EUR 850.00 For Business Accounts Only

Morningstar | Tsingtao’s 2018 Results Largely in Line; Market Share Declines in Southern Regions Concerns Us

We maintain our fair value estimate of HKD 35 per H-share (CNY 30 per A-share) for narrow-moat Tsingtao Brewery, following its full-year 2018 results that were largely in line with our expectations. China’s beer volume consumption per capita will likely remain unchanged in the medium term, but we expect the growing premiumization trend will ignite beer sales growth. While we expect Tsingtao’s sales volume to grow at low-single-digit rates over the next five years, slightly higher than industry average, we believe the profit driver will mainly come from the increasing average selling prices (both price hikes and better product mix) and improving profitability. On the other hand, we think the market share loss in the southern regions will continue to drag its volume growth, given management’s conservative selling strategy outside of Shandong province. We think the market is fully pricing in the margin improvement potential and view the H shares as slightly overvalued, while we view the A shares as overvalued at current levels.

Due to the company’s implementation of new revenue standards, adjusting promotion-related marketing expenses--previously recorded in selling and distribution expenses--to offset revenue, its revenue in 2018 grew 1.1% year on year to CNY 26.6 billion. On a comparative basis, the top line increased 5.2% from 2017, stemming from 0.8% volume growth and 4.3% average selling prices increase. The firm’s overall sales volume was better than the 0.5% industry growth and China Resources Beer’s 4.5% volume declines, bolstered by 4% sales volume increase in the Tsingtao brand, offset by the 2.2% volume declines in the lower-end Laoshan brand, as the company focused resources toward higher-brand and higher-end products.

Although the sales volume of mid- to high-end beer, including Augerta, Hong Yun Dang Tou, Classic 1903, and draft beer grew strongly at 6.6%, with volume mix up 120 basis points from last year, the 4.3% average selling prices growth was much lower than its major rival CR Beer’s 11.7% during the same period. We attributed the ASP hike differences to faster trade-ups for CR Beer, as its majority of sales were mainly coming from the low- to mid-end segments. Tsingtao’s ASP was CNY 3,300 per kiloliter, while CR Beer’s ASP was 2,800 per kiloliter in 2018. We think CR Beer will benefit more from the premiumization, bolstered by new premium product launches and its collaboration with Heineken.

By geographic region, sales from Shandong province grew 8% year on year and remained the largest contributor to the company, accounting for 64% of total sales. Business performance in the southern regions was quite disappointing, with revenue from the South and Southeastern China contracting 14% and 17%, respectively, from last year, amid intensified competition from ABI and CR Beer. Management’s key strategy was set to improve its profitability through premiumization, while maintaining its operating expenses/sales ratio. It seemed to be reluctant to increase its resources (which will lower its margins) into the southern regions, where its market share was low. In our opinion, if Tsingtao wants to solidify its market position and take market share back in the southern markets, it would need to increase selling and distribution expenses for the on-trade distribution to expand its market share outside of Shandong province.

Gross margin, down 280 basis points on the reported number or down 50 basis points on a comparative basis, was aligned with our forecast. The lower gross margin compared with last year was owing to increased costs of production (particularly packaging materials), offset by some positive effect on the improving product mix. We anticipate Tsingtao’s gross margin to improve slightly to an average of 38.6% in the medium term, driven by stronger growth from premium beer, along with more stabilized raw materials prices going forward.

Adjusting back to the previous accounting standard, selling, general, and administrative expenses/sales ratio was up 70 basis points from the prior year and was a bit lower than we anticipated. Operating profit grew 4.6% year on year to CNY 1.44 billion and operating margin, improved 20 basis points from last year to 5.4%, was slightly better than our expectation. We project the average operating margin will improve to 6.7% over the next five years, from an average of 5.3% over the past three years, on the back of gross margin expansions and effective controls in operating expenses, along with lower value-added tax rates.