1H11 results review:

Changyu reported net profit of Rmb877mn in 1H, +50% YoY, aheadof our expectations. Revenue increased 24.5% YoY to reachRmb3.1bn on 18% volume growth.

Positive: Gross margin +4ppts YoY to 70.1% in 1H and edged up to72.4% in 2Q on faster growth of high-end wine and 4%~5% ASPhikes on Cabernet and Chateau wines this March; SG&A/sales ratiodecreased 1.9ppts to 33.2% in 1H.

Negative: 2Q11 sales growth decelerated to 11.5% YoY. Theslowdown is mainly due to distributors pre-stocking Cabernet andChateau wines before March’s ASP hikes.

Factors to watch:

We believe Changyu is well positioned to benefit from wineconsumption growth in China, especially for mid-range to high-endwine, with its efficient and flattened distribution channels, as well asits strong branding. Changyu increased its salesmen to >3,000 anddistributors to 5,000, well above the industry level, indicating furthermarket penetration and channel development efforts. Impact ofimported wine on Changyu could be limited as imported winemainly competes with domestic players in the mid-range to low-endwine market, while Changyu is focused on mid-range to high-endwine (70% of total sales in 2010).

Capacity expansion could further solidify Changyu’s leadingposition in mid-range to high-end wine market and reinforce theproduct mix upgrading strategy. Ningxia and Xinjiang Chateaus areexpected to launch new Chateau wine and add 2,000 tonnes ofChateau wine capacity from mid-2012, 40% of current capacity ofCastel; The phase I factory constructed in Yantai Industrial Parkcould contribute 150,000 tonnes mid-range wine production capacity(100% increase) in coming years. We expect the company to deliver23% CAGR of sales and 26% CAGR of net profit in 2010~12E.

Valuation and recommendations:

We reiterate BUY on Changyu B-share and maintain 2012 TP ofHK$109.56. B-share is attractive at current valuation of 18x 2012eEPS vs. historical average of 23.6x considering the company’s solidgrowth outlook and high visibility of earnings delivery.

Risks: Lower-than-expected domestic wine consumption growth.