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Morningstar | Cutting 2018 Profit Forecast for Tsingtao, but FVE Raised to HKD 35 due to TVM; Shares Fairly Valued

The Chinese beer market seemed to improve slightly in fourth-quarter 2018, as domestic production volume increased 2% year on year, compared with 0.3% growth for the first three quarters. However, we tweaked our revenue and operating profit forecasts for narrow-moat Tsingtao Brewery slightly to CNY 26.67 billion and CNY 1.41 billion, respectively, from CNY 26.93 billion and CNY 1.48 billion, as we lower our average selling price growth and gross margin projections because of intensifying competition in the mid- to high-end beer space. Our fair value estimate for Tsingtao increases to HKD 35 from HKD 33.50 per H share and to CNY 30 from CNY 29.50 per A share, mainly owing to the time value of money and the appreciation of the Chinese yuan against the Hong Kong dollar. We view the H shares as fairly valued, but we think the A shares are overvalued at current levels.

We think increasing raw material costs weighed down  the company’s profitability. The prices of the high-grade barley used to produce malt to make beer started moving up in fourth-quarter 2018 and are likely to increase at double digits in 2019 because of global trade tensions and tightening supplies following China’s probe into barley imports from Australia. We don’t think margins will be materially affected because barley accounts for only about 15% of total cost of goods sold while the prices for packaging (about 50% of production costs) are stabilizing. Meanwhile, the company is confident that it will be able to pass the rising costs on to consumers through product premiumization, which will improve its profitability in the longer term.