Kweichow Moutai's Impossible Trinity

Is the most profitable spirits company in the world still a golden goose?

In context of the upcoming Third Plenum, historically a venue for the leadership in China to announce consequential agenda on a series of reforms, this will be the first of a few posts where I provide microeconomic examples of how political economy is deeply intertwined with business economics in China. As the title suggests, this following article will be about Kweichow Moutai.

For more context of the Third Plenum,

Zichen Wang

has a series of posts summarizing the domestic viewpoint of what to expect, whereas the always insightful

Bert Hofman

has written about what he would recommend from the perspective of a former Country Director of China at the World Bank.

Why am I writing about Moutai now?

Naturally, it was only appropriate that I start with the biggest (former) publicly listed company in China’s domestic capital markets. If you followed me on Twitter for a while and cared about investing in China, you’ll have noticed my ‘infatuation’ with Moutai. Additionally, the company’s stock price movement of late has even attracted the attention of The Economist - as the self anointed resident Baijiu expert on Substack, I feel obligated to chime in.

I first wrote about Moutai back when ‘Here is a Thread’ was popular - in which I discuss the genesis of the product and the history of Moutai, as well as the business/social dynamics upon which the baijiu (‘white liquor’) industry was built and why specifically Moutai came out in the lead. I also wrote about how Moutai has an “ex-factory price significantly below retail price” issue.

But it’s been over 3 years since that thread and many things have changed:

1. I’ve come to appreciate the taste and no longer think of it as ‘asinine’ (maybe I’m just getting old).

2. While revenues have grown 38% from 109.5bln RMB (2021) to 150.6bln RMB (2023) and earnings have grown 42% from 52.4bln RMB (2021) to 74.7bln RMB (2023), stock price is down 20% - the company now trades at ~20x forward P/E (BBG Consensus), a level not seen since 2019.

3. Wholesale (note, not ex-factory) price has compressed from >3000 RMB/bottle to as low as 2200 RMB/bottle.

   

   Moutai 5 Year Stock Price

Is Moutai not a screaming buy?

Presumably, when earnings are up 40% and stock price is down 20% the stock is cheaper. The normal answer is to buy more. However, as you will see below, decision here is not as clear cut as the simple spreadsheet math would indicate.

Those familiar with modern central banking are well aware of the Impossible Trinity - that a country cannot maintain fixed exchange rate, pursue independent monetary policy, and have an open capital account all at once. So how is this relevant with whether Moutai is a buy or a sell?

The Impossible Trinity

Moatless Capital is here to postulate the Impossible Trinity with Moutai Characteristics¹- that is, Kweichow Moutai cannot satisfy all three of: 1) Meeting earnings growth target set by Guizhou SASAC², 2) Sustainable distribution dynamics, 3) Stable/healthy stock price.

What do I mean by these three things?

1. Meeting earnings growth target set by Guizhou SASAC.
   Astute China watchers by this point will have recognized by this point that Guizhou is the province in question. Yes, this is the province that is widely reported in the media for having the tallest bridges in the world despite having one of the lowest per capita GDP in China and one of the highest debt to GDP in the country.³ However, the trump card that Guizhou has up its sleeve is that it owns a 54% stake in Kweichow Moutai - that’s right, the most indebted province in China also owns a controlling stake in one of the most valuable companies in China.⁴
   
   The important point here is that the Provincial government knows fully that they’ve been bestowed a proverbial golden goose (unlike some China Pundits), and the Province needs Moutai to pay out its earnings to help the Province pay interest on its debt. Ideally, officials would also like to see Guizhou’s credit metrics improve over time (as their boss in the Central Government are evaluating their performance for promotion). Therefore Guizhou SASAC would like Moutai to grow its earnings every year. In 2024 the target has been set at ~15%.
   
   Like the good Party Members they are, Moutai Management has been doing its best to achieve that goal, growing various Series Product (Moutai 1935, LayMau etc) as well as its Zodiac Series (for every animal in the Chinese Zodiac). However, the economy growing at 5% is not conducive to Moutai consumption growing at 15%. This is in context of all of the upper middle class urbanites (Financial Industry, Internet, Real Estate, and Lower Tier City Public Servants) having seen their balance sheet decimated (equity and real estate). Trees don’t grow to the sky just as Moutai’s sales cannot continue growing its volumes 15% forever without significantly changing its distribution dynamics.
   
   The political economy⁵ of this dynamic is displayed below:

   

   The other thing you will notice is the degree to which the distributors are making a lot of money via the markup of Moutai. Naturally, management team has been looking to repatriate that profit into the listed company - substantially increasing its ‘direct sales’ proportion, and raising its ex-factory price (Nov 2023 was the latest round). This is not without is issues either, as distributors are smart and realize their margins are Moutai’s opportunity when it comes down to satisfying SASAC’s orders.
   
   In the past month, due to the pressure of trying to grow Moutai ex-factory sales by 15% without a corresponding 15% growth in consumption, Moutai wholesale prices have started seeing downward pressure (which is why the stock price has come down). Clearly the distribution dynamics are no longer in harmony - leading us to the next point…

2. Stable Distribution Dynamics. As you may have read in my original thread, Moutai’s retail price has been quite stable as a % of Monthly disposable income in China (~40%). In other words, investing in Moutai and storing it has been a sure thing in growing wealth. This has attracted many investors - the question here is how much Moutai purchased in the past years has been consumed vs. hoarded by speculators betting on prices to increase. This historically wasn’t an issue because Moutai has been a great way of storing wealth. Aged liquor is also quite irreplaceable for special occasions so ‘carrying some working capital’ is not a terrible thing.

   

   Lots of Moutai sitting in storage

   You may ask, why don’t we talk to the distributors - and that people have. The general feedback from distributors is that approximately 50% of Moutai sold are opened and consumed. Assuming this only started after the last time Moutai prices went through a real cycle (In 2013 when anti-corruption campaign kicked off in full gear). It works out to be some 4 years of Moutai sales (or ~8 years of consumption) in inventory sitting out there (either in the hands of families, or in warehouses of financial speculators). As you cannot short Moutai wholesale prices, speculators are only storing Moutai with the hope that wholesale prices continue to go up. As wholesale prices start falling, they are no longer going to buy more Moutai, and instead they are likely to unwind their positions. If this forced liquidation were to happen, Bill Hwang and Archegos is Exhibit A of what would happen to Moutai wholesale prices in a disorderly unwind.
   

   Moutai Housing is for drinking living, not for speculating⁶. -

   Moatless Capital

   
   Presumably, Moutai raise prices and cut volumes (like all the other luxury companies) to achieve its targets, but in context of common prosperity, it seems more like political suicide by any management team in charge of Moutai. Additionally, it would attract even more speculators into the fray and not help the company’s problem of ex-factory prices significantly below retail prices. If that happened, at the 21st Party Congress in 2027 we might be talking about 3 Red Lines for Moutai hoarders as opposed to real estate developers. As such, it is difficult to maintain wholesale price dynamic unless volume growth was reduced. Which leads us to the stock…
   

3. Stable/Healthy Stock Price. Smart investors have figured out that the real supply/demand (as represented by wholesale pricing) of Moutai is quite transparently reported daily by WeChat Accounts⁷. As a reminder, this is an industry where there are hundreds of investors in WeChat groups with distributors. In fact, distributors themselves may also be participants in the stock markets and may spread news/narratives helpful for their own business or positioning. To have a stable stock price, the wholesale price cannot keep going down. However, to have a stable wholesale price, Moutai cannot keep pushing 15% volume growth (to the extent price is not a viable lever). To the extent Moutai cannot cut volumes to drive a bigger speculative bubble, the stock price is likely stuck unless the inventory pressures alleviate.
   
   At this stage of Guizhou’s debt-management plan it, is unlikely they are going to monetize sizeable chunks of their ownership in Moutai (much to the chagrin of

   Bert Hofman
   ), so I assume short term stock price volatility is unlikely a key decision making factor.
   
   One potential solution is for Moutai to leverage up to 3x Debt/EBITDA (something like 300-400bln RMB of debt) and dividend it out to shareholders, but this is not a sustainable solution and politically risky for the senior management. I suspect Guizhou SASAC won’t do this unless forced to do so.
   
   The best thing for Moutai in the long term, is for the company to give up earnings growth in the short term and destock the inventory - but to do that, the speculators need to be shaken out - and you cannot do that with a wholesale price going up to the right (as we’ve found out with Real Estate in China).

To have #1 and #2, Moutai must give up #3 - and this is what’s happening now - as investors realize the dynamic;

To have #2 and #3 - Moutai must give up its earnings growth target;

To have #1 and #3 - Moutai must relent with stable wholesale pricing/distribution dynamics - i.e control volume and raise prices - but this is clearly politically unviable - see my “3 Red Lines for Moutai Hoarders” comment above.

Which one of the 3 options will Moutai choose?

Moutai just yesterday announced that it is pausing delivery of Moutai 1935. Does this mean it is choosing to give up #1?

To the extent these issues are being priced into the stock, Howard Marks would say that it’s time for #SecondLevelThinking and it is in fact time to buy.

These are the billion dollar questions for investors - most importantly for Guizhou SASAC.

What’s not changed? What’s gotten better?

1. The Moutai brand and its synonymity with luxury remains - be it the first time visiting your future in-laws, using it as more nefarious social grease (read: bribes) - the social status/importance of Moutai has been ingrained into multiple generations of people and is unlikely to change.

2. As much as there is ‘a lot of inventory’ - annual baijiu consumption in China is over 6 mln tons - and the Moutai inventory is only 2% of that - so the ‘inventory destocking’ can be quite rapid if there ever was a “kitchen sinking” moment by the company. The real risk here is for the companies without true brand heritage but with products selling at high prices (I’m looking at you ZJLD). If this were to ever happen, it would also represent an opportunity for those brands with heritage but selling for ‘value’ prices.

3. The financials and business quality remains as strong as ever - more importantly, shareholders have received substantially all of the earnings as dividends in the past 3 years (basic + special dividend) - corporate governance has improved significantly.

4. Capital intensity of Moutai is functionally zero⁸ (in fact I would suggest the Poverty Alleviation mission is likely a higher CapEx line item than real capacity expansion). At a 3.5% dividend yield growing at low teens without reinvestment needs, what should this earnings stream trade at?

What are the other questions?

Life, Death, and Taxes
So this is a massive profit pool in China - the question you’ll ask, what’s the tax rate? You may find it interesting that the taxation of baijiu in China has 2 tiers - 1)1 RMB of taxes per 1 liter of baijiu produced; 2) 20% VAT with 60% tax-base (meaning 12% effective tax rate). What this means is that if you are a local baijiu brewery selling 10 RMB/liter moonshine, effective tax rate is 22% (1 RMB + 12%), whereas Moutai pays ~12% (the 1 RMB/bottle tax for Moutai can be functionally ignored). From a consumer perspective, this means that the migrant worker drinking Erguotou in Zhumadian, Henan is paying a higher tax rate than Desmond Shum was when he was sipping Moutai in his private club. This is a highly regressive tax system that makes no sense and will be adjusted as part of the Third Plenum. Unlike other countries, the government/state is a shareholder alongside minority shareholders - so there will likely be negotiations between Guizhou and the NDRC and the impact wouldn’t be as bad as otherwise. How big will be the change? Where will be the tax rate after tax reforms reported today? How much of it will be borne by consumers vs. by producers?

You drink baijiu? How boomer of you.
Like their Western counterparts, Chinese Gen Z are…different. One question as a super long term investor you have to think about, is whether if the youngest people in China are going to consume baijiu vigorously as their parents. The answer here is a resounding no - total industry baijiu consumption has more than halved in the past decade - people are drinking less baijiu, but they are selecting higher quality baijiu. Additionally, Moutai in the past years have had its 3-pronged effort in engaging with youth - Moutai Ice Cream, Moutai Latte with Luckin, and Moutai Chocolate. How successful were these efforts at engaging with the youth? Did it do so while diluting the Moutai brand?⁹

For the Allocators who Subscribe: these are the hard questions you need to be asking your China/Asia/EAFE managers.

Evidently, just as I wrote last time with

East Asia Stock Insights

on the hotel industry, the current issues facing Moutai is not simply a function of “consumption downgrade” nor is it simply a function of “political malarkey”; rather it is a result of the nuanced combination of the various factors and interest groups I’ve outlined. Additionally, note that all of the key decision makers and stakeholders are *all* Party Members - but they are not necessarily aligned on incentives.

Ergo, any “analysis” of China that labels “the Party” as some fully united and omniscient entity without delineating between the interests of the various stakeholders is deeply unserious and needs to be treated with utmost skepticism. Remember, this is a political organization that practices Democratic Centralism (or, Disagree and Commit in Amazon Basics lingo) - the notion that there are no disagreements is farcical.

I am not going to predict what will or won’t happen, other than to say that this is complex, and that there is no easy answer. I may or may not have a position in Kweichow Moutai; this is not an opinion of whether Moutai is a long or a short; and given the dynamic nature of the situation, I also reserve the right to change my mind without updating this post. This is not investment advice, and do your own work.

TL/DR: Reforming is hard, especially when its in the ‘deep waters’. I hope this is the beginning of a conversation and welcome any feedback - as usual, would love to be proven wrong.

1. The previous installment of Moatless Capital’s Impossible Trinity for COVID in China suggested (correctly) that China had to pick 2 out of the 3: 1) Zero Covid Lockdowns; 2) Structural Real Estate Reform; 3) Real GDP Growth >5%.

2. SASAC - State-owned Assets Supervision and Administration Commission of the State Council - think of it as the government agency in China in charge of all of the SOEs. In this case, Guizhou SASAC is the provincial level organization which is the ultimate owner of Guizhou Province’s stake in Kweichow Moutai.

3. For those interested in the “but at what cost” angle of reporting - read any of the Bloomberg/The Economist/FT headlines out there, or read up what Michael Pettis has said (for a decade) about this issue. For those interested in a more sanguine take,

Glenn Luk

is your guy and we’ve discussed in-depth and he’s written in-depth about this issue.

4. Clearly, pundits in the China Watching Community needs a remedial lesson in accounting - they do not seem to understand the difference between gross debt and net debt. Assuming a 2trln RMB equity market cap, 54% ownership represents some 50% of GDP of Guizhou. Whatever Debt/GDP statistics the media reports, you should recalculate after you take reduce the numerator by 54% of Moutai’s market cap. Unless of course, the said media reports a Moutai-Adjusted Debt/GDP for Guizhou, in which case they are Moatless Capital Certified as a China Watcher fluent in Accounting 101.

5. In Chinese, this would translate to something like “上升到政治高度” - meaning that the issue in question needs to be elevated to a matter of political importance.

6. In Chinese, this would translate to: 茅台是用来喝的，不是用来炒的

7. This is yet another example of why you are a deeply unserious China Watcher if you do not spend time on the WeChat ecosystem. cc:

Zichen Wang

8. For those who aren’t investment nerds, the idea here is that when you have a company that can produce cash without having to reinvest anything to generate growth, it is worth a lot more than say a company who cannot grow without reinvesting significant of its cash.

9. “But at what cost” is a legitimate question in this regard.