Dukang Distillers Holdings

UOBKayhian on 26 June 2013

Valuation

Dukang Distillers Holdings (Dukang) is trading at 9.1x FY12 PE and 1.3x P/B. This is in comparison to peers’ averages of 12.3x and 3.9x respectively.

Investment Highlights
Top provincial brand in Henan, China with a 3% market share in a highly  fragmented industry. According to management, Dukang had surpassed  Henan Songhe Liquor Industry Co., Ltd. as of end-12. Its premium Dukang  brand (vs the low-end Siwu) is considered the official baijiu in Henan,  commonly served during local government affairs.

Elevated to first-tier status with endorsement by the Chinese government. The Dukang brand was recently officially designated as one of the appointed baijiu to be served to foreign dignitaries. This places it in the country’s elite list of only less than ten brands. We think the strong support from the national government provides the company with a crucial stepping stone in growing its presence in China.

Almost 40% capacity increase by August. Dukang is set to add 700 (+24%) fermentation pools by August, which is estimated to add 3,000 (+39%) more tonnes in annual capacity of grain alcohol (pure alcohol). This amount of grain alcohol, when converted to Dukang-branded baijiu, could potentially contribute Rmb540m-675m of revenue p,a..

Premium Dukang product line to boost margins further. The company’s overall gross margin has improved significantly in the last 2-3 years as it ramped up its premium Dukang product line. Currently at over 40% (over 30% historically), management believes there is still upside ahead as its most premium product (gross margin of >50%) continues to enlarge its share in the group’s revenue pie. As an indication, sales of the iconic Jiuzu Dukang made up 22% of 3QFY13 revenue; this is in comparison to the typical 50% contribution seen from competitors’ respective iconic products.

Carving a presence outside Henan. Currently, Dukang-branded products are being distributed in over 20 other provinces. Management intends to grow its <1% nationwide market share by targeting the core markets such as Guangdong and Tianjin first. Ad & promo expense will be kept at 12% of revenue while the distribution network for the Dukang brand will be further enhanced. Since 2011, the distributor count outside of Henan has grown more than 50% to reach 85 as of end-March.

Low credit risk with cash-on-order payment scheme for its Dukang product line. This has allowed the group to maintain a low receivables turnover period of 10 days in 3QFY13 (15 days in FY12).

Singapore debut by end-13 through Singapore’s leading baijiu distributor, Oasis Global. The current baijiu market in Singapore is estimated to be worth S$3m in revenue p.a. and this is projected to double by 2015, driven by Chinese businessmen in the country.