08 January 2020 | Fiona Yang, Analyst
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. 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 2019 in the Invesco Asia Trust plc. Sales had 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 to have another round implemented in the next few quarters.
As long-term investors, we are willing to see through short-term volatility and believe that 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 consumers upgrade their product purchasing. Since listing, Yanghe has generated a return on equity 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.
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