Dukang

Another recent question and answer (via e-mail) between me and Dukang's IR Manager Mr Ngo Yit Sung.

Disclosure: i am long Dukang. This is not an invitation to buy/sell. Every investor should do his/her own homework.

1. Regarding Dukang's trademark

I recently read about Wanglaoji trademark dispute between Guangzhou Yangcheng Pharmaceutical vs Hung To Group Co (Jiaduobao Beverage Co., Ltd.) and can't help but thinking about Dukang trademark.

Is Dukang trademark wholly owned by Yichuan Dukang Jiuzu Asset Management (41% owned by Dukang Distillers Holdings Limited and 59% owned by Mr Gao Feng) ? Is there any possibility of Shaanxi Dukang Liquor Group or any other group bringing Dukang trademark dispute case into supreme people's court?

Yes, the Dukang trademark cannot be majority owned by foreign entity, and so the holdings company being registered in Bermuda cannot own the Dukang trademark wholly. The workaround is to let Mr Gao Feng own 51% of the trademark as he is a PRC Chinese while Dukang Distillers owns the other 49%. Mr Gao has entered into 2 agreements with the Dukang Distillers: 1. To grant irrevocable use of the Dukang trademark to Dukang Distillers to produce and sell Dukang baijiu. 2. To sell back his 51% stake to Dukang Distillers at cost whenever the PRC law allows us to fully own the brand.

There is no dispute as we own the Dukang trademark and Shaanxi Dukang owns the Baishui Dukang trademark. Before the acquisition of Luoyang Dukang in 2010, both Ruyang Dukang and Yichuan Dukang generated RMB300 mil sales annually, today Luoyang Dukang's sales is more than RMB1.3 bil (9M13), more than 4-fold since the acquisition, whereas, Shaanxi Dukang's sales is still below RMB100 mil per annum.

2. Regarding recent Siwu production disruption

Has the production disruption issue been resolved? Can Siwu production volume be fully restored this quarter (April-June 2013)?

The Siwu production disruption is due to relocation of the plant to be integrated with Luoyang Dukang. It has been completed in January 2013, we expect Siwu's sales to normalize in future.

3. Regarding Siwu distributor for outside Henan province

In page 28 of the 2013-Q3 presentation, number of Siwu distributor for outside Henan province is zero.
For current quarter (April-June 2013) are you still focusing Siwu sales on Henan province? Looking ahead for the next quarter, what is management plan on Siwu distribution network and marketing outside Henan?

Siwu is a provincial brand, due to its brand appeal, it is very hard or requires huge effort from us to promote this brand out of Henan. As most of our resources are channeled to grow Dukang, Siwu's sales will be flat or marginally increase/decline.

4. Regarding Dukang's interest income and cash balance

Looking at Dukang's Q3-2013 and Q4-2012 financial result, why is the interest income for Dukang's cash balance so low? (0.16% for Q3-2013 and 0.78% for Q4-2012). Without sacrificing the liquidity and operational needs (advertising plan, land lease commitment, working capital requirement, raw material purchase commitment, etc), can we get better use of the cash balance?

The low interest income is because the cash is kept in current account. We have plans in the pipeline, we will share the capex for future expansion when the time is ripe. Recently we announced the acquisition of office space for rmb106 mil

5. Regarding Dukang's grain alcohol production

Is there any possibility of contamination during grain alcohol production? if yes, could you please share a bit about Dukang's management current action to prevent and minimize the contamination? if such contamination happened, can the grain alcohol be sourced from third parties without sacrificing the baijiu quality?

There is of course contamination risk in our production. We do periodic sample test on the grain alcohol, meaning we extract sample and send to our in-house lab for examination. Contamination during production like the plasticizer is mitigated by not using plastic container to collect the freshly distilled grain alcohol, all the while we have been using stainless steel container. It is unlikely for our workers to sabotage the distillery as we are one of the largest employer in Ruyang district and Yichuan district in Luoyang City.

If there is an excursion, we are able to purchase external grain alcohol to produce our baijiu and that's when our technical team will play a vital role in ensuring the taste, fragrance and quality remains the same as before. We currently boast the largest technical team in Henan with 3 national level brewmasters and 22 provincial level brewmasters.

But again the chances that all our grain alcohol being contaminated at the same time until we do not have enough for production is very low as we store our grain alcohol in different facilities and only authorized personnel are allowed to enter the facilities.

Thank you Roger! I think you are one of the experts on Dukang in this forum. Thus, I would like to ask: On a scale of 1 to 10, how would you rate Dukang as a stock to enter at the current level of 48 cents? (10 being very attractive and 1 being Avoid at All Cost).

Big Fish, i am not an expert on Dukang. I sent the q and a to Dukang's IR contact because I want to gain more knowledge about one of the stock in my portfolio. I post the q and a because i just want to share it with other investor who have already own Dukang or want to know more about Dukang.

I am really sorry but i can not give you any rating on Dukang. You have to decide by your own based on your own reading and research. In investing, there is an adage that I hold really dear:

"Believe nothing, no matter where you read it or who has said it, not even if I have said it, unless it agrees with your own reason and your own common sense."- Anonymous

　　而对于豫酒杜康而言，第一季度销售收入增长100%，销量同比增长90%以上。截至5月18日，杜康公司回款金额已经突破12亿元。
Can someone help to explain what is the meaning....does that means their subsequent Q result will grow by this %?

Rogerwilco, Thank you for your insightful post.

Will sales growth of Dukang Distillers Holdings be limited by the amount of aged grain alcohol it inherited from Ruyang Dukang and Yichuan Dukang several years ago?

Before being acquired, both Ruyang and Yichuan did not produce much grain alcohol. In fact their idle fermentation pools were reactivated only after they were taken over by Dukang Distllers Holdings. The higher amount of grain alcohol that Dukang Distillers Holdings has produced may not have aged enough for it to be sold as premium products.

Diversity, based on what i read on several NextInsight articles and Dukang's presentations (on SGX) Dukang will increase (or has increased) their grain alcohol production capacity 40% by mid 2013.

The increase comes from:
1. Idle old fermentation pool at Luoyang and Ruyang Dukang that have been revived/reactivated.
2. New fermentation pools + microbes from older fermentation pools to make sure the grain alcohol quality do not differ much from old fermentation pools
3. Old fermentation pools belonging to the villagers who live near the Ruyang plant (one of the article said that Dukang was looking into acquiring these pools)

As for grain alcohol aging, Dukang tries to shift customer perception from age of grain alcohol to age of fermentation pools (that produce the alcohol). Using this way, Dukang does not have to age the grain alcohol too long.

I am not a baijiu connoisseur (expert) so to be honest I do not know whether there is any taste/aroma difference between baijiu produced from a 20 years alcohol versus baijiu produced from 6 months alcohol but the alcohol produced from 20 years old fermentation pool.

Maybe someone who is more expert in baijiu can give more insight into this?