February 28, 2012

Jiangsu Yanghe Brewery earnings are the toast of China

by Sridharan Raman

Since 1949, the Jiangsu Yanghe Brewery (002304.SZ) has been producing high quality liquors, primarily for China’s domestic market. With the country’s growing middle class able to devote some of their rising levels of disposable income to discretionary purchases like this, the demand for branded alcohol has never been stronger, particularly when the Chinese New Year was celebrated as it was on January 23 this year. Within the Chinese market for alcoholic beverages, Jiangsu has strong brand recognition, and its Yanghe Daqu brand of barley-based liquor is one of the most popular locally-produced beverages in the country. This spirit is made using water from a specific spring in China (known as the “Spring of Beauty”), and the demand for it far outpaces the supply. This brand has been in existence for more than 300 years and thus has a historical significance for Chinese consumers. That gives Jiangsu Yanghe tremendous pricing power, which they took advantage by raising prices by 5% in late 2010. Thus, increasing profit margins may be one of the reasons the company earns the highest possible StarMine Earnings Quality (EQ) model score of 100.

StarMine has used computer-driven models to analyze the financial statements of Jiangsu Yanghe Brewery and more than 33,000 other companies; the proprietary StarMine Earnings Quality (EQ) scores it produces have proven to be reliable predictors of the extent to which a company generates earnings that are sustainable over the forthcoming 12 months. Expressed on a scale of 1 to 100, with a higher score indicating higher-quality earnings, the StarMine EQ score allows investors to set a company’s earnings quality against that of another company in its industry, or companies in its region, or even measure it against the entire universe of stocks. Companies with low StarMine EQ scores are likely to have difficulty in sustaining past earnings, while stocks with high StarMine EQ scores are more likely to be able to deliver earnings at or above current levels in the future. This look at Jiangsu Yanghe Brewery is the final installment of our series of examining examples of companies across Asia that can either boast a particularly high EQ score, or that have a notably low ranking according to this quantitative measure of earnings quality.

Strong and increasing earnings are typical indicators of a company’s financial strength. However, those earnings aren’t always backed by strong cash flows, making them less sustainable in the long run. In the chart below the green bars represent fiscal quarters when the cash flow from operations (CFFO) exceeded net income; in the case of Jiangsu Yanghe Brewery, that occurred in three of the last four quarters. In the last quarter, the net income was 1.1 billion Chinese Yuan (CNY), the highest level reported in the last three years. Even more encouraging was that during the same quarter, the CFFO also set a three-year record, of CNY1.9 billion. Such robust earnings growth, backed by strong cash flows, is usually a positive sign of sustainable earnings.

Source: Thomson ONE / StarMine

The impact of the price increases that Jiangsu Yanghe Brewery implemented at the end of 2010 seems to be visible in its operating profit margins. Since those price increases were put in place, the company’s trailing 4Q operating profit margin has risen and is now at 41.3%, far above the industry median of 23.9%. Some analysts attribute that to the company’s decision to devote more of its advertising budget to promoting higher-margin products. The return on Jiangsu Yanghe’s net operating assets also has risen; together these two factors show that the company is increasing its operating efficiency.

Source: Thomson ONE / StarMine

The company also owns other liquor brands and is using its status as a popular household name to launch even more differentiated product lines. Although it is spending more on advertising, Jiangsu Yanghe’s operating income easily covers those costs. The company may see additional benefits from these investments in the long run but even without the contributions of new products or advertising the StarMine EQ score of 100 signals that the earnings for the company are likely to be sustainable in the coming year.

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