1H12 results review

Changyu reported net profit of Rmb921mn in 1H12 (+5% YoY), slightly lower than our expectation, given the higher-than-expected SG&A expenditure. Revenue declined 2.5% to Rmb3,013mn, largely in line with our expectations.

Sales growth rebounded to 10% YoY in 2Q (vs. 1Q’s -8.5% YoY), thanks to the company’s efforts to regulate and stabilize distributors’ pricing. Brandy recorded 25% YoY growth and we expect AFIP wine to grow 30% YoY in 1H. Castel declined in 1H, though we saw sales recover from 2Q. Gross margin increased 0.9ppt to 70.9% in 1H given the ASP hikes from 2Q11, and stayed flat YoY at 72.2% in 2Q. SG&A/sales ratio increased 2.7ppts to 34.6% in 2Q12 on the low base (the company reversed some ad expenditure in 2Q11).

Factors to watch

To find new growth drivers, Changyu has separated the operation (budgeting, performance evaluation, marketing & sales functions) of grape wine, brandy and imported wine segments from this year.

To strengthen its distribution system, Changyu has regulated the pricing of Cabernet and Castel wines since April, by aligning distributors’ prices and improving their profitability. The above efforts support the sales recovery from 2Q.

We expect 24% revenue growth and 25% net profit growth in 2H. Changyu is launching two new wine products under AFIP and Castel to stimulate sales growth and further stabilize distributors’ margins. High-end wines from new Chateaus in Ningxia, Xinjiang and Shaanxi will be launched in September, which could drive up sales growth and improve profitability. We see fast brandy growth in 1H12 and expect it to deliver ~30% growth in 2012. The contribution from imported wine business via Changyu’s franchise stores could be another growth driver in the long term.

Valuation and recommendation

We reiterate BUY on Changyu-B on its attractive valuation; it is currently trading at 13.4x 2012e EPS vs. its historical average of 18x, and its PEG is low at 0.7. Our new TP of HK$71.3 (vs. the previous HK$74.0) is derived from DCF analysis. The current B-share price is at a 29% discount to the price of the A-share. Risks include lower-than-expected domestic wine consumption growth.