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Morningstar | Launching Coverage of Asahi Group With Narrow Moat and Negative Moat Trend Ratings, FVE of JPY 6,000. See Updated Analyst Note from 07 Jul 2019

We initiate coverage of Japanese leading brewers Asahi Group Holdings (Asahi) and Kirin Holdings (Kirin), and assign both brand a narrow moat and negative moat trend ratings. We view Asahi as undervalued with a healthy upside of 24% to our fair value estimate of JPY 6,000 and Kirin as fairly valued with a modest 10% upside to our fair value estimate of JPY 2,600. The secular decline in the beer and beer-like volume seems unlikely to reverse. However, the coming liquor tax revisions will offer brewers opportunities to not only cease volume contraction but lift profit margins of beer.

We believe the brewing businesses of both Asahi and Kirin have a narrow moat underpinned by a cost advantage and intangible assets. Specifically, local economies of scale enable meaningful cost savings through optimization of production and logistics in the core operating markets as a result of the capital-intensive nature of the brewing business and a sizable weight of transportation costs. The scale further empowers investment in brand building and product development, and also acquisitions, which reinforces its brand equity and enriches the brand/product portfolios. The moat trend is turning negative as the secular volume decline in beer and beer-like drinks in Japan, and some core markets in developed countries will eventually impair cost advantages and investment returns when there is limited room to increase profit margins.

Establishing a foothold in the global premium beer market by leveraging SABMiller’s European brand portfolio and distribution capabilities to grow Asahi Super Dry brand will support Asahi’s long-term growth. We project a 3.2% EPS CAGR over the next five years on the assertion that overseas expansion in the premium markets, combined with the introduction of the zero-based budgeting, will lift overseas top-line growth and group margins. Moreover, the beer tax cuts in Japan will work in favor of Asahi’s leading share position in the beer category.

Contrary to Asahi’s focus on beer, Kirin is seeking new revenue streams in the wellness industry. It is looking to develop proprietary products/services for health management and disease prevention by leveraging its know-how in consumer products and Kyowa Hakko Kirin’s expertise in pharmaceuticals. Nevertheless, margin expansion of the lucrative brewery business, combined with the expansion of pharmaceutical sales abroad, will remain the midterm profit drivers, sustaining a 3% CAGR in Kirin’s operating profits excluding charges over the next five years.

We consider Asahi the beneficiary of the planned liquor tax reform in Japan, beginning in October 2020, with multistage tax revisions through October 2026. We expect excise tax cuts in beer and tax hikes on the beer-like drinks will cease the ongoing volume contraction of beer. Moreover, tax cuts offer brewers rare opportunities to hike beer prices, allowing Asahi to fully offset the profit decline caused by shrinking beer-like demand, estimated at JPY 17 billion over seven years. Please refer to our report "Liquor tax reforms turning the tables on Japan’s brewing market" for more details about Japan’s brewing industry and the financial effects of tax reforms on Asahi and Kirin.