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Morningstar | CRB's Strong 1H Result Boosted by Higher ASP; Raising FVE to HKD 25, but shares Remain Unattractive. See Updated Analyst Note from 20 Aug 2018

No-moat China Resources Beer, or CR Beer, posted an upbeat first-half 2018 result slightly ahead of our projections, with revenue and net profit up 11% and 29% year on year, respectively. Despite sales volume dropping 1.5% year on year to 6.21 billion kiloliters, revenue increased 11% year on year to CNY 17.6 billion, driven by 13% average selling price, or ASP, growth on the back of price hikes and better product mix. Higher-end products, such as Brace the World Super X and Lianpu, saw strong sales growth during the period. Operating margin also saw 1.6 percentage points increase from last year, thanks to the company's premiumization strategy, despite higher costs for staff annuity and impairment loss from production optimization. EBIT came in at CNY 2.06 billion, up 22% over the same period last year.

While we maintain our no-moat and stable trend ratings, we are raising our fair value estimate for CR Beer to HKD 25 per share from HKD 23, as we are more optimistic to see increasing mix contribution from the mid- to high-end products amid the accelerating premiumization trend. That said, we think the shares are overvalued at current levels, trading at 44 times 2018 price/earnings, as we believe the market's higher expectations on gross margin expansion is too bullish and this positive has already priced in.

On the positive side, we tune up our five-year revenue growth to 7.4% from 6.4% previously, stemming from 1.5% volume growth and 5.9% ASP increase. Although the company expects the overall volume demand to remain sluggish for the next five years, between a decline of 1% and growth of 0.5%, it believes the industry is transforming toward premium products and estimates high-end beer mix will contribute 25% of total volume by the end of 2023 from 11%.

In order to enhance its premium product portfolio, CR Beer has signed a strategic partnership agreement with Heineken NV, including acquiring Heineken's China operations and the right to use the Heineken brand on an exclusive basis in China. We believe the collaboration with Heineken will strengthen its presence and seize the opportunities in the fast-growing premium beer market in China.

We also increase our average gross margin forecast to 36.3% from 35.8% previously, buoyed by rising mix contribution of higher-margin premium products, along with improving production efficiency. In contrast, we revise up our selling, general, and administrative expense to revenue ratio to 28.4% from 27.9% previously to account for the higher impairment costs and employees' compensation. As a result, we project CR Beer's operating profit to grow at a CAGR of 23% for the next five years, with operating margin averaging at 9.9%. We have yet factored the potential growth of Heineken's China business into the model, given the uncertainty on the agreement with Heineken remains, which is subject to due diligence, further negotiations, and approvals of the regulatory authorities.

CR Beer's 1.5% volume decline was lower than the 1.2% industry growth. We attributed this underperformance to the intensifying competition in the northeastern market, as well as the negative impact from selling price hikes. Encouragingly, the average selling price increased 13% year on year to CNY 2,827 per kiloliter, which was higher than we anticipated.

On the cost front, the selling expense ratio decreased 1.5 percentage points year on year, thanks to the management's solid execution on cost control, despite higher transportation costs. However, the general and administrative expense ratio rose 2.6 percentage points year on year, owing to higher costs for the new employee annuity plan and impairment loss resulted from shutting down of one brewery. We believe the production efficiency will be enhance in the longer term via the continuous optimization of production capacity.