Shanxi Xinghuacun Fen Wine:Potential SOE reform could support LT growth;Neutral on valuation

What's changed

According to a company announcement on Feb 25, Shanxi Fen Wine Group(groupco, not covered) is planning to list the entire group and employeeholding as required by the Shanxi government. We see this as evidence offurther mixed ownership reforms in the industry. The groupco has set itselfgrowth targets of 25%/25%/25% in 2017-19 for profit before tax and30%/30%/20% for revenue, though listco management stated that it has notreceived any allocated operating targets and has not set 2017 plans.

Implications

If the report is accurate and while we do not take a view on the likelihoodof any deal materializing, we see these implications: (1) Given the groupcois a legacy SOE, reform could have positive long-term implications for thelistco (see related research on page 3). The listco has lower margins thanpeers like Yanghe and Laojiao (Exhibit 1) and we believe there are chancesto reduce SG&A if SOE reform is carried out given potential to improveoperating efficiency. (2) Listco accounts for more than half of grouprevenue, while listco profit is even higher than groupco, so we thinkpotential growth targets for listco would also be high. Separately, (3) thespirit market in Shanxi province recovered in 1Q16, driven by consumptionupgrade and the accelerating Shanxi economy. We expect higher revenuegrowth for the listco in 2017 due to higher ASP on product mix upshift,among which high-end brands like Qinghuaci are likely to maintainrelatively high growth rates.

Valuation

We raise 2016E-21E EPS by 8.2% to 15.5% to reflect the recent recovery in thespirits market. As a result, we increase our 12-m TP 9.8% to Rmb25.71 (fromRmb23.42), still based on 18X 2021E P/E discounted back to 2017E using 8.7%sector COE. We do not factor the proposed listing in our numbers. MaintainNeutral on rich valuation (31X 2017E PE vs. sector average of 24X).

Key risks

Faster/slower-than-expected recovery of the spirits sector.