Biz times..
 


ONCE upon a time in September 2008, China baijiu (white liquor) producer Trump Dragon Distillers launched its initial public offering (IPO) in Singapore with much fanfare. It was, after all, the first China baijiu company to be listed overseas.

Taiwanese singer-songwriter Emil Chau, who was the company' s products spokesman, sang his hit song Friends at the listing ceremony. The counter closed at 36 Singapore cents, above the IPO price of 31 Singapore cents.

Nine years later, the stock is far from being anybody' s friend.

It is now known as Dukang Distillers. And it is languishing - after a 10 to one share consolidation, no less - at 24 Singapore cents. This was less than a tenth of its end-March book value of roughly S$3.50.

Trump Dragon' s original " Siwu" brand had collapsed by end-June 2015, with sales volumes for Siwu Regular Series falling from 8,266 tonnes in FY2014 to 10 tonnes in FY2015. The brand has been discontinued.

The Dukang brand that the company acquired in 2010, meanwhile, is now in danger of fading away. This is despite substantial sums of money spent through the years to promote the venerable Dukang name - the name of a legendary inventor of Chinese wine, mentioned in a poem by Chinese warlord Cao Cao.

After quite a bit of lobbying, Dukang was even endorsed in 2013 by China' s Ministry of Foreign Affairs as one of a number of brands to serve foreign dignitaries with.

But shareholders, if there are any left, are nursing a giant hangover. Sales are sliding fast, and the firm' s third quarter for the three months ended March 31, 2017 was a nightmare. Sales volumes for Dukang' s regular series baijiu plunged to 705 tonnes from 6,486 tonnes a year ago. Average selling prices for these were less than 30 yuan (S$6) a kg. Its " premium" line of baijiu, with average selling prices around 140 yuan a kg, is also declining.

What happened? The company partially blames the slump on severe air pollution affecting its production and logistics. Yet there are bigger issues mentioned in its financial reports through the years.

The Chinese baijiu industry is enormously fragmented. There are many thousands of brands, a variety of flavours and large price differences. Baijiu can cost a few yuan for a small bottle to thousands of yuan for the top brands.

At the lower end, the product is commoditised and competition is intense. Dukang is based in densely populated Henan province, and bills itself as a top local brand among a few hundred. Yet it has previously said that its market share is just a few percentage points.

Moreover, since Xi Jinping took power at the end of 2012, a massive anti-corruption crackdown has ensued where ostentatious displays were frowned upon. Chinese officials no longer chug expensive liquor.

In this environment, top-tier baijiu brands such as Kweichow Moutai were forced to cut prices. As the big guys engaged in a price war, they successfully made inroads into new markets. They squeezed provincial incumbents such as Dukang, who once thought their second-tier status would shield them from the first-tier baijiu crackdown.

Dukang also did not have much luck expanding beyond their home province, or even overseas markets such as Taiwan and South Korea. It also could not attract younger drinkers.

Moutai stock, for that matter, is up about 400 per cent from its 2014 low, aided by earnings growth and significant earnings multiple expansion.

How did Moutai succeed where Dukang, with its interesting historical name, could not? It is an unfair fight. An industry downturn does not affect everyone equally. The biggest players with the best-recognised brands always have an advantage. Moutai, which enjoyed gross margins as high as 90 per cent, has formidable advantages of scale that Dukang does not.

Yet the extremely low valuations of Dukang today bears investigating.

A glance at its balance sheet through the years throws up some peculiarities, and tells a story of investments made too early when the cycle turned.

Why did Dukang, for example, ramp up inventory and capital expenditure purchases in its financial year ended June 30, 2014, despite an intensifying anti-corruption crackdown and drastically lower sales?

In that year, inventories doubled to 689.6 million yuan, mainly due to the bulk purchase of good quality grain alcohol at a competitive price. Property, plant and equipment increased by 289.8 million yuan mainly due to the completion of the acquisition of a two-storey office space in Zhengzhou city, costs for warehouses, infrastructure, and machinery improvements.

For its financial year ended June 30, 2015, the group recognised a massive impairment loss of 547.4 million yuan on property, plant and equipment, intangible assets and interest in its Dukang trademark-management associate. The hit included a 364 million yuan impairment on leasehold buildings.

Now, Dukang might be on its way to record a third consecutive year of losses. More impairments could come, especially if sales do not improve. The firm is due to report its full-year results by the end of the month.

Not all is lost, if the company comes up with a viable strategy to defend its home turf. If sales improve and the company realises value from its 754.6 million yuan pile of inventories, the stock might be a classic Benjamin Graham " cigar butt" . Value investors can take advantage of how the company is likely trading below its liquidation value. If sales show signs of bottoming out, Dukang shares will rise. What' s a load of grain alcohol worth? What' s in a name?

Yet that might be the cigar butt' s last puff. Investors should then quickly sell if they don' t think the company can build a sustainable franchise.

In all, Dukang offers yet another cautionary tale of the risks of investing in small " value" companies versus the largest ones. For the longest time, Dukang was trading at three to four times earnings and analysts were shouting that it was cheap. Even fund manager Fidelity was attracted, taking a sizeable stake a few years ago.

So much for that. Dukang is down 90 per cent from those times.

In his hit song, Emil Chau sang of friends who will walk with you for life. Unfortunately, many friends and brands don' t.