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Why China is targeting shares of the nation’s iconic liquor maker

  (Bloomberg)
Guizhou
Thu, November 23, 2017

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Why China is targeting shares of the nation’s iconic liquor maker Operations inside Kweichow Moutai's facility in Guizhou Province. (Bloomberg/Nelson Ching)

China got more than it bargained for when it took aim against one of the country’s best-performing stocks.

A week ago, the state-run Xinhua News Agency called out gains in Kweichow Moutai Co., the nation’s biggest liquor maker, saying it was rising too fast. Since then, the company -- which produces China’s most iconic baijiu alcohol in the mountains of Guizhou province -- has lost the equivalent of $16 billion in value, spurring a slump in other liquor and consumer shares.

Those losses melded Thursday with concerns about the bond market to trigger a widespread equity selloff: China’s large-cap SSE 50 Index sank the most since March last year.

Moutai’s five-day slide marks a significant about-turn for a stock that had surged 115 percent until the Xinhua warning. It’s still the second-best performer on the SSE 50 after financial giant Ping An Insurance Group Co. The tumble also comes just after Goldman Sachs Group Inc. raised its target on Moutai for the 11th time this year.

Beijing has a history of trying to rein in what it sees as speculative activity in China’s markets -- with mixed success. But why did it single out this liquor company?

Its Hefty Weighting

It’s easy to see why investors flocked to Moutai, which makes its sorghum-based flagship liquor in a small town of the same name. The company’s 72 percent operating margins make it the most profitable among the world’s biggest 100 firms by market value.

But Moutai is also the second-largest stock on the SSE 50 gauge, with its 6.3 percent weighting putting it behind Ping An Insurance at 16 percent. That means gyrations in Moutai’s shares can impact the wider mainland equity market, a point drummed home by Xinhua in its commentary.

“Moutai is like the anchor for value investing,” says Dai Ming, a fund manager at Hengsheng Asset Management Co. in Shanghai. “Its valuation and market cap will affect the pricing of other blue chips, and a rally within a short period of time is just the opposite of what authorities want for the market.”

It’s Gained a Lot

Even with the recent selloff, Moutai’s advance this year is still more than 11 times that of the Shanghai Composite Index and about six times the S&P 500 Index’s climb. As of Tuesday, it was the best 2017 performer on a global Bloomberg gauge of luxury-goods producers in dollar terms.

Moutai’s gains put it on track for its best year in a decade, and the authorities would prefer a “slow bull run,” Dai says.

On the Radar

The company’s baijiu has long been a favorite of China’s ruling class, giving Moutai a unique visibility.

It was one of the first stocks to drop in August, when government officials in its home province were reportedly banned from drinking alcohol at events. One of President Xi Jinping’s signature initiatives has been his anti-corruption drive, which has seen wide-ranging crackdowns on things like gambling and luxury gift-giving.

Hao Hong, chief strategist at Bocom International Holdings Co. in Hong Kong, says this crackdown on Moutai is a buying opportunity. He likens it to the situation with Chinese tech behemoth Tencent Holdings Ltd., whose top-selling smartphone game “Honour of Kings” was criticized by the state-run People’s Daily for harming children. While Tencent stock slid on that news, it’s subsequently rallied almost 60 percent.

Moutai is Richly Priced

While Moutai’s climb this year trails that of Ping An Insurance, which is up 110 percent, the liquor maker trades at 33 times its own earnings, nearly double the insurer’s valuation. When the distiller’s shares hit a record Nov. 16 it was at its most expensive relative to the SSE 50 gauge since 2011.

Even with this week’s correction, Moutai still has a market value of about 800 billion yuan ($121 billion), compared with the 1.05 trillion yuan gross domestic product of home province Guizhou in 2015. Moutai also surpassed U.K. liquor giant Diageo Plcearlier this year to become the world’s most valuable distiller.

A price-to-earnings ratio of more than 30 is too high compared with its historical average and sentiment around Moutai’s shares has become “overheated,” says Allen Cheng, a Shenzhen-based analyst with Morningstar Investment Services.

Foreigners Love It

Moutai has been one of the most sought-after mainland stocks by Hong Kong investors using an exchange link with Shanghai. China restricts access to its local equity market to these so-called connects and also has quotas on foreign investment in stocks.

As of Wednesday, investors offshore held a combined 5.68 percent of Moutai shares, well ahead of its fellow baijiu producers Wuliangye Yibin Co. and Luzhou Laojiao Co., Hong Kong exchange data show.

Moutai is the sort of stock that someone like Warren Buffett -- revered in China for his financial prowess -- would pick, says Dai at Hengsheng Asset Management.

“It has a wide economic moat, abundant cash flow and high return on equity -- it fits more into the standards for long-term investment,” Dai said, referring to a company’s ability to maintain its competitive edge. “Heavyweights like financials are more subject to economic cycles while consumer staples are unshakable: Moutai is top of all those.”

— With assistance by Amanda Wang, Amy Li, Rachel Chang, and Jeanny Yu

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