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Morningstar | Tsingtao’s 1Q19 Result Beat From Strong Premium Beer Growth, but Shares Remain Overvalued. See Updated Analyst Note from 02 May 2019

Narrow-moat Tsingtao Brewery’s first-quarter results surpassed the market’s and our expectations, with revenue and net profit growing 11% and 21% year on year, respectively. Both sales volume and average selling prices were higher than we anticipated, driven by strong sales growth for premium beers. We’re raising our fair value estimate to HKD 39 from HKD 35 per H-share (to CNY 33.50 from CNY 30 per China A-share), after taking into account higher revenue and gross margin forecasts. However, we think Tsingtao is overvalued presently and the positive outlook for profit growth is already reflected, after a 50% share price increase within a month.

Sales volume was up 6.6% year on year in the first quarter, exceeding both the industry growth and our 1% projection. The volume growth for its core Tsingtao brand was 8.5%, while lower-end Laoshan brand grew 4%. Meanwhile, the premium products saw a promising volume increase of 10.5%, driven by the ongoing consumption trade-ups and management’s strengthened marketing and advertising strategies. As such, we expect the company’s volume growth to remain at mid-single digits for 2019 and revise up our volume growth forecast to 5% from 1.5%.

Average selling prices increase of 4.4% from last year was also higher than our estimates, buoyed by price hikes and favorable mix from premiumization. We expect the higher-end beer will continue to grow faster than mass market beer and increase our average selling price growth assumption to 4% from 2.5% for 2019.

Gross margin, up 51 basis points from last year, was in line with our forecast in the first quarter, while the production costs per kiloliter went up slightly. We tune up our average gross margin assumption slightly to 39% from 38.6% previously over the next five years, as we expect the increasing mix of premium products and improving utilization rate will boost the profitability.

Although the selling and distribution expenses ratio increased 77 basis points, due to higher marketing and advertising costs, the lower ratio of sales tax and administrative expenses offset the negative impact. As such, the operating profit and normalized net profit rose 16% and 26.7%, respectively, which were better than our projections.