Deutsche Bank Markets Research

Rating Company Date 2 March 2017 Sell -H Coverage Change Asia Reuters Bloomberg Exchange Ticker Price at 1 Mar 2017 (HKD) 35.10 Consumer 0168.HK 168 HK HSI 0168 Price target - 12mth (HKD) 27.22 Alcohol & Tobacco ADR Ticker ISIN 52-week range (HKD) 36.00 - 25.80 TSGTY US8985291025 HANG SENG INDEX 23,741

An ailing giant

Charlie Chen Research Analyst (+852 ) 2203 6178 Change to survive [email protected] Tsingtao has long been considered China’s national beer brand, selling over 9m tons of beer at peak. TB has 18% market share in China, but as this market turns more sophisticated, TB is losing its competitive strength. Since Price/price relative

2015, it has lost market share for the first time in its history, and the trend 60 continues in 2016. As an SOE, TB is suffering chronic internal issues. Its 50 outlook will likely remain clouded unless some radical changes are made to its operations. We resume coverage with Sell and a TP of HK$27.22. 40 30 Uncertainty in government subsidy a big risk 20 TB receives a lot of government subsidy, equal to 20-25% of its pretax income, 3/15 9/15 3/16 9/16 or 40-60% of its FCF in the next three years. These subsidies (mainly special Tsingtao Brewery-H project allowance & relocation compensation) have no guarantee of continuing HANG SENG INDEX (Rebased) forever. Given its large size, subsidy discontinuation could cut our TP by 18%. Performance (%) 1m 3m 12m Although we forecast fundamentals to improve in 2017 with Chinese beer Absolute 5.9 14.0 22.3 market recovery, government subsidy uncertainty and current high PE (33/48x HANG SENG INDEX 1.8 3.8 22.3 FY17 PE with/without subsidy) make the share price at a high risk of de-rating. Source: Deutsche Bank

Asahi’s potential disposal of stake; short-term noise We believe TB’s recent stock price strength is related to Asahi’s potential disposal of its 20% holding in TB. We believe this is only short-term noise, as: 1) it is difficult to find an investor who is willing to pay big premium; and 2) a new shareholder is unlikely to make a meaningful impact on TB’s operations, hence synergy is limited. The share price is likely to fall after this deal news settles. Resuming coverage with Sell and TP of HK$27.22 based on DCF model We use a DCF model with 8.8% WACC and 2% terminal growth to derive our TP at HK$27.22 and resume coverage with Sell. TB is trading at an expensive 47x FY17 PE (33x FY17 recurring PE), a huge premium to peers. Main upside risks include: Asahi managing to dispose TB’s stake at a premium price and weaker-than-expected raw material price increase.

Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 26,866.7 25,604.3 24,518.5 25,509.1 26,279.4 EBITDA (CNYm) 2,844.5 2,045.6 2,035.5 2,215.5 2,416.8 Reported NPAT (CNYm) 1,990.1 1,713.1 1,367.2 1,288.5 1,439.0 Reported EPS FD (CNY) 1.47 1.27 1.01 0.95 1.07 DB EPS FD (CNY) 1.24 0.79 0.66 0.66 0.77 DB EPS growth (%) 12.5 -35.9 -17.3 1.3 15.5 PER (x) 37.2 45.1 47.3 46.7 40.5 EV/EBITDA (x) 19.9 20.0 16.8 15.0 13.4 Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items 2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which uses the year end close

______Deutsche Bank AG/ Distributed on: 01/03/2017 23:54:35 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.

2 March 2017

Alcohol & Tobacco Tsingtao Brewery-H

Model updated:01 March 2017 Fiscal year end 31-Dec 2013 2014 2015 2016E 2017E 2018E

Running the numbers Financial Summary Asia DB EPS (CNY) 1.10 1.24 0.79 0.66 0.66 0.77 Reported EPS (CNY) 1.46 1.47 1.27 1.01 0.95 1.07 China DPS (CNY) 0.31 0.31 0.31 0.31 0.31 0.31 BVPS (CNY) 10.4 11.4 12.2 12.9 13.5 14.3 Alcohol & Tobacco Weighted average shares (m) 1,351 1,351 1,351 1,351 1,351 1,351 Tsingtao Brewery-H Average market cap (CNYm) 59,619 62,188 48,304 41,964 41,964 41,964 Enterprise value (CNYm) 53,440 56,561 40,966 34,113 33,227 32,275 Reuters: 0168.HK Bloomberg: 168 HK Valuation Metrics P/E (DB) (x) 40.1 37.2 45.1 47.3 46.7 40.5 Sell P/E (Reported) (x) 30.2 31.2 28.2 30.7 32.6 29.2 Price (1 Mar 17) HKD 35.10 P/BV (x) 5.01 3.67 2.34 2.41 2.29 2.18

Target Price HKD 27.22 FCF Yield (%) 2.3 nm 2.7 2.2 3.1 3.3 Dividend Yield (%) 0.7 0.7 0.9 1.0 1.0 1.0 52 Week range HKD 25.80 - 36.00 EV/Sales (x) 2.1 2.1 1.6 1.4 1.3 1.2 Market Cap (m) HKDm 47,420 EV/EBITDA (x) 19.4 19.9 20.0 16.8 15.0 13.4 EV/EBIT (x) 28.5 29.4 37.4 30.9 28.6 24.6 USDm 6,109 Income Statement (CNYm) Company Profile Sales revenue 26,063 26,867 25,604 24,519 25,509 26,279 Tsingtao Brewery produces and distributes beer products. Gross profit 9,055 8,967 8,412 8,949 9,375 9,723 The Company markets its products throughout China and EBITDA 2,751 2,844 2,046 2,036 2,215 2,417 around the world under the Tsingtao Beer brand name. Depreciation 712 731 746 733 838 887 Amortisation 167 192 204 199 216 215 EBIT 1,872 1,922 1,095 1,103 1,161 1,314 Net interest income(expense) 251 335 300 267 284 315 Associates/affiliates 229 24 462 140 20 20 Exceptionals/extraordinaries -2 4 -2 -8 -8 -8 Other pre-tax income/(expense) 316 399 420 490 510 526 Profit before tax 2,667 2,683 2,275 1,993 1,967 2,166 Price Performance Income tax expense 692 663 663 598 551 585 Minorities 2 29 -101 28 127 142 60 Other post-tax income/(expense) 0 0 0 0 0 0 Net profit 1,973 1,990 1,713 1,367 1,288 1,439 50

DB adjustments (including dilution) -488 -319 -641 -481 -390 -402 40 DB Net profit 1,485 1,671 1,072 886 898 1,037 30 Cash Flow (CNYm) 20 Mar 15Jun 15Sep 15Dec 15Mar 16Jun 16Sep 16Dec 16 Cash flow from operations 3,401 1,691 2,575 2,424 2,706 2,860 Net Capex -2,025 -1,943 -1,271 -1,490 -1,423 -1,466 Tsingtao Brewery-H Free cash flow 1,377 -252 1,304 934 1,283 1,394 HANG SENG INDEX (Rebased) Equity raised/(bought back) 0 0 0 0 0 0 Margin Trends Dividends paid -618 -686 -691 -420 -396 -443 Net inc/(dec) in borrowings -170 -1,477 357 0 0 0 12 Other investing/financing cash flows 537 287 1,339 0 0 0 11 Net cash flow 1,126 -2,129 2,309 513 887 952 9 Change in working capital 1,172 -681 956 86 227 171 8 6 Balance Sheet (CNYm) 5 Cash and other liquid assets 8,532 6,389 8,402 8,915 9,802 10,753 3 Tangible fixed assets 9,252 10,189 10,191 10,929 11,493 12,051 13 14 15 16E 17E 18E Goodwill/intangible assets 3,613 4,088 4,014 3,815 3,619 3,424 EBITDA Margin EBIT Margin Associates/investments 1,272 1,536 1,508 1,508 1,508 1,508

Other assets 4,696 4,803 4,386 4,134 4,222 4,290 Growth & Profitability Total assets 27,365 27,004 28,501 29,300 30,644 32,026 Interest bearing debt 2,353 762 1,065 1,065 1,065 1,065 15 20 Other liabilities 11,137 10,954 11,270 11,095 11,419 11,662 10 15 Total liabilities 13,491 11,717 12,335 12,160 12,484 12,727 5 Shareholders' equity 14,021 15,388 16,458 17,405 18,297 19,293 10 Minorities -147 -100 -292 -264 -137 6 0 5 Total shareholders' equity 13,874 15,287 16,166 17,141 18,160 19,299 -5 Net debt -6,178 -5,627 -7,337 -7,850 -8,737 -9,689 -10 0 13 14 15 16E 17E 18E Key Company Metrics Sales growth (%) 10.5 3.1 -4.7 -4.2 4.0 3.0 Sales growth (LHS) ROE (RHS)

DB EPS growth (%) 5.1 12.5 -35.9 -17.3 1.3 15.5 Solvency EBITDA Margin (%) 10.6 10.6 8.0 8.3 8.7 9.2 EBIT Margin (%) 7.2 7.2 4.3 4.5 4.6 5.0 0 Payout ratio (%) 21.1 20.7 24.3 30.8 32.2 28.9 -10 ROE (%) 14.9 13.5 10.8 8.1 7.2 7.7 -20 Capex/sales (%) 7.8 7.3 5.1 6.1 5.6 5.6 -30 Capex/depreciation (x) 2.3 2.1 1.4 1.6 1.3 1.3 -40 Net debt/equity (%) -44.5 -36.8 -45.4 -45.8 -48.1 -50.2 -50 Net interest cover (x) nm nm nm nm nm nm -60 Source: Company data, Deutsche Bank estimates 13 14 15 16E 17E 18E

Net debt/equity (LHS) Net interest cover (RHS)

Charlie Chen +852 2203 6178 [email protected]

Page 2 Deutsche Bank AG/Hong Kong

2 March 2017

Alcohol & Tobacco Tsingtao Brewery-H

Investment thesis

Outlook: stabilize in 2017, rebound in 2018 Armed with a little outmoded Tsingtao Beer brand, Tsingtao Brewery (TB) is taking a hard fight against emerging rivals like China Resources Beer (CRB) and ABInBev, who are equipped with a more aggressive execution team or a strong product portfolio. In the last three years, when the Chinese beer market experienced the first consecutive volume decline, TB was not able to protect its territory and lost market share. Having enjoyed its brand advantage for many years, TB, as an SOE, has developed some chronic issues internally, such as ineffective brand communication strategy, an inefficient distribution model and over-reliance on top management’s personal capability. All of these problems are unlikely to be solved in the short term; hence, we expect TB to continue losing market share to CRB and ABInBev in the short-to-medium term.

Despite losing its competitive edge, a strong rebound in Chinese beer market volume is likely to stabilize TB’s sales performance in 2017. With expected volume growth exceeding 3% in China this year, TB should resume positive revenue growth of 4% and 3% in 2017 and 2018, respectively. Due to the market rebound and an improving competitive environment in Chinese beer market, TB should achieve 1.3% and 15.5% net profit growth in 2017 and 2018, respectively, based on our forecasts.

With a strong Tsingtao brand and a few powerful local brands such as Hans and Laoshan, we believe TB will be able to hold up its strong markets such as in the and Shaanxi Provinces, but upside potential for revenue expansion will be kept at a CAGR of 3% or below, due to a mature market situation and competition from other players. Driven by industry recovery and gradual efficiency improvement, TB is likely to achieve a 10% recurring net profit CAGR in the next five years. Valuation We use DCF as our valuation methodology. We believe the Chinese beer market is becoming mature and there is no more large expansion capex requirement for TB, therefore we should have a good grasp of TB’s future cash flow. Using 8.8% WACC and 2% terminal growth, we derived our target price of HK$27.22, which implies 25.4x FY17 PE (36.4x excluding government subsidy) and 8.9x FY17 EV/EBITA (11x excluding government subsidy). Although we assume a perpetual government subsidy equivalent to 2% of TB’s annual net sales in our DCF model, we remind investors that TB receives sizable government subsidies every year (25% of TB’s 2016 pretax profit) and there is no guarantee that this subsidy will be paid forever. Stripping out subsidy, our DCF model gives a lower target price of HK$22.19. Risks Main risks include: raw material prices fluctuation, competitive landscape change due to M&A, major management change and overall beer market trend change. For 2017, we believe the biggest upside risks are: a strong rebound in the Chinese beer market and Asahi disposing 20% stake of TB at a higher- than-market price. Please see the detailed discussion in following section.

Deutsche Bank AG/Hong Kong Page 3

2 March 2017

Alcohol & Tobacco Tsingtao Brewery-H

Valuation and risks Target price of HK$27.22 on DCF method

Government subsidy is a big uncertainty No matter which valuation method is used or how TB’s future cash flow and Watch out for the subsidy: earnings are forecasted, our first suggestion to investors is be aware of TB’s We assume a government government subsidy. This item includes things like subsidies to special subsidy equivalent to 2% of investment projects (e.g. subsidies to investment in underdeveloped areas), TB’s revenue per year in our compensation of factory relocation, tax returns and others. In 2016, TB’s model – but this subsidy government subsidy is estimated to be 25% of its total pre-tax income. Although we modeled RMB500-RMB530m government subsidy in 2016 to could go away in the future. 2018, there is no guarantee as to how long this subsidy will last and how much will be paid in the future. As this subsidy has been around for over 20 years and there is no signal of immediate discontinuation, we .assume a perpetual government subsidy equivalent to 2% of TB’s net revenue every year in our DCF model. However, discontinuation of government subsidy could substantially lower TB’s FCF in the future and our target price accordingly.

Figure 1: Nearly 1/3 of TB’s 2016E Figure 2: Breakdown of government Figure 3: TB pretax profit forecasts, pretax profit is non-recurring subsidy in 2015A 2013A – 2018E RMBm RMBm RMBm Recurring pre-tax profit Government Subsidy Other Non-recurring Gains Others 3,000 58 Tax return 15 2,500 Subsidies to Recurring Net 2,000 corporate 872 development 2,178 2,364 Non- 1,500 1,614 1,764 and special 1,576 guaranteed gov. 1,512 projects 1,000 sub. Factory 225 494 relocation 500 Minority on 511 recurring Net compensation 375 448 494 510 526 11 Other 213 0 Tax on recurring pretax non- 113 -129 149 -13 -120 -124 Net recur. Gains -500 473 143 2013A 2014A 2015A 2016E 2017E 2018E Source: Deutsche Bank estimates Source: Deutsche Bank Source: Deutsche Bank estimates

Target price of HK$27.22, implying 25.4x FY17 PE and 8.9x FY17 EV/EBITDA In the next 20 years, we forecast TB’s EBIT growth to slow from 10% to 7% per year, driven by around 1-2% volume growth per year, 2-3% ASP growth and some operating leverage. Meanwhile, TB’s capex will remain around RMB1.4b per year and its depreciation and amortization should gradually rise to the same level. Using 8.8% WACC and 2% terminal growth, we calculated TB’s DCF valuation at HK$27.22. Without government subsidy, our DCF derived target price will be HK$22.19

Figure 4: TB’s FCF Figure 5: TB’s DCF target price Figure 6: Sub as a percentage of pretax income 2,500 30 30.0% RMB million HK$ per share27.21 FCF with sub 25 25.0% 2,000 22.19 FCF without Sub 20 20.0% 1,500

15 15.0% 1,000 10 10.0% 500 5 5.0% 0 2017 2019 2021 2023 2025 Terminal 0 0.0% Value TP with sub TP without sub 2013 2014 2015 2016 2017 2018 2019 2020 Source: Deutsche Bank Source: Deutsche Bank Source: Deutsche Bank

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Alcohol & Tobacco Tsingtao Brewery-H

Figure 7: Tsingtao Breweries DCF Model 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Term. Value Revenue 25,509 26,279 27,102 27,921 28,764 29,665 30,561 31,484 32,434 33,414 34,082 EBIT 1,671 1,840 1,992 2,150 2,316 2,492 2,674 2,865 3,065 3,275 3,340 …Adjusted Cash Tax -468 -497 -518 -559 -602 -648 -695 -745 -797 -851 -835 NOPLAT 1,203 1,343 1,474 1,591 1,713 1,844 1,979 2,120 2,268 2,423 2,505

Add. Depr. & Amort. 1,055 1,103 1,144 1,186 1,225 1,256 1,287 1,315 1,338 1,359 1,359 Less: Chg. In Working -227 -171 -183 -180 -185 -198 -195 -200 -204 -210 -214 Cap. Less: Capex -1,423 -1,466 -1,512 -1,418 -1,461 -1,448 -1,431 -1,412 -1,390 -1,365 -1,393

Operating FCF 608 809 924 1,178 1,292 1,454 1,640 1,823 2,013 2,207 2,257 Present Value 566 692 727 852 859 889 921 941 955 962 984

Sum of PV: 2017-2026 8,363 Risk Free Rate 3.90% PV of terminal value 14,483 Equity Beta 0.9 NPV of FCF 22,846 Equity Risk Premium 5.6% Add: investment 1,508 Cost of Equity 8.94% Add: Net Cash 8,104 Debt Premium 6.10% Minus: Minority Interest (264) Cost of Debt 7.50% NPV of Total Equity 32,721 Tax Rate 25.0% Number of Shares 1,351 Target D/E 10.0% Share price in RMB 24.22 WACC 8.80% Share price in HKD 27.22 Nominal LT Growth 2.00% Source: Deutsche Bank estimates

Our target price implies 25.4x FY17 PE and 8.9x FY17 EV/EBITDA. The 25.4x PE is trading at a premium to global peers, while the 8.9x EV/EBITDA multiple seems attractive. Like many other Chinese staple companies, TB has a good cash flow and a very strong balance sheet with nearly an expected RMB9bn cash by the end of 2016 and RMB800 bank loans. TB’s net cash is equivalent to nearly 20% of its total market capital. The big cash pile explains the gap between its high PE while low EV/EBITDA

Figure 8: Valuation comp table (share prices as of 1 March 2017) Name BBG Ticker Price Mkt cap Reported PE (x) Adjusted PE (x) EV/EBITDA (x) ROE (%) Div Yield (%) Local USDm 2016 2017 2016 2017 2016 2017 2016 2016 Tsingtao (H) 168 HK 35.10 6,109 30.7 32.6 47.3 46.7 16.8 15.0 8.1 1.0 Tsingtao (A) 600600 CH 33.31 6,551 32.9 32.6 50.8 50.1 18.3 16.4 8.1 0.9 CRB 291 HK 17.70 7,397 56.9 22.8 56.9 22.8 13.0 11.2 6.2 0.0 Yanjing 000729 CH 7.52 3,080 41.8 39.4 41.8 39.4 13.3 12.7 2.7 0.9 Zhujiang 002461 CH 13.59 1,343 79.9 64.7 79.9 64.7 NA NA 3.4 0.4 Thai Beverage THBEV SP 0.95 16,913 21.6 19.9 24.4 21.6 18.5 17.2 22.1 2.5 EM average 43.97 35.34 50.18 40.88 15.98 14.50 8.44 0.95

ABInBev ABI BB 104.35 221,791 31.8 23.1 30.2 21.9 15.8 12.4 9.7 NA Carlsberg CARLB DC 622.00 13,386 18.8 17.0 18.8 17.0 9.3 8.9 9.5 1.6 Molson Coors TAP US 100.39 21,596 15.8 14.7 15.8 14.7 9.0 NA 21.4 1.6 Heineken HEIA NA 78.26 47,449 19.8 18.1 19.8 18.1 10.6 10.0 11.5 1.7 Asahi 2502 JP 3,999 16,979 17.6 16.1 17.6 16.1 10.2 9.5 5.2 1.5 Kirin Holdings 2503 JP 1,960 15,724 21.1 19.8 21.1 19.8 10.5 10.1 17.6 2.0 Suntory Bev & Food 2587 JP 4,750 12,886 29.0 25.5 29.0 25.5 9.4 9.0 8.1 1.6 Ambev ABEV US 5.69 89,433 23.1 20.6 23.2 20.5 13.7 12.2 25.1 0.4 DM Average 22.11 19.33 21.93 19.18 11.07 10.29 13.51 1.49 Source: Deutsche Bank for companies covered, Bloomberg Finance LP for non-covered names

Deutsche Bank AG/Hong Kong Page 5

2 March 2017

Alcohol & Tobacco Tsingtao Brewery-H

Currently, TB’s stock price of HK$35 implies 33x FY17 PE (47x PE without subsidy) and 11.5x FY17 EV/EBITDA, which seems to be a result of recent news that Asahi is considering disposing its 20% holding in TB. We believe this restructuring news has driven share price to deviate from its fundamentals and suggest investors to take profit.

Historical average PE at around 30x Figure 9: Tsingtao(A) one year forward PE band Figure 10: Tsingtao(A) one year forward PB band

RMB RMB 70 Price Price 80 +2STD:43x 60 +1 STD:36x +2STD:5.5x 70 Avg:29x -1 STD:22x 50 60 -2 STD:15x +1 STD:4.5x

50 40 Avg:3.6x

40 30 -1 STD:2.7x

30

20 -2 STD:15x 20

10 10

0 0

09 10 12 13 15 16 08 11 14

09 10 13 16 08 11 12 14 15

08 09 12 13 15 10 11 14 16 17

08 10 11 14 09 12 13 15 16

08 09 10 11 15 12 13 14 16

16 08 09 10 11 12 13 14 15

08 09 10 11 12 13 14 15 16 17

08 09 10 11 13 14 15 12 16

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Jul Jul Jul Jul Jul Jul Jul Jul Jul

Jul Jul Jul Jul Jul Jul Jul Jul Jul

Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan

Oct Oct Oct Oct Oct Oct Oct Oct Oct

Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan

Apr Apr Apr Apr Apr Apr Apr Apr Apr

Oct Oct Oct Oct Oct Oct Oct Oct Oct

Apr Apr Apr Apr Apr Apr Apr Apr Apr Source: Deutsche Bank, company data Source: Deutsche Bank, company data

Tsingtao has traded on an average of 29.4x in the past ten years. We believe this was a fair valuation given that TB had strong double-digit net profit growth. As TB’s net profit growth is slowing to around 10% CAGR in the next three years, the current 33x FY17 PE seems rich and we expect the share price to fall. TB’s PB valuation has been going down in the past three years, probably due to its increasing cash. As of the end of 2016, nearly half of TB’s net book value is idle cash (vs. only 30% ten years ago) and we believe investors are unwilling to pay premium for this part of the book. With growth rate slowing down and inflating non-working assets, the PB valuation multiple depreciating appears to be natural.

Risks

Sustainability of non-recurring items Change in government subsidy may surprise us in either a positive or negative way, and we have no clear view now. As we stated previously, government subsidies account for a significant portion of TB’s profit before tax. Based on our forecast, these subsidies will contribute 22-24% of TB’s pretax income in 2017 and 2018, and the portion will gradually decline thereafter. If government subsidy is totally discontinued somewhere down the road, there will be up to 20% downside potential to our target price.

Slower-than-expected raw material price increase We have priced in the negative impact from rising raw material. Currently in TB’s COGS, 60% goes to raw material costs, 5% is direct labor, 15% is manufacturing costs including depreciation and the remaining 20% is outsourcing costs. Major raw materials include: , , hops, aluminum, glass and carton paper. We have seen commodity prices on a rising trend, in particular, crude oil and aluminum. Continuous rising commodity prices may weigh on TB’s margins. However, if raw material price does not rise as fast as we expected, TB’s margin could surprise the market on the upside.

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Alcohol & Tobacco Tsingtao Brewery-H

Involvement in major M&A as either a buyer or a target TB has confirmed its second largest shareholder Asahi is considering disposing the 20% stake in TB. If this potential share disposal goes through and the final settlement price is substantially different from current market price, TB’s share price could be impacted. Our Sell recommendation is based on assumptions that the final settlement price will be lower than the current share price, and there would be no significant synergy between TB and the new shareholder in the near term. If Asahi manages to dispose TB’s stake at a premium to market price, TB’s share price is likely to perform better than our expectation.

Substantial change in dividend payout policy Currently, TB pays out around 30% of their annual profit. As the Chinese beer market is in an over-capacity situation and TB already has sufficient capacity, we believe TB’s FCF will continue to strengthen. TB may consider increasing dividend payout if they have no other plans for their idle cash. Share price can has upside risk if TB raises dividends.

Overall economy and consumer market change in China Volume of the Chinese beer market has declined in 2014 and 2015, and per capita consumption of has also exceeded the global average. Expectation on future beer volume growth in China is low. However, reasons like uncommon weather, sports event, timing of festivals and base effects can change short-term beer volume growth drastically. Favorable conditions including weather and economy could bring upside risk to our forecasts on TB.

Management change may bring new initiatives to revive the company TB’s Chairman, Sun Mingbo, was first appointed in 2012 after former Chairman, Jin Zhiguo’s resignation, and was re-elected company Chairman in 2014. TB is facing a new election this year. Mr. Sun is 60 years old and it is rare for a Chinese SOE senior management to be re-elected when he has reached retirement age. We believe the chance is high that TB will have a new Chairman in June 2017. The new leadership may bring new initiatives that could help TB get out of the swamp.

Deutsche Bank AG/Hong Kong Page 7

2 March 2017

Alcohol & Tobacco Tsingtao Brewery-H

An ailing giant Company overview

Strong brand heritage Tsingtao Brewery (TB) is the second largest brewer in China and sixth largest Figure 11: Sales volume of TB brewer in the world. It brews around eight million tons of various beer KT 10,000 products from 66 breweries in China every year. Tsingtao Beer is the most 9,000 8,014 prestigious domestic beer brand in China and was founded by a group of 8,000 7,000 German merchants in 1903. For a long time, Tsingtao Beer was considered the 6,000 5,000 beer of China and was an icon of Chinese beer industry, for its quality, long 4,000 history and comprehensive product distribution in China. In the 21st century, 3,000 2,000 Tsingtao Beer has won recognition as the top Chinese beer brand by various 1,000 0

third parties, including the Financial Times and consulting firm, Interbrand. TB

1998 1999 2000 2002 2004 2005 2006 2007 2009 2010 2011 2012 2014 2001 2003 2008 2013 2015 was also the Official Sponsor (beer category) of the Beijing Olympics 2008, the 2016E exclusive Chinese beer partner of the Cleveland Cavaliers from 2010 to 2014 Source: Deutsche Bank estimates and many other sporting events.

Comprehensive distribution network By the end of 2015, TB employed around 43,000 people in its 66 breweries (54 Figure 12: Global brewers ranking wholly-owned and 12 associated and joint-venture) located in 20 provinces in China. The vast majority of TB’s products are sold in mainland China with only ABInBev 39.9 SABMiller 19.1 less than 2% exported to other markets. TB’s core markets in China include the Heineken 18.8 Carlsberg 12.0 Shandong Province (nearly half of its revenue) and Shannxi, where TB owns a CRB 11.7 strong local brand, Hans. Tsingtao 8.5 Molson-Coors 5.8 Yanjing 4.8 One of the two most profitable breweries probably due to strong brand Kirin 4.3 BGI/Groupe … 3.0 MT By far, TB is still the most profitable domestic brewery in China (despite the 0.0 10.0 20.0 30.0 40.0 50.0 fact that its margins have been deteriorating in a tough market). This is probably due to TB’s higher end product positioning and large scale. With 10- Source: Company data, Deutsche Bank 20% price premium to most of its domestic competitors, Tsingtao’s pretax profit margin of 8.9% is the highest among all. Stripping out government subsidies, Tsingtao’s recurring pretax margin of 5.5% ranks second, following CRB’s 5.8%.

Figure 13: Ex-factory prices, 2015, in Figure 14: Pre-tax profit margins, Figure 15: Recurring pre-tax profit RMB per ton 2015 margins (excl. government subsidy) RMB/ton 10.0% 8.9% 8.0% 3,500 7.5% 5.8% 8.0% 6.0% 5.5% 5.1% 3,019 3,083 6.2% 3,000 2,742 6.0% 4.0% 2,455 2,408 4.0% 3.8% 2,500 2,331 4.0% 1.9% 2.0% 1.5% 2,000 2.0% 0.0% 1,500 0.0% -2.0% 1,000 -2.0%

500 -4.0% -4.0% -3.6% -3.8% 0 -6.0% -6.0% TB CRB Yanjing Zhujiang Chongqing Huiquan TB CRB Yanjing Zhujiang Chongqing Huiquan TB CRB Yanjing Zhujiang Chongqing Huiquan Source: Deutsche Bank Source: Deutsche Bank Source: Deutsche Bank

Page 8 Deutsche Bank AG/Hong Kong

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Alcohol & Tobacco Tsingtao Brewery-H

Falling behind competitors in the last decade

Shining brand shadowed by disappointing results… Despite its strong heritage, the company has underperformed its rival CRB recently. Since TB was surpassed by CRB in 2006 and lost its No.1 market share by volume in China, TB has never regained the crown. On the contrary, the volume gap between TB and CRB has widened since then, and CRB has also firmly claimed the No.1 position by revenue in 2014, with its successful product upgrading strategy.

Figure 16: Market share by vol. 2015 Figure 17: Sales vol. of TB and CRB Figure 18: Revenue of TB and CRB

KT RMBm 14,000 35,000 CRB Others Tsingtao Vol. Tsingtao Rev. 25% 26% 12,000 30,000 CRB Vol. CRB Rev. 10,000 25,000

8,000 20,000

15,000 Carlsberg 6,000 5% 10,000 4,000 TB Yanjing 5,000 18% 2,000 10% 0 ABI 0 16% 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: Deutsche Bank Source: Deutsche Bank Source: Deutsche Bank

This competitive landscape shift is also reflected in TB’s quickly deteriorating financials. From 2000 to 2010, TB’s ASP rose from RMB1,916 per ton to RMB3,133 per ton with a 5.0% CAGR, when CRB was at 1.5%, driving a recurring net profit CAGR of 36% during the same period. However, entering the second decade of 21th century, TB has fallen behind its main competitor CRB on all three metrics: revenue CAGR, ASP CAGR and Net Profit CAGR. In particular, when CRB has been able to continue increasing its ASP and net profit, TB experienced price deterioration and profit decline.

Figure 19: Revenue CAGR Figure 20: ASP CAGR Figure 21: Recurring NP CAGR

30.0% 6.0% 40.0% 36.3% 26.9% TB TB TB 5.0% 4.8% 5.0% 35.0% 25.0% CRB CRB CRB 30.0% 4.0% 19.2% 25.0% 20.0% 19.9% 3.0% 20.0% 15.0% 2.0% 1.5% 15.0%

9.8% 1.0% 10.0% 10.0% 3.6% 5.0% 5.2% 0.0% 0.0% 5.0% -1.0% -0.7% -5.0% -5.2% 0.0% -2.0% -10.0% 2000/10 2010/15 2000/10 2010/15 2000/10 2010/15 Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank

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Web of chronic issues TB’s SOE background and national brand have given TB competitive advantages when China’s beer market was at its early stage of development. However, like many other SOEs, the company has been slow to adopt new strategies and implement changes to stay ahead of the competition.

Brand losing out in competition for consumer connection

Brand value deterioration Although Tsingtao Beer has been undoubtedly the No.1 beer brand in China for Figure 22: Brand Value a long time, its leading position is at risk as followers such as (an USDbn 2.0 Tsingtao ABInBev brand) and (a CRB brand) are catching up. According to 2016 1.8 1.8 1.7 Harbin 1.6 BrandZ Most Valuable Chinese Brands Top 100 by WillwardBrown and WPP 1.4 Snow 1.4 Group, Tsingtao Beer’s brand has devalued 20% to US$1.44bn, while Harbin 1.2 1.0 1.0 1.0 0.9 and Snow brands have appreciated 23% and 9% in 2016. In the past two years, 0.8 0.8 0.8 0.7 Harbin and Snow’s brand value has also appreciated faster than Tsingtao. 0.6 0.4 0.2 In our opinion, TB’s brand depreciation is a result of a flawed marketing 0.0 2014 2015 2016 strategy. As the No.1 national beer brand, TB has some edge in winning sponsorships of large events and becomes the title sponsor. CRB’s Snow Source: LogoNews, BrandZ.com instead focuses more on consumer promotion activities. Take the 2008 Beijing Olympics as an example, TB won the exclusive beer sponsor for the whole event, while CRB explicitly said Snow will only focus on promotion activities in retail outlets and reward its marketing budget back to consumers. Biased marketing strategy with over weighting on brand advertisement leads to disconnection between the TB brand and consumers, which seems to be the critical factor that has alienated the Tsingtao brand from the masses. While brand sponsorship is relatively easy to do with sufficient marketing budget, on- the-ground promotions require carefully budgeted plan and strong execution capability. In our opinion, the latter needs long time cultivation inside a company, and it seems TB lags behind its competitors.

Changing management and strategy created distraction

Lack of powerful leaders In our opinion, credit of TB’s success in earlier stages should largely go to TB’s two previous leaders, Mr. Peng Zuoyi (President 1996-2001) and Mr. Jin Zhiguo (President 2001-2008 and Chairman 2008-2012). It was Mr. Peng who pushed for the strategy of building up scale through massive acquisitions, and it was Mr. Jin who successfully lifted TB’s price and substantially increased TB’s profitability. In TB, as well as the whole Chinese beer industry, Peng and Jin are widely considered two visionary business leaders.

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Figure 23: TB’s two legendary leaders from 1996 to 2012 Peng Zuoyi Jin Zhiguo Tenure President 1996-2001 President: 2001-2008 Chairman: 2008-2012 Main strategy - Change from “sell where TB is produced” to “produce - Change from “make it big and then strong” to “make it where TB can be sold” strong and then big” - Quickly build up capacity by acquisition in strategic - Focus on integration of acquired breweries, consolidating markets national distribution network and improving profitability Main achievement - Acquired 47 breweries in five years - Turned around multiple acquired loss-making subsidiaries including Shaanxi Hans - Substantially boosted production capacity - Instituted TB’s “1+3” brand strategy, to focus on 1 national brand and 3 regional brands to consolidate resources and improve profitability Financial Results in - Revenue increased 230% (27% CAGR) - Revenue increased three times (16% CAGR) tenure - Volume sales increased 610% (48% CAGR) - Volume increased over two times (11% CAGR) - NP increased 230% (27% CAGR) - Recurring NP increased over 17 times (30% CAGR) Reason for leaving TB - Died of heart attack - Resigned before tenure ended Source: Deutsche Bank

Figure 24 illustrates TB’s two visionary leaders’ praiseworthy contribution to the company. On the negative side, their talent has made TB highly dependent on the top management’s leadership. Unfortunately, both of them left the company abruptly. While TB was lucky enough to find Mr. Jin as the successor for Mr. Peng and extended TB’s glory for another 12 years, Jin’s resignation without warning left TB no time to conduct a proper transition or find a comparable replacement. After 2012, TB’s new management has not demonstrated convincing capability to lead the company fare through hard times.

Inconsistent strategy creates execution risks and resources wastage In TB’s post Jin Zhiguo era, partly due to adverse market environment, TB has not found a consistent and effective strategy. Unlike Peng’s strategy of “keep buying” and Jin’s strategy of “integration”, TB’s strategy from 2012 to 2015 has been constantly changing with no clear commitment to a single strategy. In our opinion, this is not a good sign for a consumer company because it may create a lot of wasted effort by staff on the front desk due to frequently changing direction, as well as frustration and low morale internally.

Figure 24: TB’s corporate and brand strategy 2012-2015 Year Main strategy 2012 - Focus on integration and expansion; carry out the development strategy of dual-drive. Target 10m tons sales volume in 2014. 2013 - Carry out strategy of double-drive, i.e., to keep on expanding the company’s advantages in market competition through the internal growth and external expansion.

2014 - The company adjusted its development strategies to try to improve its product mix while increasing its market share. - The company announced that it would adjust its brand strategy to “1+1+N”, i.e., principal brand, Tsingtao Beer + national secondary brand Laoshan + regional brands. 2015 - Does not seem to have a clear corporate strategy. - Continue to promote the implementation of the branding strategy of “Principal brand Tsingtao Beer + Secondary brand Laoshan Beer to further optimize the brand mix and product mix. Source: Tsingtao Brewery Annual Reports 2012-2015, Deutsche Bank

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Crippled distribution model drags performance

Legacy distribution model hits a wall TB is the first brewer in China to use the “large client” distribution model. The “large client” model means a brewer appoints one large-scale strong distributor in one region as the regional general distributor, who is responsible for the business development in that region such as developing sub- distributors, opening new retail accounts, managing inventory and logistics, etc.

At a certain point in time, this “large client” business model could work well, especially when the market has low penetration, strong demand and small supply. Utilizing this business model will enable a beer brand to quickly penetrate a local market, leveraging general distributors’ network and local connections. In the early 2000’s, the Chinese beer market was exactly this, which explained why this model worked for TB.

However, after the Chinese beer market became more mature, the negatives of the “large client” business model started to emerge, such as the following:

 Inefficient use of marketing budget In a “large client” distribution model, a general distributor usually receives a sizable-volume based rebate from the brewer as part of the subsidy to develop the local market. Occasionally, this rebate can be given in another format such as favorable ex-factory price. However, this kind of rebate or subsidy continues even if the local market is mature. Due to the long-term relationship and sometimes fear of business interruption, brewers tend to keep this cash support, which is no longer used in business development.

 Change of bargaining power at the expense of brand owners At the time when a general distributor is appointed, the brand owner usually holds greater bargaining power as the sales of a new territory are very small and it does not cost much for a brand owner to change a general distributor. While the distributor works hard to expand business, it also gains bargaining power against the brand owner, which makes brand owners not always able to implement their business strategy in the local market when the distributor becomes strong enough, such as new product launch, price adjustment, etc.

 Creating environment for potential wrongdoings Compared with small distributors, monetary incentives that a general distributor can receive are massive and more difficult to measure, making it more tempting for general distributor to exaggerate their actual marketing expenses and ask brand owners to give more financial support. .

Entering the 2010s, the negatives of the “large client” business model started to emerge and TB realized this issue, thus it has turned to be more focused on “deepening distribution management”. However, as legacy general distributors have all grown big and are reluctant to give up their existing territory and benefits, the transition has not been smooth. In 2011, Ms. Yan Xu who was TB’s VP Sales & Marketing and a faithful believer of the “large distributor” model, quit without pre-notice. Some industry commentators believe this signals a big setback of “large distributor” strategy. One year later, TB’s President and Chairman, Mr. Jin, also resigned in the middle of his tenure, and

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some industry consultants believe this shows TB’s business model transition was not going smoothly. In our market visits in the last couple of years, we have heard TB’s continuous push for more flat distribution models in selected markets such as Jiangsu and Sichuan. However, the result is massive market share loss.

New strategic partnership may help, on conditions

One of the reasons for the strong price performance of TB recently is the news that TB’s second largest shareholder, Asahi, is considering disposing its 20% holding in TB. In theory, if Asahi finds a buyer who is willing to pay a premium to take over the 20% stake, the market is likely to respond positively. However, there are still some issues that need to be resolved.

In principal, TB can block any brewers buying from Asahi Asahi acquired 20% of TB’s stake in 2009 and set up a strategic cooperation Without TB’s written agreement with TB. There are certain restrictive clauses regarding the disposal approval, Asahi CANNOT: of TB’s shares by Asahi, stated below: - Dispose TB shares before 27 Aug., 2014 “ undertakes that, unless with the prior written consent of the company: - Dispose TB shares to any (a) Within five years from the date of the Strategic Cooperation Agreement, Asahi beer companies that have Breweries will not, and procure that members of the Asahi Breweries Group will business in China not, sell or dispose in other manners any of the Shares save for transfer of - Dispose TB shares to Shares from Asahi Breweries or its subsidiaries to Asahi Breweries or its wholly- anyone who will hold more owned subsidiaries (depending on the circumstances); and than 20% TB stake after the th (b) After the 5 anniversary from the date of the Strategic Cooperation Agreement, disposal Asahi Breweries can, and can procure that members of the Asahi Breweries Group to sell or dispose any of the Shares except (i) Asahi Breweries or the relevant Asahi Breweries Group member is aware that the assignee will own at least 19.99% in the entire issued share capital of the Company immediately after the proposed sales or disposal; or (ii) at the time of sales or disposal the assignee is directly or indirectly engaged in the manufacture or sale of beer or related business in the PRC or is interested in any such business.

Tsingtao Brewery announcement, 27 August 2009 “

This clause effectively prevented any beer company that has business in China to buy TB stake from Asahi, unless TB approves. In our opinion, TB will leverage this clause to negotiate the best terms for TB if any of the existing brewers want to take over from Asahi – and this is likely to make the negotiation process difficult and lengthy.

TB’s willingness to “cooperate”: a key risk Although TB and Asahi signed the Cooperation Agreement eight years ago, there has not been much real cooperation except for cross-selling each other’s products in different markets. In our opinion, this is also one of the reasons Asahi is considering disposing the stake. TB has been a relatively closed provincial SOE and the company highly respects its legacy, and it is not easy for external parties to exert influence in this entity. Assuming TB, Asahi and a potential buyer finally reach an agreement, and the new buyer becomes TB’s shareholder, it remains a question of how much power TB will give out if the new shareholder controls only 20% of TB. If the new shareholder is an SOE or a Chinese company, TB may be willing to give a little more, but it still will not be much, in our opinion.

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Change of management may be a turning point

TB’s Chairman Sun is approaching retirement age TB’s Chairman, Sun Mingbo Mr. Sun Mingbo took over TB Chairman’s position after Mr. Jin Zhiguo’s is likely to retire in June, in resignation in 2012, and was re-elected Chairman in 2014, with a new tenure our opinion. New Chairman ending June 2017. Mr. Sun is 60 years old this year, which is the legal could be current President, or retirement age in China. Usually, when a senior management of a Chinese SOE someone outside of TB. is approaching his/her retirement age, it is a common practice that he or she will not be elected again. We believe the chance is high that Sun may retire in the Board Meeting in June this year.

One of the most likely successors for Mr. Sun is Mr. Huang Kexing, current President of TB. Mr. Huang joined TB in 1986 right after graduation from Shandong University. Mr. Huang worked in various roles and in particular, spent a lot of time in TB’s M&A and restructuring projects. Although Mr. Huang seems to be a natural choice, we cannot rule out the possibility that TB (or TB’s largest shareholder, City Government) may want to find someone outside of the group.

As discussed previously, TB’s historical performance has been highly reliant on its top management. As TB has been going through a difficult time, TB’s controlling shareholder, Qingdao City Government, may want to bring in some new blood to revive this beer giant. This could be a risky move, but it may work out if a good candidate can be identified.

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Outlook: Three-year EPS CAGR of 10%

Stabilize in 2017, rebound in 2018 Key assumptions for TB 2017: Vol. +2%. ASP +2. Rev. +4% The Chinese beer market had a good start in 2017, based on the feedback GP margin: 36.8% (+25bps) from our market visits, with volume rebounding strongly. Although TB will also Opex: 29.2% (+10bps) face continuous competition from other brands, the volume decline of 5.5% in EBIT margin: 4.2% (flat) 2016 is unlikely to happen again, and losses in some areas should narrow. We forecast TB to stop its declining trend in 2017, with revenue picking up with EBIT: RMB1.2b, +5.2% 4% growth and recurring net profit improving 1%. The margin deterioration in Non-recurring gains: 2017 is a result of a rising raw material price, increasing marketing expenses RMB510m (2016: RMB622m) and higher minority interest after the company fully consolidated a loss- Rep. NP: RMB1.29b (-5.6%) making Suntory JV in . Recur. NP: RMB898m (+1%) Due to a base effect, we forecast TB to report stronger revenue growth in the first half (~5%) than the second half (~3%) this year.

Figure 25: Tsingtao Brewery main changes in P&L, 2016– 2017E Unit 2016E 2017E Change (%) Remarks Volume Million tons 8.01 8.17 +2.0% Industry recovery of 3%, TB below market growth ASP RMB per ton 3,308 3,374 +2.0% 2016 ASP up 1.5%, 2017 ASP growth accelerates Revenue RMB m 26,506 27,577 +4.0% GP margin % 36.5% 36.8% +25 bps Product upgrading, offsetting by rising commodity prices S&D expense ratio % 26.0% 26.2% +20 bps S&D expense ratio up 390bps in 2016, with 360bps expansion in GP margin. We expect GP margin and S&D expense ratio will rise in 2017 but a milder magnitude G&A expenses ratio % 6.0% 6.0% -10 bps EBIT margin % 4.2% 4.2% - Net Interest Income RMB m 267 285 +6.7% Income from asso. RMB m (5) 20 N.A. Gain from disposal of subsidies RMB m 130 - N.A. Other investment gains RMB m 22 0 N.A. Government Subsidies RMB m 494 510 +3.3% Other Non-recurring RMB m (3) 0 N.A. Pretax profit RMB m 1,993 1,968 -1.3% Tax rate % 30% 28% -20 bps Overall tax rate drop due to less loss from some local breweries Net Profit (Incl. MI) RMB m 1,395 1,417 1.6% Minority Interest RMB m 28 128 357.1% Full consolidation of Suntory JV business; lower loss shared by minority shareholders NP Attrib. to Shareholders RMB m 1,367 1,289 -5.6% Reported EPS RMB 1.01 0.95 -5.6% Recurring NP RMB m 886 899 +1.5% Recurring EPS RMB 0.66 0.67 +1.5% Source: Deutsche Bank estimates

We expect TB’s net profit growth to rebound stronger in 2018 to 16% because after the initial rebounding of raw material prices, TB will be able to fully absorb the negative impact by rising prices or changing product mix and thus, continue to expand GP margin, while saving some expenses in S&D. Better performance in regional companies will also lower the overall corporate tax. Also, we will not see a sharp rise of minority interest again in 2018. With all these normalized data, we are forecasting a 3% revenue growth, 13% EBIT growth and 16.7% recurring EPS growth in 2018.

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2016-2019: Revenue CAGR 3.4%, Net Profit CAGR 9.8%

Figure 26: 2016-2019 P&L YE Dec 31 (in RMB m) 2016E 2017E 2018E 2019E Gross Revenue, Company Reported 26,506 27,577 28,410 29,281 Business Tax and Surcharges (1,988) (2,068) (2,131) (2,166) Net Revenue, DB Calculated 24,519 25,509 26,279 26,939 Net revenue growth -4.2% 4.0% 3.0% 3.1% COGS (15,569) (16,134) (16,556) (17,007) Gross Profit 8,949 9,375 9,723 10,096 Selling & Distribution Expenses (6,375) (6,683) (6,833) (7,020) General & Administrative Expenses (1,471) (1,531) (1,577) (1,626) Other incomes and loss on inventory valuation 0 0 0 0 EBIT 1,103 1,161 1,314 1,450 Depreciation (733) (838) (887) (930) Amortisation (199) (216) (215) (215) EBITDA 2,036 2,215 2,417 2,594 Net Interest Income (Expenses) 267 284 315 348 Income from Associated Companies 140 20 20 20 Net non-operating income 490 510 526 542 Pre-Tax Inc. 1,993 1,975 2,174 2,360 Taxes (598) (553) (587) (614) Effective Tax Rate 30.0% 28.0% 27.0% 26.0% Net profit before Minority Interest 1,395 1,422 1,587 1,747 Minority Int. 28 128 143 157 Net Income attributable to shareholders 1,367 1,294 1,444 1,589 NP Growth -20.2% -5.4% 11.7% 10.0% Non-recurring gains (losses) 481 390 402 415 Adjusted Net Profit 886 898 1,037 1,175 Adjusted NP Growth -15.8% 1.9% 15.4% 12.7% Source: Deutsche Bank estimates

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Appendix A Financial Statements

Figure 27: Income Statement

YE Dec 31 (in Rmb m) 2014 2015 2016E 2017E 2018E 2019E Gross Revenue, Company Reported 29049 27635 26506 27577 28410 29268 Business Tax and Surcharges -2183 -2030 -1988 -2068 -2131 -2195 Net Revenue, DB Calculated 26867 25604 24519 25509 26279 27073 COGS -17899 -17192 -15569 -16134 -16556 -16988

Gross Profit 8967 8412 8949 9375 9723 10085 GP Margin(GP/Net Revenue) 33.4% 32.9% 36.5% 36.8% 37.0% 37.3%

Selling & Distribution Expenses -5683 -5905 -6375 -6683 -6833 -7012 General & Administrative Expenses -1362 -1412 -1471 -1531 -1577 -1624 Other incomes and loss on inventory valuation 0 0 0 0 0 0

EBIT 1922 1095 1103 1161 1314 1448 EBIT Margin 6.6% 4.0% 4.2% 4.2% 4.6% 4.9%

EBITDA 2844 2046 2036 2215 2417 2593 EBITDA Margin 9.8% 7.4% 7.7% 8.0% 8.5% 8.9%

Net Interest Income (Expenses) 335 300 267 284 315 348 Income from Associated Companies 24 462 140 20 20 20 Write Back (Write Off) 4 -2 -8 -8 -8 0 Net non-operating income 399 420 490 510 526 541

Pre-Tax Inc. 2683 2275 1993 1967 2166 2358 Taxes -663 -663 -598 -551 -585 -613 Effective Tax Rate 24.7% 29.1% 30.0% 28.0% 27.0% 26.0%

Net profit before Minority Interest 2020 1612 1395 1416 1581 1745 Minority Int. 29 -101 28 127 142 157 Minority Income as % of total net profit -1.5% 6.3% -2.0% -9.0% -9.0% -9.0% 0 Net Income attributable to shareholders 1990 1713 1367 1288 1439 1588 Net Margin 6.9% 6.2% 5.6% 5.1% 5.5% 5.9% EPS, Basic (RMB) 1.47 1.27 1.01 0.95 1.07 1.18 EPS, Diluted (RMB) 1.47 1.27 1.01 0.95 1.07 1.18

Non-recurring item adjustments Non-recurring, sub-total 401.75 868.08 622.37 510.18 525.59 541.46 Share of minority interest -14.86 -18.95 -17.00 -17.86 -18.40 -18.95 Impact on tax -68.20 -188.71 -124.47 -102.04 -105.12 -108.29 Non-recurring, net gain (loss) 318.69 660.42 480.90 390.29 402.08 414.22

Adjusted Net Profit 1671.41 1052.71 886.32 898.16 1036.97 1173.57 Adjusted Net Margin 0.06 0.04 0.04 0.04 0.04 0.04

Adjusted EPS, Basic 1.24 0.78 0.66 0.66 0.77 0.87 Adjusted EPS, Diluted 1.24 0.78 0.66 0.66 0.77 0.87 Source: Deutsche Bank estimates, Company Data

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Figure 28: Balance Sheet

YE Dec 31 (in Rmb m) 2014 2015 2016E 2017E 2018E 2019E Assets Current Assets 0.00 0.00 0.00 0.00 0.00 Cash and cash equivalents 6,389 8,402 8,915 9,802 10,753 11,824 Notes Receivable 42 23 34 34 34 34 Trade receivables 125 118 114 119 122 126 Prepayments 192 44 40 42 43 45 Interest Receivable 172 149 149 149 149 149 Other Receivables 164 201 164 173 181 188 Inventories 2,487 2,182 1,962 2,033 2,087 2,141 Other Current Assets 783 769 769 769 769 769 Total Current Assets 10,352 11,887 12,146 13,120 14,137 15,275

Non-current Assets A-F-S Financial Assets 0 1 1 1 1 1 LT Equity Investment 1,536 1,508 1,508 1,508 1,508 1,508 Investment property 11 26 26 26 26 26 Fixed Assets 9,119 9,897 10,479 11,092 11,620 12,149 Construction in progress 1,052 287 443 395 425 455 Fixed assets clearance 18 7 7 7 7 7 Intangible assets 2,781 2,707 2,508 2,312 2,117 1,923 Goodwill 1,307 1,307 1,307 1,307 1,307 1,307 LT Amortizable Expenses 33 40 42 43 45 47 Deferred tax assets 719 769 769 769 769 769 Others 77 65 65 65 65 65 Total Non-current Assets 16,652 16,613 17,154 17,524 17,889 18,257

Total Assets 27,004 28,501 29,300 30,644 32,026 33,532

Liabilities Current Liabilities ST Loans 433 810 810 810 810 810 Notes Payable 92 100 128 133 136 140 Trade Payable 2,494 2,591 2,346 2,431 2,495 2,560 Advance From Customers 788 1,000 1,343 1,398 1,440 1,483 Salary Payable 867 926 853 884 907 931 Tax Payable 249 262 256 265 272 279 Interest Payable 5 1 1 1 1 1 Dividend payable Other Payables 4,299 4,061 3,839 3,978 4,082 4,189 Current Portion of LT Loans 2 1 1 1 1 1 Total Current Liabilities 9,228 9,753 9,578 9,902 10,145 10,395

Non-Current Liabilities LT Debt 3 2 2 2 2 2 Designated Purpose Payables 325 252 252 252 252 252 Debentures payable Deferred Income 1,511 1,657 1,657 1,657 1,657 1,657 LT Salary Payable 491 538 538 538 538 538 Deferred Tax Liabilities 158 134 134 134 134 134 Total Non-current Liabilities 2,488 2,582 2,582 2,582 2,582 2,582

Total Liabilities 11,717 12,335 12,160 12,484 12,727 12,976

Shareholders' Equities Share Capital 1,351 1,351 1,351 1,351 1,351 1,351 Share Premium Acct. 4,079 4,075 4,075 4,075 4,075 4,075 Other Reserves 1,293 1,486 1,486 1,486 1,486 1,486 Retained Earnings 8,664 9,546 10,492 11,384 12,381 13,480 Minority Int. (100) (292) (264) (137) 6 163 Total Equity 15,287 16,166 17,141 18,160 19,299 20,556

TOTAL 27,004 28,501 29,300 30,644 32,026 33,532 Source: Deutsche Bank estimates, Company Data

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Figure 29: Cash Flow Statement YE Dec 31 (in Rmb m) 2014 2015 2016E 2017E 2018E 2019E

Net Profit 2020 1612 1395 1416 1581 1745 Asset Write Off (back) -4 2 0 0 0 0 Depreciation 731 746 733 838 887 930 Amortization of Intangibles 192 204 199 197 195 193 Amortization of Long Term Expenses 11 15 17 18 19 19 Net Loss (Gain) of Disposal of Non-current Assets 60 102 -6 9 7 7 Net Finance Expenses (Income) -365 -305 0 0 0 0 Investment Loss (Gain) -24 -462 0 0 0 0 Decrease (Increase) of Deferred Tax Assets -19 -50 0 0 0 0 Amortization of Deferred Income -210 -220 0 0 0 0 Increase (Decrease) of Deferred Tax Liabilities -20 -25 0 0 0 0 Operating Cash Flow Before Working Capital Chg. 2372 1619 2338 2478 2689 2894 Change in Inventory 72 293 220 -71 -53 -54 Change in Receivables -286 150 34 -16 -12 -13 Change in Payables -467 513 -169 314 236 242 Net Cash Generated from Operating Activities 1691 2575 2424 2706 2860 3070

Proceeds from Cash Out Investment 0 900 0 0 0 0 Cash Gain from Investment 15 45 0 0 0 0 Proceeds from Disposal of Non-current Assets 6 44 0 0 0 0 Proceeds from Disposal of Subsidiaries 0 460 0 0 0 0 Cash Received from Other Investment Activities 1026 965 0 0 0 0 Cash Inflow from Investment Activities 1048 2413 0 0 0 0 Purchase of Non-current Assets -1949 -1314 -1490 -1423 -1466 -1510 Purchase of Investment -246 -1212 0 0 0 0 Cash Paid to Acquire Subsidiaries -175 -100 Cash Paid to Other Investment Activities -37 -24 Cash Outflow to Investment Activities -2407 -2650 -1490 -1423 -1466 -1510 Net Cash Used in Investment Activities -1360 -237 -1490 -1423 -1466 -1510

Free Cash Flow -434 1160 934 1283 1394 1559

Borrowing from Banks 335 686 0 0 0 0 Cash received from bond issurance 0 0 0 0 0 0 Cash received from investment 0 0 0 0 0 0 Cash Received from Other Financing Activities 0 304 0 0 0 0 Cash Inflow from Financing Activities 335 990 0 0 0 0 Repayment of Bank Loans -1813 -329 0 0 0 0 Dividend Paid -686 -691 -420 -396 -443 -488 Cash Paid to Other Financing Activities -292 -1 Cash Outflow to Financing Activities -2790 -1020 -420 -396 -443 -488 Net Cash Generated (Used) in Financing Activities -2455 -31 -420 -396 -443 -488

Forex Adjustment -5 2 0 0 0 0 Net Change in Cash & Cash Equivalent -2129 2309 513 887 952 1071 Source: Deutsche Bank estimates, Company Data

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Management background

Figure 30: Tsingtao Brewery senior management background Name Age Position Background Sun Ming B 59 Chairman EMBA at Fudan University — Washington University, Doctor of Management Science and Engineering at Tongji University and applied researcher of engineering series. He is currently 孙明波 Executive Director Chairman of the Company, Chairman and CEO of Tsingtao Group and served as Deputy Factory Manager and Chief Engineer of Tsingtao Brewery No. 1 Factory, Assistant to General Manager & Vice Chief Engineer, Executive Vice President, President of Marketing Center and President of the Company with substantial experience in management of strategy, marketing, production technology, merger and acquisition and re-organization. He is Top Talent in Professional Technologies in Qingdao and an expert with special allowance from the State Council. Mr. Sun is the representative of the Twelfth National People’s Congress. Huang Ke Xing 53 President EMBA at Guanghua School of Management of Peking University, Senior Engineer. He is currently Executive Director and President of the Company and Director of Tsingtao Group and served as 黄克兴 Executive Director General Manager of Tsingtao Brewery Engineering Company Limited, Assistant to President & Head of Strategic Investment Management Department and Vice President of the Company, and Vice President of Tsingtao Group with substantial experience in strategic planning, investment management and operating management of beer industry. Mr. HUANG is a member of the Eleventh Shandong Committee of Chinese People’s Political Consultative Conference. Yu Zhu Ming 54 CFO EMBA at Dongbei University of Finance & Economics, Senior Accountant. He is currently Executive Director and CFO of the Company and served as Head of Finance Section of Tsingtao Brewery No. 4 于竹明 Executive Director Factory, Head of Finance Department, Assistant to President and Chief Account of the Company with substantial experience in finance management and capital operation. He was awarded many prizes including: Outstanding Accountant in Shandong Province in 2008 and Outstanding Accountant in Qingdao in 2009. Wei Fan 57 Vice President Mr. Wei Fan serves as the President of Manufacturing Center and Vice President of Tsingtao Brewery Company Limited and has been its Executive Director since 16 June 2016. Mr. Fan served 樊伟 Executive Directors as Chief Brewer of Tsingtao Brewery Company Limited until 23 October 2007. He served as Deputy General Manager and Chief Engineer of Tsingtao Brewery Factory No. 2. He served as Chief Engineer of Tsingtao Brewery Company Limited. He is a Senior Engineer and has rich experience in production, scientific research and technical management in a brewery with the title of Applicable Researcher of Engineering. Mr. FAN graduated with a Master's Degree from Southern Yangtze University. Source: Company data, Deutsche Bank

Corporate structure

Figure 31: Corporate structure

QingdaoCity Government

100

TsingtaoBrewery Asahi Other shareholders Group Co. Ltd

30.83 19.99 49.18

Tsingtao Brewery Co. Ltd

Source: Deutsche Bank

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Appendix 1

Important Disclosures

*Other information available upon request

Disclosure checklist Company Ticker Recent price* Disclosure Tsingtao Brewery-H 0168.HK 35.10 (HKD) 1 Mar 17 NA Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/Disclosure.eqsr?ricCode=0168.HK

Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Charlie Chen

Historical recommendations and target price: Tsingtao Brewery-H (0168.HK) (as of 3/1/2017)

60.00 Previous Recommendations

Strong Buy 1 50.00 Buy Market Perform Underperform Not Rated 40.00 2 Suspended Rating 4 3 Current Recommendations 30.00 Buy

Hold Security PriceSecurity 20.00 Sell Not Rated Suspended Rating

10.00 *New Recommendation Structure as of September 9,2002

**Analyst is no longer at Deutsche 0.00 Bank

Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Dec 16 Date

1. 12/05/2015: Hold, Target Price Change HKD55.00 Winnie Mak** 3. 11/02/2016: Hold, Target Price Change HKD31.50 Winnie Mak** 2. 16/09/2015: Hold, Target Price Change HKD36.00 Winnie Mak** 4. 07/03/2016: No Recommendation, Target Price Change HKD0.00 Anne Ling

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Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total 500 54 % share-holder return (TSR = percentage change in 450 share price from current price to projected target price 400 350 36 % plus pro-jected dividend yield ) , we recommend that 300 investors buy the stock. 250 200 Sell: Based on a current 12-month view of total share- 150 18 % 10 % 100 18 % 19 % holder return, we recommend that investors sell the 50 stock 0 Buy Hold Sell Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not Companies Covered Cos. w/ Banking Relationship recommend either a Buy or Sell. Asia-Pacific Universe Newly issued research recommendations and target

prices supersede previously published research.

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Additional Information

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