EUR 850.00 For Business Accounts Only

Morningstar | 00291 Updated Forecasts and Estimates from 22 Apr 2019

We are lowering our fair value estimate for no-moat China Resources Beer to HKD 23 per share from HKD 25, after taking account into worse-than-expected 2018 net profitsthat were dragged by two nonrecurring provisions for production capacity optimization and for the new employment annuity plan. Management expects the company’s profitability will be improved from the factory consolidation in the long term. However, we don’t expect to see a meaningful positive impact over the next five years. We retain our no-moat and stable trend ratings, but we think the shares are demanding at current levels.

Although the industry remains fierce, we believe the company will outgrow the market and continue to expand its market shares from other smaller players. We anticipate the company’s revenue and operating profit to grow at CAGRs of 6% and 26%, respectively, over the next five years, while the operating margin improving to an average of 7.8%, driven by continuous improvement in the product mix, along with positive synergies cooperation with Heineken.

Revenue growth in the second half, up 2.5% year on year, was in line with our forecast. Average selling prices were up 10.5% year on year to CNY 2,820 per kiloliter, while sale volume declined 8% year on year to 5.07 million kiloliters, leading top-line growth to decelerate from 11.3% in the first half. The higher average selling prices were driven by price hikes and better product mix, as sales volume of mid- to high-end beer grew faster at mid-single-digits rates. In contrast, sales volume declines were attributable to market share loss to ABI in the intensifying Northeastern market, as well as resulting from the increase of product prices. We think CRB’s underperformance in this region will be relieved, as the company will reinforce its sales resources into this market.

Gross margin in the second half slightly improved 10 basis points to 34.1%, thanks to improving product mix which offset the negative impact from the rising raw materials and packaging materials costs. Given the company booked a significant amount of impairment loss to implement its production optimization strategy by shutting down some (13 breweries in 2018) of the idle and out-fashioned factories and to record an one-off provision of its staff costs for 2017 for embarking a new employment annuity plan, the operating expenses increased 20% year on year and the operating expense/sales ratio rose 6 percentage points year on year. In the short term, we think the rising raw materials costs, such as barley, will weigh on its profitability but should be offset by the better product mix in the long run.

As a result, EBIT was negative CNY 599 million, compared with CNY 164 million a year ago, and EBIT margin negative 4.2%, down 5.4 percentage points from last year. Excluding impairment loss recognized in both 2017 and 2018, EBIT was down 51% year on year to CNY 436 million, and EBIT margin dropped 3.3 percentage points year on year to 3%.

The company has striven to increase its brand value and reposition its core products by launching more higher-end products. It rolled out two flagship products in 2018, Brave the World superX and Craftsmanship, looking for penetrate into the higher-price range (CNY 8 to CNY 9 per can) segment, which provided a strong impetus to the value enhancement. As for the acquisition of Heineken’s China operations, the State Administration for Market Regulation issued a written decision to not restrict the acquisition from a concentration of undertaking under the PRC anti-trust law. We believe CR Beer will be able to speed up its distribution of Heineken beer in the second half of 2019.