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liquor continues to face headwinds, making value investors feel tormented. since peaking on february 18, 2021, the csi liquor index has fallen by 55%. the depth of the retracement is extremely rare in the history of the liquor industry.

looking at valuations, the latest pe of csi baijiu is only 18 times, which has returned to the level of ten years ago. among them, luzhou laojiao and yanghe shares are only more than 11 times, wuliangye is 14 times, and shanxi fenjiu is 17 times.

why is the capital market so pessimistic?

01

davis double play

logically speaking, there are only two reasons why the price of liquor has dropped so much.

on the one hand, before february 2021, the market had been frantically clustered together, resulting in an overall valuation of liquor exceeding 70 times. now it continues to fall, and squeezing out the valuation bubble is an important factor. on the other hand, the slowdown in performance growth has gradually become a reality, and pessimistic expectations are that long-term performance will return to a slow pace.

here, we take shanxi fenjiu as an example for analysis. you know, it is the company with the best growth among the top wine companies in recent years and is very representative.

from 2017 to 2023, the compound annual growth rates of shanxi fenjiu's revenue and net profit attributable to shareholders were 30.8% and 49% respectively, while those of moutai and wuliangye were 16.2%/18.4% and 18.4%/20.9% respectively.

figure: annual compound growth rate of the top 10 liquor market capitalizations, source: wind

in the past seven years, shanxi fenjiu has been able to maintain such a high growth rate mainly due to two aspects:

first, organizational change.in 2017, li qiuxi, who had already retired, took charge again and signed a three-year performance growth "military order" with the shanxi provincial state-owned assets supervision and administration commission, launching drastic reforms covering equity, management, products, channels and other aspects.

one of the major moves was to introduce china resources as the company's second largest shareholder, holding 11.45% of the shares. as a central enterprise, china resources' business covers beer, drinking water, food, etc., and its national channel resources are very extensive, which is a great help for shanxi fenjiu's national expansion.

second, shanxi fenjiu has reaped the market dividends from the upgrading of liquor consumption.in 2016, the production and sales volume of chinese liquor reached a historical peak, and has been declining since then, with a cumulative decrease of nearly 50% by 2021. at the same time, prices continued to inflate - the average price per ton of liquor companies above a certain scale increased from 45,100 yuan to 78,800 yuan in 2020, a cumulative increase of 75%.

under the background of consumption upgrading, the average prices of shanxi fenjiu's qinghua series and bofen series have risen sharply, driving a significant increase in profitability. among them, the gross profit margin increased from 68.7% in 2016 to 76.7% in 2024q2, and the net profit margin increased from 14.6% to 37%.

today, the benefits of improved operating efficiency brought by organizational changes have almost disappeared, and the macro environment has changed from consumption upgrading to consumption downgrading. the momentum that drove shanxi fenjiu's high growth in the past is no longer sufficient.

in terms of performance, shanxi fenjiu has begun to show signs of weakness. in the first half of this year, the company's revenue was 22.7 billion yuan, up 19.65% year-on-year, and its net profit attributable to the parent company was 8.4 billion yuan, up 24.27% year-on-year. this profit growth rate hit a new low since 2016.

in terms of breakdown, the profit growth rate in q2 was only 10.2%, which was rarely lower than the revenue growth rate of 17%. in terms of products, the revenue of mid-to-high-priced liquor/other liquor in q2 was 4.567 billion yuan and 2.796 billion yuan, respectively, up 1.5% and 58% year-on-year. from this point of view, consumption downgrade is also reflected in the liquor industry.

the continued slowdown in shanxi fenjiu's growth is likely to be an irreversible trend. the capital market has already anticipated this, and the continued decline in high valuations is inevitable.

02

three major business difficulties

the last time the capital market was so pessimistic about liquor was in 2013. at that time, the ban on official consumption cut off about 40% of the market demand for liquor. coupled with major negative factors such as excessive plasticizers in jiugui liquor and the continuous decline of the market, the valuation of the liquor sector was once less than 10 times.

this time, the liquor industry has encountered major operational difficulties, so that its valuation has retreated to the level of ten years ago.

first, inventory risk.

during the three-year epidemic, the performance of liquor companies maintained rapid growth, and it seemed that the slowdown of the macro-economy and the disappearance of consumption scenarios caused by the epidemic had little impact on liquor. this is not the case, because liquor is different from many other consumer goods. the product has no expiration date, and performance growth can be maintained by continuously pushing goods to the distribution channels.

but this is not a long-term solution after all. the continued sluggish terminal consumption has ultimately resulted in increasing inventories in various chains and a gradual decline in market prices.

first, let's look at the wineries. inventories continue to rise sharply. from the perspective of the top six wine companies, 2020 is a turning point. before that, the inventory growth slope was relatively gentle, and then it rose sharply. among them, yanghe shares increased from 14.4 billion yuan in 2019 to 19 billion yuan in 2023, and shanxi fenjiu increased from 5.26 billion yuan to 11.6 billion yuan during the same period.

figure: inventory trends of leading wine companies, source: wind

it is impossible to know exactly how much inventory there is in the channel, but we can roughly infer the inventory situation from the wholesale prices of mainstream wine companies.

since 2023, the liquor industry has seen a large-scale phenomenon of zero-batch price inversion. even the most resilient moutai wholesale price has continued to fall in the first half of this year. among them, the wholesale price of moutai 1935 has dropped sharply to around 800 yuan, the same as the ex-factory price, significantly lower than the retail price of 1,188 yuan, and more than 60% lower than the historical peak of 2,000 yuan.

in addition, the wholesale prices of many products such as the eighth generation wuliangye, fenjiu qinghua 20, mengzhilan m9, guojiao 1573, shuijingfang jingtai, jinshiyuan guoyuan sikai, etc. are relatively weak.

the phenomenon of zero-batch inversion has lasted for a year, and it can be inferred that channel inventory is not optimistic.

in addition, liquor inventory also includes investment inventory and consumer inventory. among them, investment inventory will naturally form negative feedback because the price increase expectations of liquor companies have been eliminated and the retail and wholesale prices are seriously inverted, which will have a certain driving force to sell pressure on the market.

in summary, the overall inventory of liquor is quite serious, and the wholesale price continues to be weak. in response, mainstream liquor companies including moutai have reduced shipments to stabilize wholesale prices and reduce channel inventory pressure, but the effect is not obvious.

in fact, the most favorable way to solve the inventory problem is to increase the volume on the consumer side. however, multiple factors such as the downward trend of the macro economy and the reduction of consumer prices have led to the sluggish consumption of liquor, making it difficult to increase the volume.

therefore, the problem of high inventory management of liquor is difficult to resolve and may take several years to resolve, which will have a lasting impact on the performance of high-end liquor companies.

second, the long-term demand for liquor is declining.

liquor consumption demand is closely related to the macro-economy. in the 20 years before the epidemic (2000-2019), china's gdp grew by an average of 9.7%. this is a very large demand dividend. after the epidemic, macroeconomic growth has dropped to around 5%, and the growth rate will irreversibly move downward.

for many years, real estate has been the main engine of china's economic growth and the largest consumer industry for liquor. it should be noted that real estate drives a particularly large upstream and downstream industrial chain, and its direct and indirect contribution to the economy may account for 30%-40%. these industries do not have high barriers to entry, but they will generate and create a considerable number of liquor consumption scenarios.

in 2021, china's real estate market peaked and has since fallen sharply at a steep slope. from january to july 2024, the sales of commercial housing reached 5.33 trillion yuan, a sharp drop of 5.3 trillion yuan from the same period in 2021, a drop of 50%. the pressure on the real estate market has led to a continuous decline in the prosperity of the upstream and downstream industrial chains, which has a significant impact on liquor consumption and has a medium- and long-term impact.

therefore, the long-term consumer demand for liquor is bound to trend downward.

third, when will consumption recovery come?

against the backdrop of sluggish consumer expectations, the overall price range of liquor has shifted downward. in the first half of this year, many mainstream liquor companies have seen a faster growth in low-end liquors and a higher proportion of revenue. for example, the revenue share of moutai series liquors increased to 16%, and the revenue share of wuliangye's other liquor products increased to 16.78%. in addition, the growth of shanxi fenjiu's other liquor revenue and shede's ordinary liquors was higher than that of mid- and high-end liquors.

as a result, the growth logic of the past mid-to-high-end liquor companies constantly grabbing the market share of mid-to-low-end liquor companies has undergone a profound change. this also means that it will become increasingly difficult to increase the market share of mid-to-high-end liquors, while the market share of mid-to-low-end liquors may increase slightly under the current macroeconomic background. this is not conducive to the performance growth of leading liquor companies.

no one can predict how long the consumption slump will last. but rational investors should be cautious about the consumption recovery process.

03

waiting for the cycle to return

in 2013, the liquor industry encountered a major crisis. later, as government and business consumption shifted to personal and business consumption, liquor emerged from the trough and ushered in a boom cycle that lasted for several years.

although the liquor industry is facing different operational difficulties this time, it still believes that it can exchange time for space and eventually get out of the trough.

for example, consumption downgrades, which have a significant negative impact on the performance, profitability, and valuation of wine companies, will not last forever. it should be a phased phenomenon, and the consumer price system will eventually return to the normal inflation level (2%). as a historical example, cpi continued to slide into negative values ​​from april 1998 to april 2000, from november 2001 to december 2002, and from february 2009 to october 2009, but eventually returned to normal levels as the cycle recovered.

to return to normal this time, we may need to wait until the real estate market truly bottoms out and starts to recover.

however, it is an inevitable trend that the growth rate of liquor companies' performance will decline, the expected rate of return on investment will inevitably decline, and there will be obvious internal differentiation. the era of making money by buying liquor with your eyes closed is gone forever.

at present, the 18 times valuation of liquor has already fully priced in major negative factors such as long-term, medium-term and short-term performance pressures, and the downward space may be relatively limited. however, the market continues to fall, and risk appetite is very low. it is not realistic to expect liquor to bottom out and reverse in a short period of time.

in short, be prepared for a long-term battle and wait for the return of the liquor king cycle.