3Q2011 results review

Changyu reported net profit of Rmb387mn in 3Q, up 29% YoY, in line with our expectation. Revenue increased 21.6% YoY to Rmb1.3bn. In the first nine months, Changyu recorded solid performance of 42% earnings growth on a 24% top-line increase with volume growth in the high double-digits. Gross margin expanded 3ppt YoY to 67.4% in 3Q mainly on product mix upgrade and 4~5% ASP hikes on Cabernet and Chateau wines this March, while gross margin declined 2.7ppt from 70.1% in 1H, which may be due to short-term product mix change. EBIT margin improved 1.2ppt YoY and 1.7ppt compared with 1H, indicating increasing operating leverage.

Factors to watch

Changyu’s gross margin has expanded 19ppt in the past eight years given its focuses on high-end wine development and flattened channels. Ongoing product mix upgrade could also result in increased operating leverage. Given the robust industry growth outlook and consumers trading-up, we expect Changyu’s margin to continue increase in coming years, especially after its new Ningxia, Xinjiang and Shannxi Chateau wines launch in mid/late 2012, implying a 60%+ increase in Chateau wine production capacity.

We are upbeat on the industry growth outlook, with 3Q industry volume growth having accelerated to 17% from 4% YoY in 1H. Changyu recorded solid volume growth in the first nine months with mid- to high-end wine continuing to be the main driver. We tentatively maintain our 2011 financial forecast and expect the company to deliver ~28% earnings growth in 2011 and another 25% growth in 2012 as a roof. Future growth should be supported by solid margins, capacity expansion and deeper market penetration. Valuation and recommendations: We reiterate BUY on Changyu B share and maintain 2012 TP of HK$109.56. The B share is attractive at its current 17x 2012e EPS, vs. a historical average of 23.1x, given the company’s solid growth outlook and high visibility of earnings delivery.

Risks:

Lower-than-expected high-end domestic wine demand.