15 February 2014

Dukang Distillers - Bai Jiu industry in Consolidation - Feb 2014

Dukang Dislisters reported a very disappointing result, right after it issued a profit warning on 2QFY14 report. The revenue in 2QFY14  dropped a significant 45% yoy compared to corresponding period last year, with only RMB402.8M revenue recorded.

The product mix change towards Luoyang Dukang regular brand had eroded the gross profit margin. To make it worse, surging A&P expenses which amounted to more than 20% of revenue had made the net profit reduced to RMB10M in this quarter. According to the management, the it is not the time for the company to cut the A&P expenses as well as working capital needs, instead the company would increase CAPEX (as you could see that the inventories was increasing as well) in a preparation of facing fierce competition among peers.

Baijiu industry currently in a midst of intense competition (mainly due to government's curb), as many companies reduce the average selling price to gain more market shares.

While you could see that the company is still in net cash position, it is no doubt that the company would not distribute as dividends to shareholders as they would conserve the cash for CAPEX and OPEX requirements. The cash flow from operating activities had turned to negative figure this year, as the company increased the inventories (mainly grain alcohol).

Company's growth strategies remain at 3:
  1. Enhance brand value by participating in promoting baijiu, especially Dukang premium brand  
  2. Strengthen distribution networks as none of the top 5 distributors accounts for more than 10% of sales. However, I noticed that the number of distributors were lesser compared to FY2013 as I believe that mainly due to the curb of Chinese government on luxury spending in Banquets. 
  3. Improve capacity and utilization. The utilization rate was 105% for 2QFY14. 

With current 2Q2014 EPS of 1.26 RMB cents or annualized 5.04 RMB cents / 1.05 Scents, I think that Dukang distillers is trading at annualized PE of more than 20X, which I believe is still very expensive. The condition could only turn better if the sales volume could increase after positive impact of A&P activities seen. Nonetheless, the group remain positive on the long run as the management believe the demand for Baijiu will remain resilient in the long run.

I believe the sentiment for this counter is weak now, but it may take quite some time for company to turn around as revenue and net profit issue are experienced by the whole industry players. I may re-look on this counter only after the free cash flow could be improved (e.g. reduce % of A&P expenses in Revenue, better cash conversion cycle days etc) , maybe a few more years later.

P/S: I would think that to enter the share price at 13c and below would be a safer bet as of now.

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