Stock story: Kweichow Moutai

The company sells the expensive hard liquor Chinese adore

Stock story: Kweichow Moutai

Most westerners have never heard of baijiu (pronounced ‘bai-j’yo’), a fiery white Chinese liquor with an alcohol content of about 50% or more that is fermented and then distilled from sorghum grains. The liquor is tied to China’s cultural identity and is traditionally consumed at banquets to shouts, or slurs, of ‘gambei’ – Mandarin for ‘cheers’.

Listed on the Shanghai Stock Exchange, Kweichow Moutai is the preeminent producer of ultra-premium baijiu. With annual revenue of 80 billion yuan (US$12 billion), Moutai is the largest alcoholic spirits company in the world and the biggest listed company in China by market capitalisation. The company’s market value of 2.3 trillion yuan, or US$350 billion, on December 14 made Moutai three times more valuable than brewing giant Anheuser-Busch InBev, owner of the Budweiser and Corona brands.

Moutai calls on a cultural heritage more than 2,000 years old. Guizhou province, where the company is headquartered, is an area with the rare climate characteristics that are perfectly suited for baijiu production – mild winters and hot summers, low wind and rainfall, but high temperatures and humidity. Much like the French ‘appellation d'origine contrôlée’ for Champagne and Cognac, Moutai baijiu can only be produced in the town of Moutai. The product is crafted by hand over one year, using techniques that have been passed down for generations. It is then aged in ancient stone-lined pits for a minimum of four years to create a complex flavour profile, one with a lingering aftertaste and a fragrance that is said to be reminiscent of soy sauce.

Moutai’s flagship baijiu brand, Feitian, is prestigious and highly sought after by the country’s elite. Commonly presented as a gift, Feitian plays an iconic role at celebrations such as weddings, state banquets and business meetings where conveying status is pivotal. Although a 500 ml bottle carries a recommended retail price of 1,499 yuan (US$230), it is rarely available for less than 2,600 yuan (US$400). Vintage editions can fetch thousands of dollars. The baijiu category is diverse and fragmented but Moutai enjoys close to a monopoly in the segment priced above 1,500 yuan (US$230) at retail.

The strength of Moutai’s brand equity and its favourable market positioning enable the company to keep charging higher prices for the product. Since 2003, Moutai has imposed eight (ex-factory) price increases on the Feitian brand, ranging from 14% to 32%, representing a compound annual growth rate of 10%. This exceeds the average price increases achieved by western luxury players such as Hermès, Gucci and Rolex on their flagship products. Moutai also generates best-in-class gross margins of more than 90%, profit (EBIT) margins of more than 75% and returns on invested capital greater than 300%, which we consider to be sustainable for years to come.

Over the coming decade, the rise of China’s upper-middle-class cohort is set to be the single most powerful growth tailwind for Moutai. Today, only a small portion of China’s population can afford to drink ultra-premium baijiu regularly. China’s population with annual income over US$30,000 is expected to increase at an annual rate of 18%, from about 60 million people to 133 million by 2025 – that is to say, in terms of people, from the size of Italy to the size of Mexico. As consumers become wealthier, we expect them to upgrade their consumption from entry-level baijiu products to higher-priced segments. The biggest challenge for Moutai will be keeping up with the growing demand for its products, given the physical and geographic constraints it faces production-wise.

We are conscious of governance and agency risks associated with an investment in Moutai because it is majority-owned and controlled by the state. Stakeholder management is a complex task, due to potential conflicts of interest between the state controlling shareholder, minority shareholders, management and distributors. This has led to concerns that there will be value leakage to other stakeholders at the expense of minority shareholders. Further, it is apparent that Moutai’s strategic initiatives are often motivated by government policy rather than commercial realities. The company, for example, recently announced ambitions to expand sales of Feitian overseas and to target ‘200 million’ middle-class consumers in China despite having little chance of boosting output to fulfil such hopes.

Investment returns could also be hampered by government intervention in the form of price controls and unfavourable policy developments. Because of its high price point, and the fact that most deals in China are made at the dining table rather than the boardroom, Moutai has developed a reputation as the bribe of choice for unprincipled government officials. In 2012, the Chinese government initiated a nationwide anti-corruption campaign that rocked the ultra-premium baijiu sector and transformed its demand profile. Moutai’s volume growth fell from 21% in 2012 to -4% in 2014 as demand for its products shifted dramatically from government and business consumption to individual consumption. On balance, we think these risk factors are more than offset by the high quality of the underlying business and the strength of Moutai’s growth outlook.

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