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Morningstar | Tsingtao’s 3Q Largely in Line With ASP Up 5.4%; Shares Are Fairly Valued. See Updated Analyst Note from 31 Oct 2018

Narrow-moat Tsingtao Brewery’s third-quarter results were largely in line with our expectations, with revenue and net profit up 2% and 10.6% year on year, respectively. The result reaffirmed our positive view that the company will benefit from better product mix and price hikes amid the ongoing premiumization trend, while the volume growth remains stagnant. Meanwhile, the effective control on selling expense also helped the firm’s profitability. That said, we don’t expect to see its competitive advantage to further enhance, given its weak market position outside of Northern China.

We forecast the company’s five-year revenue and net profit will grow at a compound annual growth rate of 3.7% and 12.2% respectively, with gross margin and operating margin averaging at 40.7% and 6.3% respectively. We lower our fair value estimate to HKD 33.50 per H-share from HKD 35, mainly due to the depreciation of the Chinese yuan against Hong Kong dollar, but raise the A-share to CNY 29.50 from CNY 29. We view the H-share is slightly undervalued and A-share is fairly valued to our new fair value estimate.

Revenue rose 2% year on year to CNY 8.49 billion, in line with our expectation. Excluding the impact from a changing accounting method, revenue increased 5.7% from last year. The firm’s total shipment volume was up 0.4% year on year to 2.62 million kiloliters, which was better than the industry’s 1.4% volume decline in the third quarter. Product mix continued to improve, as volume of premium beer grew 6.3% from last year, while the volume of low-end Laoshan beer declined 2.1% year on year. The average selling price was up 5.4% in the third quarter (before the accounting adjustment), slightly higher than 4% ASP growth in the first half, stemming from better product mix and price hikes.

On the cost front, the rising raw material costs continue to weigh on its gross margin. Although paper box prices declined in the third quarter, the higher glass price lifted the cost of goods sold. Cost per metric ton was around CNY 1,975, up 9% year on year, higher than our expectation. As a result, gross margin went down 2 percentage points to 41.2%. However, the company’s effective control on selling expense and better financial income helped profit margins improve in the third quarter, with operating margin improving 80 basis points. With additional asset disposal gain, the bottom line increased 10.6% year on year to CNY 798 million.