- Source : WSJ, July 30, 2007

 

MORE BEER is consumed in China than in any other nation -- so why are some investors in Chinese shares reaching for a wine glass rather than a mug?

It is partly a matter of growth potential. China's wine drinkers are relatively small tipplers, each sipping, on average, 0.4 liter a year, according to the Chinese Alcohol Industrial Association. The group says that globally, the average wine drinker consumes seven liters a year.

There isn't so much room for growth for beer in China. The association says China already accounts for 73% of the world's beer consumption. ABN Amro has forecast that Chinese wine consumption will grow 15% a year over the next five years, compared with annual 8%-to-10% growth for beer in that period. China's major wine players also command greater market share than the more-competitive beer market, and as such have relatively greater pricing power, say analysts.

Though still unlikely to become top choices for Robert Parker and other famous wine connoisseurs, brands including Dynasty, Changyu and China Great Wall Wine command a total of about half of the market in China, with distribution networks that foreign competitors can't match.

This year, the Chinese players expect to benefit from last autumn's abundant domestic grape harvests. Several also are expanding production capacity, branching out into higher-value products and looking to buy vineyards overseas.

It was a less-heady situation a year ago, when poor harvests in China led to a 15% increase in grape-juice prices. That dented Hong Kong-listed Dynasty Fine Wines Group, which saw its 2006 net profit fall 36% from a year earlier to HK$114.8 million (US$14.7 million). China's third-largest wine producer, Dynasty experienced difficulties with sourcing and had to import grape juice from Australia.

Now, better grape harvests are likely to lower grape-juice prices, which could help Dynasty's gross margins expand 1.3 points to 57.9% this year, according ABN Amro's estimates.

In April, ABN Amro analyst Lei Yang upgraded Dynasty to 'buy' from 'hold,' raising her one-year price target to HK$3.75 from HK$3.13. One factor she cited was the company's push to tighten distribution costs. On Friday, shares of Dynasty declined 10 Hong Kong cents each to HK$3.

Dynasty, which was 27%-owned by Remy-Cointreau of France at the end of 2006, says it is looking to keep distribution costs to below 30% of sales this year by using auctions to select transportation agents. The company also is building a new production plant in Tianjin that will double capacity to 70,000 metric tons by 2009.

Rival Yantai Changyu Pioneer Wine, China's biggest wine producer, is also expanding, venturing into higher-premium products. Last September, the Shenzhen-listed company put 50 million yuan (US$6.6 million) into a joint venture with Canada-based Aurora Icewine to build a vineyard for ice wine -- a type of dessert wine produced from grapes that have been frozen while still on the vine -- in Liaoning province with a production capability of 1,000 tons a year.

In the first quarter of this year, Changyu's net profit rose 30% from a year earlier to 195.3 million yuan. Sales grew 23% to 995.8 million yuan.

Changyu has been aggressively pursuing cooperation with foreign players. Aside from Aurora, the company also has joint ventures with French winemaker Group Castel and New Zealand vintner Kely Estate.

Zhao Zongjun, an analyst at Shanghai-based Guotai Junan Securities, has a buy rating on Changyu with a target price of 77 yuan by year end. Friday, Changyu shares rose 46 fen to 61.61 yuan.

The company has been investing heavily in expanding a vineyard near Beijing, and Mr. Zhao says that project's output can increase to 1,000 tons in 2008 from 200 tons at present. He expects the company's net profit to grow annually by about 35% to 40% in the next three years.

China Foods is the country's second-biggest wine producer. Sales of its Great Wall Wine brand have helped buoy the Hong Kong-listed company, said company executives. During 2006, sales of wine rose 16% to HK$1.8 billion, according to the company's Web site. Beverage and wines account for 17% of the company's total profit, Thomson Financial says. Mah Ling canned meat is one of China Foods' strong brands.

Until April, China Foods was known as Cofco International, the listed arm of state-owned China National Cereals, Oils & Foodstuffs Import & Export Corp. Cofco International underwent a major reorganization that included spinning off its agricultural subsidiary. For 2006, Cofco International reported a 76% rise in net profit to HK$990.1 million.

According to J.P. Morgan analyst Selina Sia, Great Wall appears to be ironing out problems from its different vineyards using different distributors, who competed against one another in the retail market. Management has pledged to consolidate distribution, which should raise profit margins, Ms. Sia wrote in June.

At that time, she gave China Foods an 'overweight' rating and a one-year target price of HK$5.80. The shares fell 12 Hong Kong cents Friday to HK$5.18.