consuming class population should drive a mid-teens CAGR (compound average growth rate) in the consumption of ultra-premium baijiu over the next five years, as more consumers are able to afford the product and the consumption frequency of premium baijiu increases with income. Wuliangye is well placed to grow in the ultra-premium baijiu segment, as its flagship product is more affordable than Moutai, its chief competitor. Wuliangye also plans to launch a new generation of its flagship product (PuWu) this year, with new packaging and a higher price point. The company has also been making significant efforts to improve its marketing and distribution, which would be of incremental benefit if executed successfully.
Wuliangye has compounded intrinsic value per share over the last decade at approximately 20% annually. While the compound will likely be lower going forward, we believe the company should still be able to grow operating income at least in the low teens annually. The company has also been increasing its dividend payout ratio (currently 52%), and the dividend yield at the time of purchase was approximately 2.6%, with room for growth. Given the company’s wide moat around its premium-end brands and attractive margins, the company has also generated strong returns on equity, return on assets, and return on invested capital. At purchase, we paid roughly 9X 2019 estimated EV to adjusted EBIT, and approximately 13X 2019 estimated earnings.
Wuliangye is an example of a terrific business – a branded consumer products company with strong competitive advantages that have allowed it to have pricing power and to compound its intrinsic value at a well above average rate over time. It is rare to get pricing opportunities in businesses such as this. However, with the dramatic sell off in the Chinese stock market, we had an opportunity to purchase shares for Global Value Fund II in one of China’s premier businesses when it was trading at significant discounts, in our view, to what comparable beverage businesses were trading for in other parts of the world. The one caveat is that Wuliangye is a Chinese state-owned enterprise, and, as such, it is subject to potential corporate governance and other risks that are typically less of an issue in the developed world. That said, we feel that the Fund’s purchase price more than compensates it for these heightened risks.
From Tweedy Browne (Trades, Portfolio)'s March 2019 annual report.
