The Patrón of Xinghuacun - a modest proposal for Fenjiu (600809.CH)

Good wine needs no bush - 酒香不怕巷子深

TL;DR: How would you like the opportunity to invest in the best-positioned Chinese baijiu brand with substantial expansion potential driven by market share gains and penetration growth without significant reliance on macroeconomic inflection?

Okay I lied, this post is not about wine, nor is it about Patrón, but it is about Xinghuacun¹. If you’re at all familiar with the name, you’ll have immediately recognized that we are going to talk about Fenjiu. It’s not as famous as Moutai, but it has a cool backstory. I mean, sure, some of it might be made up, but who’s keeping track of that?

That being said, for those of you who aren’t interested in investing in China - I’ve made sure to include some extremely well made YouTube videos about local cuisine (as delicious sustenance should be the greatest common denominator among readers here), as well as some cocktail recipes so you can try it yourself should you prefer alcoholic libations.

The sudden interest in Chinese equities predictably started with ADRs and “Chin-ternet” companies, but I don’t feel I have more to add to the conversation. As I wrote at the start:

it is my opinion that we do not need the 43209478293874th write up on how Alibaba is cHeAp, how Tencent Dreams, or how Pinduoduo gamification is changing Chinese ecommerce (that is *so* 2020).

But let’s be honest here, you should not be surprised that I am writing about another business engaged in the business of selling alcohol, after my previous musings on Moutai. If you haven’t read that yet, you should pause here and read that before going into this one - as I believe that will give you additional context on why I believe Fenjiu is much better positioned.

Why does the opportunity exist?

1. Disinflation/deflationary environment in China with negative PPI & low CPI - it is difficult to raise prices when the entire economy is grinding down prices. Meanwhile, consumer sentiment has not recovered since 2022, consumer propensity to spend remains low vs. propensity to save. Despite recent excitement as a result of DeepSeek & revaluation of Chinese Internet, this has not (yet?) transpired to the real economy or domestic consumption.

2. The vast majority of A-share professional investors are quite pessimistic about the future of the Chinese economy - in general the market does not believe the effectiveness of fiscal stimulus² and the subsequent improvement of the economy. As such investors remain skeptical about the continuity of the company’s share gain & growth in the short term. While there is recognition of Fenjiu’s relative opportunity, they’re all too busy chasing what’s ‘working’ today - “I’ll look at it in 2H25” is the prevailing vibes.

3. Potential risk of China Resources selling pressure.

What is a Fenjiu?

Fenjiu (“the Company”, “Fenchiew”, “Fen Wine”) is one of the leading premium baijiu producers in China, specializing in light-aroma baijiu, with its operations deeply rooted in the centuries-old Xinghuacun region of Shanxi Province. As of 2024, Fenjiu generated approximately ~¥36 bln in annual revenue, having benefited significantly from previous premiumization of baijiu.

In the recent ‘upcycle’ of Fenjiu, revenues grew from ¥6bln to ¥36 bln from 2017 to 2024 while Net Income grew from ~950 mln to ~12 bln. Share prices went from 40 RMB/sh to as high as 375 RMB/sh (currently settled at ~190 RMB/sh). Shares are trading at 19x T12M earnings or ~16.5x N12M earnings (Peaked at over 100x earnings in 2021). For all you chartists, the stock chart looks like this:

The stock did extremely well from 2016-2021 but has since stagnated.

The company generates extremely attractive ROIC and boasts over 75% gross margins and 30% net income margins. If you lay out the company’s financials on a spreadsheet, it’s obvious to the youngest of padawans of value investing to know that its a great business.

In the past 4 years, the stock has dropped by about 40%, while earnings have grown by 240%. Now, frequent readers will and ask “that’s the same you said for Moutai, what’s different this time?” Well, as you will hopefully see below, I surmise that the outcome for Fenjiu is likely different. And as you will note, the decision here is also not as clearcut as simple spreadsheet math.

History of Fenjiu

“Moutai stole our processes”.³
If you call up an expert in the industry and ask, you will likely be told that the folk lore in Shanxi goes that the original fermentation process of Fenjiu was stolen by people who travelled towards Guizhou and that the local soil/water/microbes in the mountainous regions of Guizhou is superior to that of the dry and arid yellow dirt plateau in the North.

The next thing that the expert will explain to you is that Fenjiu ‘beat out’ Moutai at the 1915 Panama Pacific International Exposition as the only Chinese recipient of a gold medal award.

Thirdly, I bet you someone will comment in a ‘matter of fact’ attitude that suggests that the famous poet Du Fu wrote a famous poem that referenced Xinghuacun⁴:

清明 (杜牧)

清明时节雨纷纷，

路上行人欲断魂。

借问酒家何处有？

牧童遥指杏花村。

However, the poem really did not have anything to do with Shanxi as baijiu in its current form wasn’t even consumed during the Tang Dynasty. It was the deed of Shanxi merchants⁵ during the Qing/Ming dynasties that cleverly leveraged this coincidence to associate Fenjiu with the poem. Additionally, the Fenjiu/Moutai lineage is likely just folk lore and nobody really cares about the 1915 exhibition save people in China. However, what IS absolutely relevant is that Fenjiu holds its own in terms of ‘historical relevance’ as Fenjiu is endowed with a heritage that is stronger than it’s current market position - they had a poor strategy of making 3123987436 SKUs all at low prices - Fenjiu had done the business equivalent of ‘sitting at the cool kids' table’ for years, only to find that, shockingly, not every table is as fun as it looks. In short, they fell behind Wuliangye and Moutai.

“Four Famous Spirits”
What *IS* absolutely true is that Fenjiu was named along with Moutai, Luzhou Laojiao, and Xifengjiu⁶ as the four famous spirits in the inaugural National Alcohol Appraisal Conference in 1952. Aside from bragging rights, the commercial implication was that during the centrally planned economy of China before 1978, only those products with certain ‘certificates’ were allowed to be sold nationally. In the case of alcohol, only ‘famous spirits’ were allowed to be sold nationally - and as such Fenjiu benefited significantly from mindshare even in regions outside of Shanxi. For example, it is legitimately a ‘thing’ that chasiu (BBQ Pork) in Guangdong is supposed to be cooked with Fenjiu. As well, older folks who spent their formative years during the cultural revolution would recognize Fenjiu regardless of where they grew up. However, for one reason or another, Fenjiu did not capitalize on its endowed position and failed to keep up with Wuliangye/Moutai in the 2000s. The company did not have a great management in place to drive a premiumization push (the way the late Yuan Renguo did with Moutai) and did not synonymize itself with luxury and status the way Moutai did.

However, Fenjiu began a concerted nationalization⁷ effort in 2016. The management team were extremely successful in revitalizing the brand/products of Fenjiu and kick started the impressive growth I discussed earlier. They themselves profited immensely as the company’s Communist leadership core group of enterprising employees took home some 1bln RMB as their restricted stock units soared in value. In the context of the value creation, this was *more than fair*. I am really cutting the story short here but the gist of it is what I laid out. If you are interested in the details, call up your favorite sell side analyst and ask them.

Why is Fenjiu positioned to win?

Downgrade? Upgrade?
As mentioned in ATAT 101, an important theme in consumption brands within China is the so called ‘consumption downgrade’ effect.

East Asia Stock Insights

and I highlighted how complacent it was to have such a simplistic view and it is why ATAT 0.00%↑ has performed as well as it has - as much as the economy has been sluggish, nobody, absolutely nobody wakes up in China feeling as if they want their lives to be worse off - they are currently in the stage where they do not feel like they want to pay up for quality. As I’ve shitpoasted commented before, the economy doesn’t work quite well when everyone behaves like Warren Buffett.

Where are we seeing downgrade in Baijiu consumption?
To be extremely clear, we are absolutely seeing consumption downgrade within baijiu consumption. As a result of the popularity of Moutai, sauce aroma baijiu became synonymous with ‘good’ - not because it was somehow good - but it was ‘the Moutai aroma’. A cottage industry of sauce aroma baijiu master brewers started with all sorts of different brands - the result is a classic capital cycle where undersupply caused excessive capacity which caused overcapacity - just as the economy was slowing down from real estate & COVID lockdowns. The result was not pretty - other than Moutai, the random sauce aroma baijiu priced as “Poor Man’s Moutai” have seen their prices drop significantly - and volumes have been hit as consumers recognized the low ‘price to value’ proposition of these random brands. While the occasions demanding Moutai still require Moutai, slower economic activity also meant there are less of those occasions. Wuliangye has also been hurt as it’s caught between a rock and a hard place - Moutai pricing coming down also hurts Wuliangye’s value proposition. Fenjiu’s Qinghua 20/25⁸ product, priced at ~400 RMB - offers an extremely attractive replacement. Non-Moutai, randomly named sauce aroma baijiu retails for some 700-800 RMB - and Fenjiu is a great product to reduce expenses *and* enjoy brand recognition - especially in banquet settings where one needs to set a certain standard but also needs to recognize cost considerations. Quantifying the market share of Qinghua 20 below - it currently represents ~10% of the share of the 300-500 RMB price segment. Using the analog of Jiannanchun, which has a similar product of similar price range - which generates sales of approximately 20bln RMB - that offers a sense of how big Qinghua 20 can grow within China. Additionally, because nobody hoards Fenjiu (like they do Moutai), the channel inventory of Fenjiu is rather clean and the company has not mortgaged the future by engaging in funky business to stuff the channels (unlike some other players). Importantly, Qinghua 20 has much higher margins than its current product portfolio - which implies that we will see margin expansion as Qinghua 20 contribution grows.

CICC Report from Feb 2024, 2023 Data

Qinghua 20 - Qinghua is named after Blue and White Porcelain that is part of the product design as seen here.

Where are we seeing upgrading in Baijiu consumption?
In addition to the success of the Qinghua 20 product, Fenjiu has a ‘secret weapon’⁹ in the mass segment. Similar to hotels, lower tier city and lower income consumers are upgrading their purchases of baijiu as well. Instead of no-name hotels, consumers are switching from no-name alcohol (10 RMB) to branded alcohol - in this segment, Fenjiu’s 'Bofen’¹⁰ (Glass Fen), which retails for approximately 50 RMB is the beneficiary of the upgrade. The quality of BoFen is superior to anything in that price range in China, bar none. In fact, industry experts will frequently drink Bofen with close friends in settings where higher priced alcohol is unnecessary. In addition, the proliferation of Bofen educates consumers about the light aroma and the brand, and will be extremely helpful as these consumers decide to upgrade later on - this is the classic ‘land and expand’ strategy at work. The <100 RMB price segment is estimated to be ~100bln RMB of sales in China of which BoFen had a HSD% market share. You can assume that this will continue to grow for the foreseeable future into a large but shrinking market (remember, baijiu industry has been shrinking in volume for a long time - especially in the low end). Additionally, if you speak to distributors, BoFen sells itself - they have to do zero marketing to generate a strong profit dollars (low margins but they don’t care since there’s low inventory risk).

This is the ‘export’ version of BoFen that most of you will see outside China. I would recommend using it for mixology.

Premiumization Option
In addition, the company offers Qinghua 30/40/50 products that are only really consumed by diehard fans (often in Shanxi) - the price at which these products are priced approach that of Wuliangye/Moutai and simply do not have the recognition outside of Shanxi province to attract sufficient sales. However, as the current ‘slowdown’ in baijiu consumption eventually recovers, Fenjiu will have the opportunity to promote these products as the sauce-aroma players did during the last upcycle.

Capital Returns
On the company website, this following banner is the first thing you see on the Investor Relations page:

When a Chinese company is proudly displaying the dividends it has paid in it’s history, pay attention.

As a “simple, predictable, free cashflow generative business”¹¹, Fenjiu has rewarded its shareholders over time. However, the current payout ratio remains lower than its peers. In the spirit of ‘involuted competition’ among Chinese SOEs, I fully expect Fenjiu to increase its payout ratio to match that of Moutai and Wuliangye over time. It’s been fundamentally clear from all of the latest CSRC policy announcements that SOEs are expected to lead as good corporate/societal citizens by rewarding its shareholders with dividends - Fenjiu is no exception.

“Started from the bottom now we are here¹²”
There are a few key things that help Fenjiu from a cultural awareness perspective that only really happened in the past year. While I do not believe they add much to the short term (1-3 year) earnings growth driver, longer term implications could be bigger.

Black Myth: Wukong. History buffs will know that the Blockbuster AAA success extensively featured real-life historical sites in Shanxi. While Shanxi has historically been known for coal and hill billys¹³, this is perhaps the first time that the province has been featured as extensively in the modern Chinese zeitgeist. I don’t want to spend too much time here but you can check out this video on YouTube for more information, if you were ever interested in traveling there.

Noodles vs. Pasta. The other thing that Shanxi is known for is noodles. Recently Fenjiu sponsored one of perhaps the best English language Chinese Food YouTube Channel to take a bunch of Michelin Starred Italian chefs to Shanxi to learn about the lineage of Shanxi style noodles. While the specific impact to Fenjiu’s business is limited, what this tells me is that the marketing team is serious about globalization - and this type of long-term brand promotion is crucial early on to ‘plant the seeds’ of an appreciation of Shanxi culture - which is inexorably tied to the success of Fenjiu outside of Shanxi and China. Additionally, the quality of content they decided to sponsor demonstrates to me that they know exactly what they’re doing.

Shanxi Mojito. In my opinion, one of the most underrated attribute of Fenjiu’s light aroma is that it is *much* more applicable when it comes to modern mixology. This aroma attribute is often met with complaints within China that the product does not have as sophisticated pungent aftertaste as the other types of baijiu (Moutai/Wuliangye for example). However, the more subtle aroma allows for much more versatile application in mixology fit for younger and especially international audience. Lime, Mint, Sugar, Ice, Soda, Fenjiu. Try it out.

In short, I do not believe the “Customer Relationship Management” characteristics of Moutai are likely to be adopted globally, as they are deeply Chinese in the way they are utilized in business. As much as people ‘claim’ that Moutai is the ‘best’, it is likely because of the social stigma associated with the brand. In fact, I would bet that the vast majority of people who consume Moutai do not personally enjoy it as much as they claim they do.¹⁴ Additionally, the complex flavor of the sauce-aroma baijiu makes it difficult to adopt by global customers. This is where Fenjiu has an advantage - its versatility and flexibility is much more likely to be adopted globally like Tequila - associated with a surge in Chinese cultural influence globally (Black Myth: Wukong, DeepSeek, Ne Zha 2 etc) and I expect this to continue going forward.

Valuation

This is going to be short and simple, this is a 75% gross margin (30% net margin) business that will likely grow revenues at LDD% and net income slightly faster (due to margin expansion from the growth of Qinghua series), in the current economic environment. It currently trades at ~16.5x earnings. To the extent that the consumption economy recovers and that growth accelerates, this could trade in the 20x-25x range with growth in the Mid-teens to high teens range. You can plug in your own assumptions and determine what you feel is comfortable.

Key Risks

“Drink Less, Drink Better”

If you’ve read this far, I’m sure you’d be thinking in the back of your head about the risk of alcohol consumption reduction from younger generations drinking less & the GLP-1 risk. That’s the precise point, one of the cultural legacy in China was that baijiu used to be consumed with the frequency (and often quantity) of beer - a *highly* unhealthy and irresponsible legacy. And we’ve seen baijiu consumption continue to shrink on an industry basis in the past years despite Fenjiu growing its volumes *and* value. I would argue this is the feature, not bug, of the premiumization thesis. In 2023 (we don’t have 2024 data yet), Fenjiu produced ~225k Kiloliters, which is about 5% of industry production volume - this will continue as the leading baijiu players (Moutai/Wuliangye) continue to consolidate the industry at the expense of smaller players (Yanghe might NGMI¹⁵).

Made with ChatGPT, not precise but directionally accurate.

‘What about the risk you mentioned with Moutai where SASAC would push you to sell more’?
This risk would be applicable if the industry in question was coal in Shanxi. When one mentions Shanxi in China, the immediate word that comes to mind is coal. I’m too lazy to go through the various Chinese statistics reports¹⁶ but suffice to say its big. One aged sell-side report I read suggested that coal-related taxation (VAT/mineral tax/income tax of coal mining companies) represented ~35% of total taxes generated in the province which itself was a majority of Book #1 (see this post for what I mean) fiscal revenues. As such, Fenjiu is not big enough to matter to the Province, and the local government fully recognizes its cultural importance. This is especially important in context of the cultural export opportunity I mentioned earlier. The real risk here is if coal prices take a plunge which would impact the provincial economy and slow down the ‘upgrading’ process within Shanxi.

Consumption Tax Collection
Last but definitely least, this is an important risk factor. Consumption taxes in China are collected on only a limited number of products. As a reminder, it is taxed on a volume *and* value basis - 20% statutory tax rate but only 60% inclusion on the ex-factory value (meaning 100 RMB bottle = 60%*20% = 12 RMB) + 1 RMB/liter. Any changes to the current consumption tax regime will impact (at least in the short term) baijiu consumption/sales and it is unknown the exact split of the burden of said tax.

I’m cutting this one a little short and excluded a lot of the background - you should do your own work as I think the cultural implications of this is quite interesting in a China context - the stock is just an added benefit.

As usual, this is not investment advice - do your own work. The author may or may not be involved in the securities mentioned and that may change without further update to the article.

1. Fenjiu really should be paying me for writing this - I’ll take 1/10th what they paid Jia Zhangke for the video he made for them.

2. Major doubt about the magnitude of fiscal stimulus.

3. As you will see, fake news started way earlier than the age of social media.

4. 此杏花村非彼杏花村.

5. Shanxi merchants were also pioneers of the banking system in Imperial China.

6. https://en.wikipedia.org/wiki/Xifengjiu - this is not very well known.

7. Note, nationalization here =/= getting expropriated by the state - but rather national expansion.

8. Qinghua 20 is sold outside of Shanxi, Qinghua 25 is sold within Shanxi. The product itself is actually not too different - the nomenclature is done to prevent unauthorized sales of channel partners crossing up inter/extra-Shanxi sales.

9. Or should I say ‘assassin’s mace’? For those of you who’ve read think tank reports on PLA strategy

10. They call it the “Moutai of the Masses”

11. Please do not cancel me for quoting General Ackman.

12. It absolutely pains me to quote Drake (especially after the damned 51st State team beat us in Hockey recently), but alas.

13. I did indeed hear a friend from there call the province the “West Virginia of China”.

14. Let’s be honest, some of these people mixed 1982 Chateau Lafite Rothschild with Sprite.

15. #IYKYK - the situation at Suqian with Yanghe is rather….unfortunate.

16. They are *really* difficult to access, perhaps

Zichen Wang

and colleagues can help inform the relevant authorities about the difficulty of data access at a provincial level. Its hard to blame foreigners for not knowing things when the statistics are not easily accessed on a desktop computer.