Drinks firms eye Chinese temptations

Last year China’s economy grew by 9%; this year the growth rate may moderate to 7%, marking the first slowdown in 19 years.

To the planners in Beijing that is a worry, but to western companies the prospects of a burgeoning and brand conscious middle class are a magnet, especially as the mature markets in Europe and America are only slowly coming out of recession and consumers there are trading down to commodity lines.

For instance, even on chancellor Alastair Darling’s own forecasts, Britain’s economy will grow by a meagre 1% this year after falling nearly 6% in 2009.

It is not surprising, therefore, that global drinks companies such as Diageo are eager to strengthen their positions in the Chinese market.

Last week Pierre Pringuet, Pernod Ricard’s chief executive, said that China was now on the verge of eclipsing Spain as the group’s third largest customer in terms of both value and volume.

China Jianyin Investment Securities estimates that the Chinese market for alcohol will rise between 20% and 25% this year alone and high-end consumption, it forecasts, will rise by more than 30%.

What is more, margins for luxury goods in China are said to be every bit as attractive as in the mature West.

No wonder, then, that Diageo, the world’s biggest drinks group, is seeking to take control of its joint venture in China and widen its influence in the country. In the six months to 31 December it generated free cash flow of £904 million and so could easily fund a deal.

Diageo entered the Chinese market in 1995 and took a 43% stake in Sichuan Swellfun (formerly Sichuan Quanxing) in 2006, increasing its stake to 49% in August 2008.

Swellfun is one of China’s largest alcohol producers, its main product being white wine and major brands including ‘Quanxing,’ ‘Swellfun’ and ‘Tianhaochen’.

Earlier this week Sichuan Swellfun’s shares were suspended because talks between its owners were taking place. Observers interpret this as Diageo wanting to add to its stake and take a controlling interest.

Similar talks last year were inconclusive, but the reason for Diageo’s interest is obvious. Apart from Swellfun’s extensive distribution network, it is growing rapidly in the mid- to high-end alcohol categories.

In the third quarter of 2009 sales grew by 23.2% but profits fell by 51%, making it a suitable target for Diageo’s tight management style.

Swellfun’s profit margin on local brands is thought to be about 40% while local estimates suggest that China’s top two high-end drinks producers, Moutai and Wuliangye, enjoy profit ratios of between 85% and 90%.

Reports from China say that Swellfun’s shares will resume trading by Tuesday at the latest, suggesting that the discussions will be concluded by then.

If a deal is done, however, it will no doubt be conditional on approval from Beijing. Last March the Chinese government vetoed Coca-Cola’s proposed takeover of Huiyuan Juice, the country’s premier producer of fruit drinks, citing anti-monopoly laws.

Most observers believe the underlying reason was to ensure that Chinese interests maintain majority control of rapidly expanding companies in successful sectors.

Diageo is eager to control its key routes to market, especially in countries where demand for premium goods is expanding.

Last year it secured official permission to take a 100% stake in its Indian joint venture with Radico Khaitan.

This was described a “technical measure” and no action has been taken, but the move is indicative of Diageo’s strategy.

Finance on Friday, 26.02.2010