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Morningstar | Despite Weak Consumer Sentiment, Heineken Will Strengthen CRB’s Presence in the Premium Segment. See Updated Analyst Note from 03 Jan 2019

We lower our 2018 full-year earnings forecast for no-moat China Resources Beer, or CRB, by 7% to CNY 1.94 billion to reflect the weaker beer consumption demand in the second half due to slowing economic growth. However, our fair value estimate is unchanged at HKD 25 per share, as our five-year profit growth CAGR remains at 27% driven by its collaboration with Heineken. By leveraging CRB’s strong nationwide distribution network, we expect to see a meaningful contribution from the Heineken brand in 2020 and believe CRB will increase its market share in the high-end segment.

The Chinese beer market softened in the second half, as the volume production decreased by 2.2% year on year during July to November, versus 1.2% year-on-year increase in the first half. The theme of premiumization continues to drive the top-line growth, but more modestly than in the first half. We expect CRB’s revenue growth to decelerate to low-single-digit rates in the second half of 2018 given weaker consumer sentiment from the U.S.-China trade tensions and unfavorable weather conditions (more rain). We expect CRB’s average selling price will be up at high-single-digit rates, while forecasting sales volume to decline 4%-5% year on year in the second half, which slightly trails the industry average. The volume underperformance was due to higher price hikes compared with its competitors, along with market share loss in the northeast provinces, where experiencing challenging operating conditions from much weaker economic growth and severe competition from ABI and Tsingtao Beer.

Although the prices of materials, such as paper box and glass, have stabilized recently, we see more cost pressure in the second half as the price of procurement was already locked in at higher prices. Gross margin is expected to slide slightly year over year, compared with the 2.5 percentage points increase in the first half. We also expect the operating expense ratio to rise due to higher advertising expenses for new product launches and provisions for employee’s mandatory provident fund, as well as additional operating costs for establishing the Heineken sales channel.

Management is concerned that the near-term demand will be affected by weaker consumer sentiment but is confident about the collaboration with Heineken will strengthen its presence and allow it to seize the opportunities in the fast-growing premium beer market in China in the longer term, on the back of its entrenched nationwide distribution network. Note, CRB is the largest beer maker in China with about 27% market share. In addition, the company has a five-year plan to increase its utilization rate by shutting down its idle and less modern factories. Although we expect to see some negative impacts to earnings from this due to higher impairment loss, we believe CRB’s profitability will be enhanced going forward.