Kweichow Moutai:Increasing ex-factory supply;sales growth to

To increase ex-factory volume from August 15

Restocking cycle to continue; revising up TP to Rmb745.

Moutai Group: sales and earnings growth accelerate QoQ in 2Q17

Around 70% yoy volume growth for mainstream Moutai (DB estimates).To recap, Moutai indicated on August 28that it supplied 6,200tons ofliquor (including 5,600tons of "Feitian Moutai" and 600tons of otherSKUs) between August 15and September 30, to meet the strong demandduring National Holiday and Mid-Autumn Festival, implying 70% yoygrowth.

    Kweichow Moutai will supply more than 4500tons of mainstream "FeitianMoutai" between 15August to 30September, according to the media reportsfrom China Securities Daily. This implies 100tons/day during the peak season.Meanwhile, the company has delivered 150tons on August 15according to thenews. Through increasing supply, Moutai management aims to ease down thesupply shortage in retail end during the peak consumption seasons (Mid-AutumnFestival and National Holidays). It also target to control the retail price belowRmb1299/bottle.

    We estimate Moutai’s current channel inventory equals six months of Moutai'sreal consumption, indicating there is still room for distributors and high-wealthindividuals to fill up their warehouses. More importantly, this would leavemanagement time to deal with the channel stocking problem. Meanwhile, weidentify three possible catalysts that might trigger channel de-stocking, andbefore these catalysts are triggered, we expect less risk of a strong de-stocking.

    On July 10, Moutai Group (the controlling shareholder of list-co Kweichou Moutai)indicated that sales (VAT included) increased 31% yoy to RMB31bn and profitbefore tax ("PBT") increased 24% yoy to RMB16bn in 1H17, according to newsrelease from its official website. This news implies Moutai Group's sales/earningsgrowth is accelerating from 24%/13% in 1Q17 to 40%/36% in 2Q17.

    Strong growth of super premium Moutai. We estimated that most of 600tons of other SKU are super premium Moutai. This drives mix-upgrade formainstream Moutai.

    This implies over 40% volume growth in 3Q17

    We are revising up Moutai’s TP to Rmb745 and we maintain Buy.

    According to the news, the strong growth has been mainly driven by 1) goodgrowth from high-end customized liquor and lower-end sub-brands; 2) overseassale; and 3) strong demand for main stream "Feitian Moutai". It indicates Moutai'smain products are still short of supply even in traditional slack season postChinese New Year holidays. Further, we believe this is also driven by distributors'channel re-stockings with expectations of retail price hikes (refer to our report"The restocking cycle is just beginning " published on June 22).

    Strong growth of mass market Moutai products. According to news fromMoutai website, mass market Moutai sales increased over 200% yoyin the first 9months. This is a result of Moutai's "133" brand strategy(one core brand, three strategy brands - Huamao, Wangmao, Laimao,and three key brands - Hanjiang, Renjiu and Wangzi). Meanwhile, thenumber of domestic distributors increased by 634YTD to 2,965, mainlyfor penetration of mass market Moutai.

    This implies over 40% volume growth in 3Q17for main stream products, if itdelivers more than 100tons per day from August 15. To recap, Moutai's dailyvolume was 55tons in 3Q16, and we estimate the daily volume was 60-70tonsbefore August 15. In addition, we expect its average selling price for premiumMoutai continue to increase driven by increasing portion of super premiumcustomized Moutai. This is higher than 36% yoy sales growth in 1H17andconsensus estimates at 20% yoy sales growth for 2H17.

    Current channel inventory equals six months of real consumption.

    Implications for the Listco: 1H17 growth tracks ahead of market consensus

    Net margin expanded 440bps yoy on operating leverage

    Channel restocking to continue; maintaining Buy

    We think Moutai’s strong sales recovery from 2016 has been mainly driven byboth channel restocking and a consumption upgrade. Therefore, it is importantfor investors to gauge the water line in the channels. Based on historical channelinventory movement, Moutai’s ex-factory supply, and Moutai’s real consumptionpattern, we estimate that currently there are 12,000 tons of Moutai in distributors'and investors' warehouses, representing six months of real consumption in 2017.

    The listco Kweichou Moutai ("Moutai")'s sales/earnings growth trend tracksclosely with Moutai Group (refer to 1) since 2012, and the listco's sales accountsfor 93% of Moutai Group's total revenue in 2016. We believe it indicates thatlistco's sales/earnings growth also speed up QoQ in 2Q17. The sales/earningsgrowth of Moutai group in 1H17 is higher than market forecasts at 20%/25% forthe listco in 2017.

    Moutai's gross margin was stable at 75% in 3Q17, as the impact from lowermargin mass-market products was offset by high margin customized Moutai.Selling expense ratio increased 20bps yoy to 3.2%, due to increasing A&P expensefor its "133" brand strategy and "5 5" channel strategy (5core markets and 5potential markets). G&A expense ratio declined 480bps yoy , mainly helped byoperating leverage.

    In next 6month, Moutai will experience two traditional peak consumptionseasons - the mid-Autumn festival & National holiday in October and Chinese NewYear in Feb 2018. We expect supply shortage to continue, driven by increasingretail demand and distributor's channel stocking up. Our recent channel checkin Shanghai and Beijing also indicates that most retail stores are running out ofinventories. (For Moutai's re-stocking and de-stocking cycle history, please referto report "The restocking cycle is just beginning; reiterating Buy" ) . Within theshortage environment, we expect Moutai to increase its sales volume and reportaccelerating sales growth. We maintain Buy.

    Compared with the peak level of 12 months in 2012, this implies there is roomfor channels to stock up (Figure 1).

    We reiterate Buy on the stock. We expect above-mentioned drivers, especially thechannel restocking, to drive its sales growth in the near term. Our TP at Rmb550is based on DCF approach (factoring in 9.5% WACC and a 2% terminal growthrate). Main downside risks: shorter-than-expected restocking cycle; governmentpolicy changes; food safety incidents.

    Increasing transparency in revenue recognition

    Three catalysts that could trigger channel de-stocking in next 12 months.

    Moutai booked most ex-factory shipments as revenue in 3Q17. This is differentfrom market's and our expectation that it would allocate the shipments into salesand advances from customer accounts. Therefore, advances from customers were stable at Rmb17bn on Sep 30(vs Rmb18bn on June 30). This partlycontributed to the results beat in 3Q. We believe this implies increasingtransparency and improving cooperate governance for the company.

    Distributors are building up channel stocking because they expect the retail priceto continue to go up. Therefore, whenever such an expectation weakens, thecycle could turn from restocking to de-stocking. We identify three events thatmight lead to weakened expectation: 1) Moutai strictly implements a fixed pricee-commerce policy; 2) Moutai raises its ex-factory price at an inappropriate time;and 3) the retail price rises to Rmb2000 suddenly, which is the peak level in the lastcycle. Before these catalysts happen, we believe risk-reward remains attractivefor a Buy on the stock.

    Maintaining Buy.

    Moutai's management is undertaking several measures, including implementingprice guidance, increasing supply and implementing an e-commerce policy, tostabilize the retail price. We expect these measures to push distributors to releasechannel inventory gradually (instead of suddenly). We are revising up our TP toRmb745 based on the DCF method (factoring in 9.5% WACC and 2% TG). Wereiterate Buy. Downside risk: sudden channel de-stocking.

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