In addition, there was 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.

Source: itrade chart (1 Feb 13)

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.

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 RMB300-1,000 with 1,000 being their top end product. (Moutai’s products are typically more than RMB1,000) During a teleconference with analysts in Nov 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. http://www.nextinsight.net/index.php/component/content/article/918-2012/6086-dukang-1q2013-net-profit-surge-75-to-rmb-639m)

1QFY13 revenue and net profit ended Sep 2012 rose 68% and 75% to RMB407m and RMB64m respectively. This is typically a lull quarter and results have been very good. According to 1QFY13 results announcement, management remained upbeat on their prospects and believe the upcoming 2Q and 3Q 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.

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.

On 24 Jan 13, it was reported on the SGX 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 Nov 12, OZ Master Fund has also ceased to be a substantial shareholder by selling 21.5m shares in an off market transaction. (Do refer to the SGX announcements for more information.)

Based on an article in China Daily on 14 Jan 2013, the retail prices for Moutai and Wuliangye products had reportedly dropped to as much as 60% 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 else 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 4.6m and 3.6m 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 – 0.315. (See Chart 1 above)

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 1QFY13 results, Dukang’s NAV per share is around $0.40 vs the current market price of $0.310 on last Friday.

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

*Readers who wish to see the chart above / Dukang’s financial results can email me at crclk@yahoo.com.sg.  This writeup was sent out to my clients last Sunday.

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