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Dukang Distillers – Still Growing Despite Industry Headwinds
Perspective | 05 February 2013
By: Ernest Lim
Articles (134) Profile

It never rains but it pours. This phrase is an apt description for Dukang Distillers Holdings. Why is this so? With reference to Chart 1 below, it is apparent that Dukang is a laggard in the recent market rally. Dukang’s price suffered a setback in November after the official Xinhua news agency cited findings by Hunan provincial authorities, who corroborated earlier Chinese press reports, that excessive plasticizers (i.e. toxic chemicals which can induce early female puberty and cause damage to men’s reproductive health over prolonged consumption) were found in Jiugui Liquor products.

In addition, there is a continuous strong anti-corruption rhetoric from the new Chinese leaders, which might reduce demand for expensive baijiu. This is because expensive baijiu such as Moutai are often used as gifts to local government officials. Furthermore, according to an article published in the PLA Daily (i.e. the official army newspaper) last month, expensive liquor has been banned in military and government receptions. All of these contributed to the weakness in the share price performance of the baijiu players, which undoubtedly affected Dukang.

Chart 1: Dukang lags in the market rally

Source: itrade chart (1 Feb 13)

Notwithstanding the industry headwinds, I would like to point out several noteworthy points on Dukang.

1. Dukang’s end customers are not sold to the military

According to Dukang, their products are sold through distributors to mainly hospitality establishments, supermarkets and specialty stores selling tobacco and alcohol products in the PRC. Thus, the ban on expensive liquor does not seem to have a direct and significant impact. Nevertheless, there may be indirect effects, such as the possibility that other baijiu players may start to divert some of their attention from military and government to sectors such as hospitality and retail.

2. Dukang’s products are not as high end as Moutai or Wuliangye

From the news that I have gathered, it seems like the official banquets are replacing the expensive baijiu with less expensive baijiu (since expensive ones are banned), thus, this may have a net positive effect on Dukang over the long term. Dukang products are priced around Rmb300 to Rmb1,000 with 1,000 being their top end product. (Moutai’s products are typically more than Rmb1,000.) During a teleconference with analysts in November 2012, management cited that the government curbs may arguably lead to an increased demand for more affordable alternatives such as Dukang’s products. (Readers can refer to Nextinsight’s takeaways on Dukang’s teleconference with analysts.

3. Results – 2Q & 3Q are key

1Q13 revenue and net profit ended September 2012 rose 68 percent and 75 percent to Rmb407 million and Rmb64 million respectively. This is typically a lull quarter and results have been very good. According to 1Q13 results announcement, the management remained upbeat on their prospects and believe the upcoming 2Q13 and 3Q13 should be good due to the festive seasons. It would be interesting to see the management’s outlook in the coming quarters in view of the recent industry headwinds.

Investment risks

1. Government regulatory concerns

As mentioned above, the ongoing government regulatory concerns are major headwinds to the industry. It remains to be seen whether the current government curbs will have any adverse long term effects on Dukang (or perhaps, long term benefit to Dukang). Any new measures from the Chinese leaders would also pose risks to the industry as a whole.

2. Cessation of substantial shareholders over the past three months

On 24 January 2013, it was reported on the Singapore Exchange that “CIM XIII LTD distributed the shares of Dukang Distillers Holdings Limited to its shareholders via dividend in specie and to Centurion Investment Management Pte Ltd for fees incurred”. As there is limited information available, it is difficult to judge the impact on such actions but there may be a risk that these shareholders may sell the shares on the open market.

In addition, on 20 November 2012, OZ Master Fund has also ceased to be a substantial shareholder by selling 21.5 million shares in an off market transaction. (Do refer to the SGX announcements for more information.)

3. Slumping prices for Moutai and Wuliangye products

Based on an article in China Daily on 14 January 2013, the retail prices for Moutai and Wuliangye products had reportedly dropped to as much as 60 percent due to promotions in supermarkets and department stores. This might be due to distributors who had stocked up Moutai and Wuliangye products because they had expected such products to appreciate in prices as festive seasons approach. However, the government curbs affected demand and the distributors have to sell at cheaper prices or they may suffer more losses on their inventories. Nevertheless, such decrease in price may narrow the difference between Moutai, Wuliangye and Dukang’s highest end products which may ultimately affect Dukang.

4. Usual S-chip risks

In addition to the usual corporate governance risk surrounding S chips, they face liquidity risk and price risk. For Dukang, its average 30D & 100D volume amount to around 4.6 million and 3.6 million of shares respectively. Thus, it is not exactly an illiquid stock. The recent price performance has been lackluster but it is resting on a strong cluster of supports of around $0.305 to $0.315. (See Chart 1 above)

Valuations trading at a steep discount vs peers

According to Bloomberg, Dukang trades at a historical PE of around 5.1x vis-à-vis the industry average of around 17.4x. In it latest 1Q13 results, Dukang’s net asset value per share is around $0.40 versus the market price of $0.310 last Friday.

In a nutshell, Dukang’s upcoming 2Q13 and its outlook in the quarters ahead may prove to be a rerating factor if they continue to deliver.

*This writeup was sent out to my clients on 3rd February 2013.

The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied. In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.
Ernest Lim is a CFA, CA and has worked at GIC Special Investment. He has a solid feel of the markets and financial world and is now a remisier.

Please click here for more information about this author.

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