China Baijiu Sector: Initiating Coverage of Luzhou Laojiao, Shanxi Fen Wine, and Anhui Gujing

We initiate coverage on China baijiu producers Luzhou Laojiao 000568, Shanxi Fen Wine, and Anhui Gujing, with fair value estimates of CNY 259, CNY 246, and CNY 225 per share, respectively. We think Laojiao and Fen Wine are undervalued relative to our fair value estimates, while Gujing is fairly valued as of market close on June 30. We continue to like the premium baijiu segment, as we expect demand for premium baijiu to remain solid amid China’s expanding prosperity in the long term, despite short-term economic swings. We also believe the sector’s premiumization is a long-term tailwind for distillers, and leading players are better positioned to benefit. Among the six baijiu companies we cover, Luzhou Laojiao is our top pick in the sector, due to its strong brand heritage, supreme product quality, extensive distribution network, and deepening co-operation with distributors, which have also fortressed its competitiveness, allowing it to generate the long-term economic profits that underpin our wide moat rating.

The baijiu sector has underperformed the broader market in the second quarter, with share prices of the six names under our coverage falling 2%-32% during the period, compared with a 5% drop of the Shanghai-Shenzhen 300 Index. We think this reflects market concerns over the slower-than-expected sales growth and higher inventory levels that may pressure future sales. Although the baijiu sector as a whole is still facing sales pressure, we think increased demand for socializing—along with premium baijiu’s irreplaceable position in the Chinese drinking culture—will help to support steady sales growth for leading baijiu brands. Our channel checks suggest demand for premium baijiu is relatively resilient, with stable wholesale prices and healthy inventory levels. We believe the second-quarter sales of the six baijiu names we cover are well on track to meet our full-year 2023 expectations.