Yanghe: combining tradition and modernity
On a recent trip to China, I visited Jiangsu Yanghe’s distillery near Suqian City, Jiangsu Province. Yanghe is the third largest Baijiu (Chinese spirit) producer in China and the Jiangsu region is famous for its terroir and high-quality water resources, both of which are critical for producing high quality Baijiu. I finished my three-hour tour deeply impressed by the company’s successful integration of tradition and modernity.
Yanghe’s fermentation, distillation and aging process follows Baijiu making traditions that are hundreds of years old. The main ingredients of Baijiu are sorghum, rice, wheat, corn and glutinous rice. These grains are fermented in aged mud pits for 80-90 days before being distilled at low temperature to remove impurities. Yanghe’s distillation process includes 24 steps, ensuring a high quality end-product. The aging process continues in ceramic barrels stored in the underground facilities as you can see from the pictures below. The barrel storage facility I visited was built over two hundred years ago and continues to produce premium quality Baijiu, which has a fragrant aroma and distinctly smooth taste
Meanwhile, Yanghe’s packaging, warehousing and inventory management systems adopt state-of-the art technology. Yanghe has eight automated assembly lines, where packaging and inspection take place. Anti-counterfeit labels, equipped with latest technology, are attached at this stage. Yanghe was the first in the industry to adopt an automated stereoscopic warehousing system in 2009. The system fully utilises the vertical space within the warehouse and reduces the amount of labour required. Additionally, management adopts advanced CRM-style software systems to monitor inventory and distribution at headquarters and regional facilities.
We initiated a position in Yanghe at the beginning of the year in the Invesco Asian Fund (UK) and Invesco Asian Equity Fund. Sales has experienced some volatility over the past 12 months due to a distribution channel inventory issue. However, management have responded swiftly, changing key sales team personnel and implementing several restructuring initiatives. The company’s progressive share incentive scheme is also due have another round implemented in the next few quarters.
As long-term investors, we are willing to see through short-term volatility and believe the share price will reflect the company’s strong fundamentals over time. Yanghe’s long-term growth strategy is underpinned by national expansion plans and the trend of premiumisation, which is seeing Chinese consumer upgrade their product purchasing. Since listing, Yanghe has generated an ROE of c.25% with an unlevered balance sheet. Our investment case is not without risk given intense competition in the lucrative Baijiu industry. However, Yanghe management have proven themselves over time, successfully transforming a regional boutique brand into a nationwide success-story, outpacing its many peers to become China’s third largest Baijiu producer.
The Chinese economy has appeared relatively robust but has continued to slow. We do not expect the authorities to ease aggressively as they attempt to strike a balance between maintaining an acceptable level of economic growth whilst managing financial risks in the economy. However, we believe the lagged impact of previous policy tightening on economic output is close to disappearing and China’s growth should improve in the medium term helped by supportive economic policies.
Investment risks
- The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. The Invesco Asian Fund (UK) invests in emerging and developing markets, where there is potential for a decrease in market liquidity, which may mean that it is not easy to buy or sell securities. There may also be difficulties in dealing and settlement, and custody problems could arise. The Fund may use Stock Connect to access China A Shares traded in mainland China. This may result in additional liquidity risk and operational risks including settlement and default risks, regulatory risk and system failure risk. The fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the fund. The Manager, however, will ensure that the use of derivatives within the fund does not materially alter the overall risk profile of the fund. As a large portion of the Invesco Asian Equity Fund is invested in less developed countries, you should be prepared to accept significantly large fluctuations in the value of the fund. The fund may invest in certain securities listed in China which can involve significant regulatory constraints that may affect the liquidity and/or the investment performance of the fund.
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