EUR 850.00 For Business Accounts Only

Morningstar | Swire Pacific's Corporate Day Highlights Progress on Beverage, Growth Opportunities Remain. See Updated Analyst Note from 30 May 2019

Swire Pacific’s Corporate Day on its beverage division reflected on the progress made since it’s last corporate day two years ago. Operations in the U.S. and China were integrated in 2017 and the focus remains on product enhancement and expansion, improving its distribution channels with enlarged footprint and outlets, digitalisation of platforms with overlay in data analytics.

Our fair value is increased to HKD 111 from HKD 102 as we factor in a more optimistic growth forecast for beverages and the time value of money. The conglomerate’s share price rallied strongly in early 2019 on the expected improvement in Cathay Pacific’s operation. We believe value has emerged with the equity market weakening though a positive catalyst is lacking. Improvements in the beverage division will be gradual and we see no improvement in Swire Pacific Offshore in the medium term as vessel demands remain subdued without significant investments from oil majors. While beverages contribute to 7% of the group’s total assets and 10% of operating income, the income is recurring and generally defensive, adding to the high-quality income generated from its investment properties. Our fair value represents a price/book ratio of 0.6 times, largely in line with its 10-year historical average of 0.65 times. A dividend yield of 3.9% is also attractive.

In China, the key long-term macroeconomic themes of rising middle class and income are unchanged and will lead to rising consumption of beverages. The latter continues to lag developed countries on a per capita basis and underpins volume growth in the long term. More importantly, Swire was able to deliver unit price increase across the large categories of sparkling, juice and water in China in 2018. This better reflects management execution in product development. Expansion into new categories with Georgia from Japan in the coffee segment, and Monster in the energy drink segment will also drive growth. Both brands are market leading in their respective markets. Positively, the launch of Real Leaf Tea in the popular tea segment in Taiwan achieved the market leading position in five years. If successful, increasing contribution from coffee and energy drinks will complement water and juice in reducing China’s reliance on sparkling. Sparkling in China makes up 70% of overall revenue, compared with 60% in the U.S. and around 50% for Hong Kong and Taiwan. While the low per capita consumption should continue to lead to volume growth in sparkling, the optimisation of the product mix will help mitigate consumers’ increasing health awareness, a long-term risk to volume, in our view. Our forecasts now assume annual volume growth rate of 7%, compared with 5.4% previously.

For the remaining geographies, Coca-Cola’s volume growth across most categories was ahead of industry growth in 2018 and on a five-year historical basis. In 2018, three of the top five beverage brands in growth belonged to Coca-Cola, with Monster leading the way. We lift our average annual volume growth forecast to 4% from 3% over the five years. While China will be the core growth driver, the U.S. makes up 35% of divisional operating profit and will continue to be a meaningful contributor going forward. For the smaller geographies in Taiwan and Hong Kong, transformation is continuing. Improvement in supplier chains saw the closure of a manufacturing plant in Kaohsiung in the south of Taiwan, to an expansion in the Taoyuan plant. Consumption in the northern part of Taiwan now makes up 70% of the country’s consumption and the readjustment in supply reduces transport costs. An upgrade in the Hong Kong bottling plant is needed as it is close to capacity from its original design from the late 1980s. Improvement in the supply chain is also needed to accommodate new products. While the company’s strength is in traditional products such as sparkling, management cited slower progress in newer products such as juice, tea, and water across Taiwan and Hong Kong. Opportunities remain with new product launches.