China could become the wine industry's next Chile

HONG KONG: Western wine connoisseurs once derided the Chinese as simple drinkers who mixed wine with soda, and regarded the country's top vintners, like Dynasty, as local oddities serving up inexpensive wines in an immature market.

But a growing number of converts - investors among them - say that China could become the industry's next Chile: a font of quality and affordable wines.

Dynasty, Changyu and Great Wall, owned by a subsidiary of China Foods, control roughly half of China's market for grape-based wines. They are angling to replace local preferences for beer and grain alcohol in a country where international wines still have a small, albeit fast-growing, presence.

Though a near-term sales slowdown is possible as the economic woes in the United States fan out across the world, analysts say that the long-term prospects for China's homegrown wines are strong as disposable incomes rise and the country's booming middle classes demand healthier and ritzier lifestyles.

"It should be a gradual process," said Shanshan Lu, an analyst at Credit Suisse in Shanghai. "The key opportunity comes from the low base, and the key challenge should be competition from foreign brands that are imported into the China market."

 International spirit and wine behemoths like Diageo and Pernod Ricard are also aggressively expanding in China, the world's fastest growing major economy, but are focusing on high-end whiskey brands like Johnnie Walker and Chivas Regal.

China's wine industry is expected to grow to roughly $13.7 billion in 2010, up from $10.5 billion in 2007, according to research from Euromonitor, and experts say it could be the world's eighth largest wine consumer by 2012.

Grape wine, however, is still a small portion of China's market. Non-grape varieties like yellow wine and rice wine will still account for almost two-thirds, or $8.8 billion, of the market in 2010, Euromonitor forecasts.

By comparison, the global wine market was worth $234.7 billion in 2007, with "light grape wine" accounting for $164.2 billion of that market, Euromonitor says.

Ninety percent of grape wine consumed in China is red wine, which, unlike white wine, is considered a symbol of class and luxury. But even with such an image, Chinese wines are relatively affordable, averaging less than $3 a  bottle.

Shares in Chinese vintners have become affordable as well after steep falls this year, and now trade roughly in line with much larger global peers. Dynasty trades at 10.1 times its forward earnings, and China Foods trades at 17.4. That compares with 15.6 times for Diageo, and 16.1 times for the U.S. giant Constellation Brands.

Despite strong long-term prospects, producers of consumer goods in China are struggling to pass their rising costs on to customers in a year when inflation hit 11-year highs, even as incomes rise.

On Wednesday, Dynasty - in which the French wine and spirits company Rémy Cointreau owns a 27 percent stake - said volume sales for the first half of 2008 rose by less than 1 percent to just shy of 30 million bottles, the result of stiff competition and weaker demand after the floods and a massive earthquake that occurred in China this year.

ABN AMRO, however, has a "buy" rating on Dynasty, citing increased sales prices and the company's commitment to improve its marketing and distribution capabilities.

Great Wall, which has 15 percent of the market and was an official supplier to the Olympic Games in Beijing, has benefited from strong demand. Its volume sales jumped 92 percent to 94,000 tons last year, yielding a 19 percent increase in turnover to 2.14 billion Hong Kong dollars, or $274 million, according to CIMB-GK Securities.

And the dominant player Changyu - partly owned by an Italian liqueur maker, Illva Saronno, and the World Bank's International Finance Corp. - saw revenue leap 27 percent to roughly 1.8 billion yuan, or $263 million, in the first half of 2008 on the back of a gross margin of 67 percent.

Further out, there are fears that foreign wines could eventually beat Chinese vintners on their home turf as tastes expand among a burgeoning middle class.

The amount of wine imported into the country grew more than 19 percent to 163,600 tons in 2007, according to UBS, and the segment is growing faster than domestic wine.

But foreign wines have not penetrated China as deeply as have other international luxury items, like BMW automobiles and Louis Vuitton leather goods.