What is Kweichow Moutai?
Kweichow Moutai sells high-end baijiu, a distilled Chinese liquor spirit made in the town of Maotai in China’s Guizhou province. Maotai is known as the ‘No. 1 National Liquor of China’ as it is commonly served at lavish state banquets or presented as a diplomatic gift to government officials. Practically everyone drinks this in large-scale events and it can be seen as a status symbol in China’s culture.
Kweichow Moutai is also partially state-owned by Kweichow Moutai Group (60% direct interest), which in turn is owned by the Guizhou Provincial People’s Government. In 2017, Maotai overtook Diageo (Johnnie Walker, Smirnoff, Baileys and etc.) to become the world’s most valuable liquor company by market cap.
In 2020, Maotai’s market cap hit a record high of US$220 billion, doubling that of Diageo’s US$76 billion market cap. Additionally, it is also the first Chinese stock that sees its share price crossing above RMB 1,000 making it the most expensive stock in the Shanghai Stock Exchange (SSE).
This is a mammoth company accelerating at break-necking speed. Gross profit margins are staggering high (above 90%) as the cost of producing a bottle of Moutai is low but they are selling it at a very high premium.
Here is a quick look at its financial and market performance over the past decades.
Moutai’s Financial Performance
Moutai has been performing exceptionally well and they are recording a double-digit growth rate from top to bottom. What is more impressive is this level of growth is not spurred by leverage. Moutai has 0% debt over the past few years and it is all purely driven by equity.
That shows you the strength of their pricing power as they are earning really fat margins from selling Moutai. Demand for expensive baijiu way outstrips supply and people are willing to pay a high premium for it. It is so popular that a quota limit (max 2 bottles) has to be capped for each person.
In addition, the company also sets a new price for its Kweichow Moutai on an annual basis. For example, the 2019 Moutai costs RMB 2,200 per bottle, 20% higher than that of 2018.
Even then, people will still buy and that is their competitive advantage, strong pricing power in the luxury segment. The more expensive it is, the higher the status symbol, the more Chinese people would buy and the higher the revenue it is for Moutai.
Moutai’s Profitability Margin
Here is a quick look at their profitability margins. Gross margin is 90%. They are in a business where they are making something for 10 cents and selling it for a dollar! Where can you find such a business? As it trickles down, operating income margin is about 65% and the net income margin is about 48%.
To put things into context, here is a look at the average margins of a beverage (alcoholic) company in the US.
The data is collated by Aswath Damodaran and its last updated date is January 2020. 8% compared to Moutai’s 48%, that is 6 times more than the average margin of a US beverage (alcoholic) company! The closest industry that came to Moutai’s net margin are banks, and they are only about 30%.
Not only their margins are high, but it is also consistent. Due to their strong pricing power, revenue can keep up with cost easily as people would still buy. This is unlike many of the other companies where revenue often failed to keep up with rising operating costs such as labour wage.
I have filtered out three profitability metrics which are return on assets, return on capital and return on equity. Return on equity tells us how efficient they are in generating profits for shareholders.
Generally speaking, ROE of 10-15% is considered fair, 15%-25% is considered good and anything more than 25% is excellent. Moutai’s ROE as of 2019 is 33.4% and it has consistently stayed above 25% since 2005. This indicates that the company is extremely efficient in generating net profits using shareholder’s money.
Moutai’s Share Price
Lastly, observe the share price performance of Moutai (Blue line). While the entire Shanghai composite is tanking from 2015 due to China’s economic slowdown and trade war tensions, Moutai’s share price skyrocketed by 360% to a peak of RMB 1250.
It has outperformed entire China’s stock market by a large extent and this is what Peter Lynch refers to as a “10-bagger” investment. Institutional investors have said Kweichow Moutai is their number one alpha generator and some even go as far to say it is the only Chinese stock you should own.
Why is Moutai so Expensive?
What makes Moutai so expensive is because of limited supply.
The original taste of Moutai can only be produced in the town of Moutai in Guizhou Province. To ensure the quality and consistency of Moutai taste, the government even ban chemical factories from operating in Moutai as that would compromise the Chishui river water that is being used in the distillation process. That is a hint of monopolistic power.
Many have attempted to replicate the taste of Moutai but has failed to do so. Even the official producers of Moutai themselves have failed. They tried to increase production by building a factory upstream of the town of Moutai, but it just isn’t the same.
The reason is that it is believed that there are over 2,000 types of microorganisms in the air of the town of Moutai. The grain, moisture, water, humidity, temperature, wind, biological community and air to produce Moutai has to be in the town of Moutai itself. Only Moutai and nowhere else.
Till date, the company still adhere to traditional methods of making Moutai. The entire production process includes nine distillations, eight filtrations and seven fermentations, all done using manual labour. It then takes another three to four years to store the distilled baijiu in earthenware jars for the alcohol to “breath”. All in all, even the most basic Moutai take at least five years to be made.
That is the reason why Moutai is unable to keep up with the demand. Expansion plans are being constrained by environmental factors and production factors. Because there are only so few Moutai going around in China, it is able to command such a high premium.
Moutai’s Economic Moat
The history of Moutai goes way back to the Qing Dynasty in the 17th century when they discovered a unique method to make baijiu. The People’s Liberation Army forces then partook in it when they camped at Moutai during the Chinese Civil War. After the victory in the war, the government then consolidated all the local distilleries into one state-owned company called Kweichow Moutai. That is how the origins of Kweichow Moutai came about.
On 1949, Moutai was served at the founding of the People’s Republic of China and it was subsequently named a “national liquor” in 1951. Ever since then, Moutai became the drink of diplomacy for greeting foreign dignitaries such as Richard Nixon, Henry Kissinger and even Kim Jong Un recently.
The most important thing to understand about Moutai’s moat is Chinese Baijiu customers. In a research done by Daxue Consulting, it was found that the top two considerations when buying Baijiu are brand awareness and price. These two factors make up 60% of their preference while taste only makes up 22% of it.
In China’s business culture, the sociological concept of “saving face” is extremely important. Everyone would try to present its best image in social groups and give the highest honour to their guests. Since Moutai is commonly served at the highest-state functions, what could be better than serving them Moutai?
There is even a saying that goes “As long as there is a business in China, there will be Moutai”. It is the lubricant that ensures everything flows smoothly, the ink that helps deals get signed. A recent hire at a major state-owned enterprise based in Beijing said, “I quickly learned that I would need to learn to drink baijiu if I wanted to survive life in a major state-owned enterprise.”
Moutai is not just another spirit. It has a deep political and social meaning behind it. The commercial value goes beyond the taste and supply shortage.
There was one reply from Moutai’s vice president and general manager Liu Zili that sums up the moat of Moutai. he countered back against a news conference about anti-extravagance measures by saying this.
“I have a question for you – if the government does not drink Moutai, what will they drink? If Moutai is banned, do you really think the government will start drinking Chateau”?
Moutai’s Baijiu Competitors
Moutai’s main competitors in the high-end baijiu industry are Wuliangye, LuzhouLaojiao, and the Swellfun brand which is owned by Diageo. As of 2017, Moutai has the highest market share of high-end baijiu (63%) followed by Wuliangye (26%), LuzhouLaoJiao (6%) and others (5%).
I have plotted the forward P/E ratio for Moutai and its competitors over the past 10 years. Moutai forward P/E as of April 2020 is about 33.4x, the highest among the other baijiu companies.
Its 10-year average is 20.2x and the high is about 36.6x. If we were to take the average P/E of all the main competitors, it is about 18.7x.
Comparing to both the industry average (18.7x) or Moutai’s historical average (20.2x), the current price is nowhere near cheap. It is near the peak of its valuations.
To make a fairer comparison against Moutai’s competitors, I have also plotted out the EV/EBITDA ratio, which might be a more accurate metric over the P/E ratio.
This is because Diageo has about 60% debt, Luzhou Laojiao has about 10% debt and both Moutai and Wuliangye have 0% debt. The EV/EBITDA ratio removes all capital structure and accounting policy differences.
Enterprise value takes into account the value of firm and makes no differentiation between debt and equity holders. The distillery business has high CAPEX and each of them might have different depreciation policy on its machineries. EBITDA removes all these differences as it is earnings before interest expenses and depreciation expenses.
Moutai’s 10-year EV/EBITDA average is 15.7x and the industry average is about 15.2x. As of April 2020, Moutai’s EV/EBITDA is 25.4x. Similarly to the P/E ratio, it is the highest among all and Moutai is nowhere near cheap.
3 Key Risks of Moutai
1. Government & Political Interventions
One of the biggest risk or uncertainty facing Moutai is government and political interventions. In 2013, Xi Jinping came into power and enacted the ‘three public consumptions’ campaign [targeting car, lavish banquets, and unnecessary overseas-travel expenses] to stamp out corruption.
There is a quote that encapsulates the essence of Moutai. “Those who drink Moutai never have to buy it, and those who buy Moutai never have the chance to enjoy it”. What this means is Moutai is commonly used as a currency in bribes during official state functions.
Xi’s war on conspicuous consumption has led to Moutai’s sales plummeting by 50% and earnings remained stagnant from 2013 to 2016. It was only until 2016 when the middle-class start emerging and fuel demand for higher-end liquor consumption.
In 2018, Moutai is under official pressure again from Beijing to stem price increases. The government is worried that the state-run Moutai revert back to the impression of Moutai being a luxury drink available only to the country’s bureaucratic elites. They wanted Moutai to position itself as a ‘people’s drink’.
Despite Moutai having strong pricing power, most of its pricing decisions follow a political logic rather than a commercial one.
2. Moutai’s Leadership Transition
In 2019, there was a change in leadership when Li Baofang took over Yuan Renguo due to corruption and bribery allegations. Due to differences in strategy, Moutai underwent an overhaul in its business model when Li came on board.
Because of government restrictions on pricing of high-end alcohol in China, Yuan wanted Moutai to diversify into many different sub-brands. He set up many subsidiaries, business customisation and started making less-expensive line of baijiu to cater for the larger mass population.
However, Li wanted to streamline Moutai’s business back to the ultra-premium line of baijiu. He shut down many of the subsidiaries that were making non-premium brands to redivert production efforts on Moutai’s core products. Many factories were abruptly halted and workers were left idle.
In addition, Li also believes that there are too many middlemen in the supply chain. He suspects many distributors were charging exorbitant prices and paying kickbacks to operate.
Fearing that the lack of oversight on the 3,000-strong network of distributors would tarnish the company’s image, he decided to establish its own sales office on the parent group of Moutai.
This would help improve margins, regain control and also to clean up the distribution network. More than 1,200 dealers are being cut off now and the company is approaching retailers directly to issue tender contracts to hold Moutai’s products.
However, some investors are not happy with this decision as many think that the new business structure shifts profits from the listed company to its parent company, Kweichow Moutai Group.
Recently in March 2020, Moutai abruptly changed its chairman again from Li to the former head of its transportation department Gao Weidong. It was stated that Li Baofang is recommended not to serve as chairman and director of the group.
You can see that there is some kind of power struggle among the top management and the stability of leadership remains uncertain. This is the second change in leadership in just two years.
3. Slower Growth in Moutai’s Earnings
Even though Moutai’s share price has tripled over the past five years, profits growth has been decelerating since 2017. In 2019, Moutai’s earnings missed analyst estimates for the first time since 2015.
Earnings only increased by about 15% compared to the consensus of 22%. This year, the company is setting an even more conservative sales target growth of only 10%.
This might indicate a broader economic slowdown in China’s consumption market. Gone were the days when earnings are growing at 50-80%. As a company grows larger, it becomes even harder to keep up with that level of growth rate. Moutai might be transitioning to a phase of high growth into mature growth.
Different phases of growth call for a different set of strategies. It is still uncertain about how the recent transition in leadership plays out on Moutai’s financial performance.
It could even be a sober reality for Moutai’s hungover share price as investors would have to rethink if current valuations support future earnings growth prospect.
Valuation of Moutai
Assuming that Moutai is going to achieve its earnings target growth of 10%, we can use it to make some ballpark estimations on the fair valuation of Moutai.
As of FY 2019, Moutai’s EBITDA is approximately RMB 57 billion. A 10% growth would mean its EBITDA for 2020 would grow to RMB 62.7 billion.
Using the industry EV/EBITDA average of 15.2x, Moutai’s enterprise value would be around RMB 953.5 billion. To determine the market cap of the company, we would take its enterprise value minus minority interest, debt and add back cash.
To make things simple, I would just extrapolate their cash position from 2019 into 2020. In reality, it requires a lot of assumptions and insider details to do a proper forecast. Using the prior year cash increase of 17% growth rate, Moutai would have about RMB 152.8 billion of cash in 2020.
To get the market cap value, we take its enterprise value of RMB 953.5 billion less minority interest (RMB 5.8 billion) and add back cash value of RMB 152.8 billion. That would give us a market cap of RMB 1.1 trillion.
Finally, to obtain the fair value share price of Moutai, we take the market cap (1.1 trillion) divided by the total number of shares outstanding (1.256 trillion). That would give us approximately RMB 880. This is how much Moutai is worth based on the industry EV/EBITDA average or Moutai’s 10-year historical average.
Do not take the final valuation too seriously as these are just some quick calculations to get a rough estimate of where might be a good price to enter.
Moutai’s Latest Q1 Results
So where is Moutai heading towards now? Has the Covid-19 pandemic affected Moutai earnings? Their Q1 results for 2020 have been released recently and here is how they fared.
Total revenue is up 12.8% to RMB 24.4 billion and net income rose 16.7% to RMB 13.1 billion. Sale of the premium Moutai Baijiu contributed 22.2 billion to its first-quarter revenue.
This is in line with the baijiu industry as Moutai’s key competitor, Wuliangye, also reported a 15% increase in revenue and 19% rise in net profits for the first quarter.
The reason why they are able to avoid the volatile market conditions is because of the lucky timing with Lunar New Year. The festive season started earlier this year at Jan 24 and most distributors have already placed their orders. This was before the Covid-19 happened and the losers are actually the distributors, not the distillers.
Using the management’s guidance of 10% growth in sales, Moutai’s revenue for 2020 should be around RMB 94 billion. The latest Q1 results of RMB 24.4 billion is in also in line with the target as it is about 26% of the forecasted sales revenue.
How to Buy Kweichow Moutai Stock?
Everything looks good so far. They have a monopolistic moat as it is government-owned. It has a unique competitive advantage due to supply shortage, historical and cultural factors. The financials and profitability margins are extremely strong. Liquor companies are resilient in both good and bad times.
The next question that is probably on everyone’s mind is “Okay. So how do I buy this Moutai stock?”
Personally, I am using SAXO Investor platform to buy US or China shares. This is going to be my growth portfolio that is separate from my current dividend portfolio.
SAXO is licensed and regulated by MAS. I think SAXO is one of the best options out there in terms of fees and user interface. If you also want to open an account with SAXO and get a share of the referral awards ($), do send me an email at [email protected] (*Don’t miss out on this one!)
Here is how the layout looks on SAXO’s platform.
Their commissions are pretty cheap as it is RMB 40 or 0.15%, whichever is higher. On top of that, there is another 0.12% annual custody fees that will be calculated daily and charged on a monthly basis. This is in contrast with the local brokerage firms where they charge a fix $2 custody fees every month.
If I were to buy 10 Moutai Shares at RMB 1280, that would cost about $2,560. The commissions would be RMB 40 ($8). Assuming that by the end of the month, Moutai’s share price rose to RMB 1400. The monthly custody fees would be (0.12% * RMB 1400 * 10 units / 12) which is about $1.40.
The custody fees are just an approximate calculations as they are actually calculated daily. I just take it as the average daily price of Moutai over 30 days is RMB 1400.
If you want a deeper dive into China stock market, Dr Wealth has also written a comprehensive article on the different ways to invest in China A-Shares.
Am I buying? Probably not now. At the current price, you are literally buying at the historical all-time high. But again, premium things (e.g. Moutai Baijiu) seldom come at a discount. They only get more expensive over time. So I hope I am not making the wrong call here.
In the meantime, I would definitely put Moutai under my watchlist. I have not seen any company that is this strong. Additionally, I have also added travelling to the town of Moutai to drink Moutai in my bucket list. The entire town of Maotai is said to have an aroma that smells like fermenting sorghum. It is really a nice place located in Guizhou province, the same place where they shot the movie Avatar.
A spirit from China. A toast to the world!