2011 results review

Changyu reported net profit of Rmb1,907mn in 2011 (+33%), in line with both our and the market’s expectations. Revenue increased 21% to Rmb6,028mn, 2~3% below our and market estimates due to lower-than-expected sales in 4Q. Dividend payout ratio is 50.32% (cash dividend payout ratio 42.02%, stock dividend payout ratio 8.3%).

In 4Q, sales growth slowed to 14% YoY and gross margin was 72.4%, down 5.4ppts from 4Q10’s high of 77.8%. We think it could be due to slower mid-range/high-end wine growth amid the unfavorable economic environment. Operating margin improved 2ppts YoY to 52.1% given 7.4ppts savings on SG&A/sales and increased operating leverage. Net profit up 16.0% to Rmb643mn.

Factors to watch

We maintain our positive view on Changyu given its leading position in China’s grape wine industry, mid-range/high-end product mix, strong execution ability and full control over its flattened distribution channel.

Sales growth is expected to slow down to the single digits YoY in 1Q, given the high comparison base and weaker demand. High-end wine growth was in line with that of mid-range/low end wine, causing a relatively flat gross margin in 1Q. However, our retail check gives positive feedback on its sales, and we believe sales growth will improve in the following quarters, especially after the launch of new Chateau wine products in the middle of this year.

We maintain our 2012/13e forecasts and expect 23% revenue growth in 2012. High-end wine to still be a key growth driver, with 20~45% p.a. revenue increase in 2012~13. Gross margin could rise to 73% in 2012, given the company’ s efforts to upgrade its product mix, however marketing expenses could edge up slightly for new Chateau wine and Brandy promotions. We expect operating margin to rise 0.9ppts to 42.2% and net profit to grow 25.1% in 2012.

Valuation and recommendations

We reiterate our BUY rating and 2012 TP of HK$112.3 on Changyu-B. It is attractive at its current valuation of 16.2x 2012e EPS vs. historical average of 19.9x, considering the company’s solid growth outlook and high visibility of earnings delivery.

Risks

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