China Consumer, Talking Point

Distilling the truth

Investor favourite Kweichow Moutai experiences choppier times

Yuan Renguo w

On Sunday former Moutai boss Yuan Renguo made a confession on state broadcaster CCTV

Usually falling in late January or February, the Chinese Lunar New Year is the domestic movie industry’s most important period for box office earnings. But before the big screen bonanza gets going, China’s anti-corruption authorities usually opt to serve up a bit of drama of their own: by televising a documentary on their efforts to fight graft that year, with denouements and confessions worthy of a cinematic thriller.

Perhaps this custom is designed to make sure that everyone starts the forthcoming year in China with President Xi Jinping’s anti-corruption campaign at the forefront of-their thoughts. The effort is still going strong, despite being unleashed eight years ago. In January last year, the documentary Red Notice detailed how a manhunt codenamed ‘Sky Net’ led to the overseas capture of 15 high-profile fugitives. And this year’s show may be particularly pertinent for foreign investors, thanks to the focus on their favourite A-share stock. Broadcast on state television, the documentary sheds light on the nefarious goings-on at Kweichow Moutai, the nation’s top distiller of baijiu liquor.

What does the annual anti-graft series talk about?

This year the documentary series is entitled Supervising the Nation and has run over five episodes since last Sunday. The programme is co-produced by state broadcaster CCTV and the National Supervisory Commission (NSC), a ‘super regulator’ set up two years ago to extend the fearsome power of the Central Commission for Discipline Inspection (CCDI) across all levels of national activity.

­­The first episode of the series put the spotlight on Kweichow Moutai, the most widely held of China’s A-shares among foreign investors, and the pride of Guizhou province, where the revered ‘national wine’ Moutai is produced.

Former Guizhou vice governor Wang Xiaoguang was the first senior official to feel the wrath of the NSC – only 10 days after the new corruption watchdog was established in March 2018. In April last year, Wang was sentenced to 20 years in prison for taking bribes and making gains from illegal investment worth more than Rmb212 million ($30 million). That said, the full extent of his wrongdoing was only revealed for the first time this week, with footage showing investigators uncovering a haul of more than 4,000 bottles of the best Moutai in a room at Wang’s home.

That wasn’t the full extent of his illicit booze collection, however. Having got wind that the graftbusters were on his trail, Wang removed the labels from the most expensive bottles – most of them collectors’ items that could fetch Rmb300,000 or higher at auction – and poured all of the alcohol into a large pot.

Still feeling fearful about the prospects of being caught, the 58 year-old later poured all of this expensive liquor away, with the documentary’s narrator pointing out how Wang’s wife had disposed of most of it down the toilet. She later admitted to investigators that Wang had become obsessed by amassing his alcohol collection, the extent of which was “more than he could drink” in his own lifetime.

In fact, his cellar was so full of bottles that he set up four franchises, all staffed by his relatives, to sell his Moutai allocations. The four dealerships were given the ‘standard quota’ to sell 132 tonnes of Moutai, which helped Wang to pocket more than Rmb40 million in seven years. Moreover, he was allocated a ‘special quota’ by Yuan Renguo, the former chairman of Kweichow Moutai. He profiteered further by selling these valuable rights to other distributors around the country (more on the company’s distribution system later).

So what happened to Kweichow Moutai’s former chairman?

Kweichow Moutai is Guizhou’s biggest corporate taxpayer and its most iconic enterprise, giving it outsize importance in one of China’s poorest provinces.

Yuan, as the distillery’s heavyweight’s boss, was always going to be close to Wang, given the latter’s seniority in the local government.

Yuan’s confession also aired in the first episode of Supervising the Nation. Since 2009 he had been currying favour with Wang by helping his relatives secure lucrative Moutai dealerships, he admitted.

The documentary claimed that Yuan’s wife and children had also made more than Rmb230 million in profit from “illegal” Moutai dealings since 2004.

Because of his control over the allocations of China’s most sought- after alcoholic spirit Yuan held a pivotal position in the country’s bribery stakes. “A lot of people would try everything possible to approach me [for a Moutai dealership]. At least 40 or 50 of them would knock on my door every day,” he confessed.

One of his dealers even offered him a ding (a cauldron-shaped vessel used to hold wine during important ceremonies, and a symbol of authority) that was made from 5kg of pure gold. Better still, the bribe had a classier dimension, as the ding was elegantly engraved with a Tang Dynasty poem that punned cleverly on Yuan’s name.

How has Yuan contributed to Kweichow Moutai?

Yuan used to take great pride as a scholar of China’s thousands of years of wine culture (baijiu liquor is also referred to as a ‘rice wine’). He penned two books on Moutai, with the company putting up giant copies of the publications’ covers outside its main cellar. Those tributes (in marble) were removed in May 2018, following Yuan’s abrupt resignation and the ensuing news that he was being investigated by the NSC (which took him away on his return from a business trip to London).

Yuan joined Kweichow Moutai as a junior staffer more than 40 years ago. When he climbed the ranks to a top role in 1998, the state-owned firm wasn’t hugely successful, failing to offer even one of the top 10 bestselling wines in the country. But Yuan was credited with improving the company commercially and taking it public in Shanghai in 2001 – becoming chairman of the listed vehicle and forging Moutai’s status as ‘the national liquor’.

Under Yuan’s leadership, a number of myths about Moutai began to spread across the country’s banqueting halls. One legend had it that Moutai was awarded the ‘golden prize’ at the World Fair in San Francisco in 1915 after a Chinese delegate broke a bottle in half to release its unique fragrance. Another story claimed that former premier Zhou Enlai had set a glass of Moutai on fire to impress the visiting Richard Nixon in 1972.

Some of these half-truths and dramatic fictions helped to propel Moutai’s popularity and as the price per bottle was driven up year after year it eventually became the world’s most valuable spirits firm, displacing Diageo in the global rankings.

From its Shanghai IPO in 2001 to May 2018 (when Yuan was fired), Kweichow Moutai’s market value spiked nearly 120 times. As of Wednesday, it was worth Rmb1.39 trillion, rendering it one of the top five A-shares, trailing only financial majors like ICBC (Rmb2.06 trillion) and Ping An (Rmb1.58 trillion).

Of the biggest A-share stocks, the baijiu maker is also the only one without an overseas listing. That’s why foreign investors piled into Kweichow Moutai when index compiler MSCI increased the proportion of Chinese A-shares in its international benchmarks. According to Shanghai Securities Times, more than 1,800 institutional investors (55% of them registered offshore) have Kweichow Moutai in their portfolios. Combined they hold more than 10% of the company, which at current value is worth Rmb140 billion.

Because of its size and brand power Kweichow Moutai was easily the most widely held A-share among foreign fund managers, the Wall Street Journal noted last year. Asset managers had also come to view the company as an indicator of the way that domestic consumption was propelling growth in China’s economy; and as a proxy for the rise of its more affluent consumers, the newspaper said.

Is Moutai a proxy for graft in China as well?

WiC has reported in the past how the country’s favourite baijiu has been a feature of some the best-known corruption scandals (see WiC53 and WiC107 for examples). And we also warned in late 2012 of its reputation as an indicator of graft in the economy (see WiC172). Indeed, both the price of the company’s shares and of bottles of baijiu in shops took a dive when Xi kicked off a sweeping crackdown on government corruption and extravagant spending on the public purse that same year.

Yuan managed to steer his way through the crisis by setting minimum retail prices for its main products (Rmb1,519 for the Flying Fairy flagship bottles) and warning retailers that dumped their inventory for less than that level that their franchise would be revoked.

Kweichow Moutai also seemed to have regained the good graces of the central authorities by supporting anti-poverty programmes in Guizhou, which is also the constituency that put Xi forward as a member of the 19th National Party Congress. With an eye on its reputation, it built a hospital and a university in its home province (see WiC378). Ironically, in Always on the Road, the anti-graft documentary in 2016, Yuan had also insisted that Moutai was no longer a ‘corrupt wine’ and that Xi’s crackdown had forced major changes at the company. This remark casts his downfall in a more eye-popping light: a man who talked about the years he had spent fighting graft at the company he headed still ended up disgraced himself, brought down by his personal conduct.

How did Kweichow Moutai’s sales network make corruption more of a challenge?

Just as it is only the town of Cognac that can lay claim to distilling the world’s best-known name in brandy, China’s most prized rice wine can only be produced in the town of Maotai. Attempts to replicate the unique taste and aging properties of the baijiu elsewhere are doomed to failure, the company has always claimed. Scarcity is thus a variable under company control. On the flipside Kweichow Moutai has wrestled with challenges in raising its output significantly – regardless of how much demand is soaring. That’s because it has a production cycle that generally takes five years. Liquor output climbed nearly 18% to 49,671 tonnes in 2018 – the biggest volume growth in the past 10 years (with much of the increase coming from cheaper derivatives under the Flying Fairy brand). However, in general new demand for the liquor has typically outpaced its supply, except for a brief spell in 2012 and 2013 . As a result the price for Moutai keeps going up, especially among bottles of an older vintage (see WiC455 for the prices fetched at auction).

Under Yuan’s leadership Kweichow Moutai relied on a franchisee model to sell its product range. Since his removal two years ago the company has been cutting down the number of external agents, yet there were still 2,530 sales franchisees at the end of June last year (95% of which are in China).

A licence to be one of these distributors (the former Guizhou official Wang once had four) could easily cost Rmb20 million upfront, Caixin Weekly reported. But the potential returns on offer to some of the franchisees were exceptionally high, given that Moutai can retail for twice its factory price, owing to the demand. In order to prevent distributors from hoarding their inventory (on the near certainty that the stocks would sell for vastly higher prices in later years), distribution quotas were also tightly controlled, although senior officials such as Yuan had the authority to allocate “special quota” at their discretion.

“Unlike distributors who only have a quota of two to five tonnes per year, some officials like Wang start with 10 tonnes or even 100 tonnes directly,” a person close to leading executives at the company told the Global Times.

Because a licenced Moutai dealership was a surefire way to make money, the company’s retail network had become a breeding ground for corruption, CCTV suggested. With the power to give out retail licences and allocate quotas, it also became a tool for Yuan’s rent-seeking and political networking.

“Using Yuan’s own words, he was the creator of the ‘Moutai chaos’, where he was the participant and the beneficiary,” CCTV’s documentary commented.

Why should investors pay attention to Yuan’s confession?

Yuan was convicted by a court for taking bribes in September last year. He is still awaiting his sentencing, which might be less severe if he redeems himself with other ‘merits’.

“I hope my case and reflection could help the Moutai Group reform its system, and systematically remove the corrupted soil,” Yuan claimed on Supervising the Nation.

Indeed, the state firm has been trying to overhaul its retail network since Yuan’s dramatic fall from grace. Citing violations of sales regulations or improper ties with company employees or local governments, it has also been slashing the number of its external dealers. Up to 970 distributors have been cut since 2018, or nearly 30% of the nationwide total.

In May last year, Moutai Group, the unlisted parent that owns 62% of Kweichow Moutai’s shares, also announced it would be setting up a wholly-owned unit to run its own direct sales network. This caused some bafflement among stockholders in the listed entity. Even the Shanghai Stock Exchange sent an enquiry to the company asking for an explanation of potential conflicts of interest.

Moutai Group said the new firm will focus on bulk buyers and complement its existing retail network. It kicked off the initiative with a foreign retailer in September when Costco opened its first store in Shanghai. The wholesale chain was given a ‘special supply’ of 15,000 bottles, which sold out in a matter of hours as they were effectively sold at a 50% discount to other franchised Moutai distributors.

Walmart is set to become a direct sales partner of the Moutai Group as well. According to media reports last week, the American heavyweight has signed an agreement with the state firm to stock up to 100,000 bottles of Moutai during the Spring Festival this month.

Perhaps the state giant has come to realise that it has been leaving too much profit on the table for its external distributors, and it now wants more control of its sales and distribution, with a greater share of the profits flowing back to the parent group’s coffers.

It remains unclear how the change in sales strategy could affect the listed firm’s commercial prospects, however. The Financial Times noted this month that Kweichow Moutai saw net profits increase about 15% year-on-year in 2019 but that the bottom-line had also come in below market expectations for the first time in five years. “Net profit growth has been on a steep downtrend since peaking in 2017. That is not going to change. It is now time for investors to sober up and scale back the festivities,” the newspaper’s Lex column warned.

Clearly a period of transition is underway. For the foreign fund managers who viewed the stock with undisguised enthusiasm, it may be time for a reassessment.

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