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Deutsche Bank Markets Research Asia Industry Date China 2 March 2017 Consumer China Consumer Initiation of Coverage Charlie Chen Research Analyst Dawn of a new golden age (+852 ) 2203 6178 [email protected] Positive view on Chinese brewers at the beginning of a recovery Key Changes We believe that Chinese brewers are at the beginning of a multi-year period of Company Target Price Rating profit growth, and CR Beer is our preferred pick. Since the last upcycle that 0291.HK 21.05 Buy ended in 2008, Chinese brewers have been struggling with excess capacity, 600600.SS 24.21 Sell falling demand, and weak profitability. Having experienced ineffective intense 0168.HK 27.22 Sell price competition after the GFC, starting in 2014, brewers have changed their strategy toward driving profitability instead of volume. Given higher market Source: Deutsche Bank concentration, we expect competition to be more rational, and combined with Top picks a premiumization of consumer taste, we forecast rising trends in margins and China Resources Beer Buy cash flow over the next five years. (0291.HK),HKD17.70 Driver 1: Sustainable secular ASP growth lifts profitability Source: Deutsche Bank Despite an expected muted volume CAGR of 1.9% for the next five years, we Companies Featured forecast an average net profit CAGR of 10% for Tsingtao Brewery (TB) and China Resources Beer Buy 18.7% for CR Beer, driven by secular ASP posting a 3% CAGR and further (0291.HK),HKD17.70 leverage on economies of scale. This ASP growth will likely be driven by Tsingtao Brewery-A Sell product mix change toward premium and specialty products, as well as (600600.SS),CNY33.31 continued shifts in product packaging to smaller but more expensive SKUs. Tsingtao Brewery-H (0168.HK),HKD35.10 Sell Driver 2: Consolidation opportunities Source: Deutsche Bank In addition, we believe that large-scale M&A is likely to materialize in the next three years, which also offers investment opportunities. While we suggest that investors take long positions on high-quality brewers such as CRB, investors could also trade around M&A news to take short-term returns. Going long on long-term winner CRB We believe that the large national players are better positioned to benefit from this secular uptrend. CRB stands out, with the largest market share and proven execution capability. We forecast its net profit to post a 22% 2016-2019 CAGR, driven by a 7.1% revenue CAGR and net margin expansion from 6.2% to 8.9%. We have a Buy rating on CRB and a Sell rating on TB We initiate coverage of CRB with a Buy rating and TB with a Sell recommendation on both A- and H-listed shares. CRB is currently trading at 23x FY17E P/E, with a stronger growth outlook and better execution capability, while TB is trading at 33x FY17E P/E (48x if we strip out subsidies). We believe that CRB is undervalued, as the market underestimates the strength of the recovery in the Chinese beer market and the competitive advantages of CRB. In our view, TB is overvalued given its lower growth profile, and recent M&A scenarios have further inflated valuation. Based on DCF valuation, we derive our target price of HKD21.05 for CRB (8.9% WACC, 2% terminal growth) and HKD27.22 for TB-H (RMB24.22 for TB-A, both 8.8% WACC, 2% terminal growth). Main downside risk for CRB is raw material prices rising too quickly hurting its margins, and main upside risk for TB is potential investor buying 20% shareholding in TB from Asahi at premium to current market price. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong 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. Distributed on: 01/03/2017 23:55:29 GMT 2 March 2017 Consumer China Consumer Investment summary A good time to buy to benefit from a turnaround We believe we are at the beginning of a new bull market for the Chinese beer industry and suggest that investors buy high-quality brewers, benefiting from the coming recovery cycle. In our opinion, beer industry profitability will grow strongly, driven by revenue growth (~5% CAGR for the industry) and margin expansion. In particular, we forecast China Resources Beer (CRB) and Tsingtao Brewery (TB) to deliver 22% and 9.8% adjusted net profit CAGRs in 2016-2019. The Chinese beer market hit a temporary setback in 2013-2016, after per capita consumption peaked in 2013 at 37.2 liters (33% above the global average). Total market volume dropped 7% in three years, which was caused by multiple factors, including a surge in imported products, short-lived but explosive performance of pre-mixed cocktails, and overall de-stocking in an economic downturn. As these factors are fading out, we believe that a strong recovery of the Chinese beer market is just ahead of us. We prefer large players; focus on profitability improvement As the Chinese beer market becomes more product and brand driven, the gap between large, national players and their followers is likely to widen, as large players with national coverage can leverage their strengths in media coverage, distribution network, and product innovation. There are three brewers in China with over 15% market share, i.e., CRB, TB, and ABInBev. We like CRB the best out of the two Hong Kong-/China-listed companies for its better upside potential in ASP increase and cost saving and its superior management team. Further consolidation likely We believe large brewers in China, in particular CRB, are seeking acquisition targets in both domestic and international markets. In our previous discussion, some SOE breweries in China have good brands and good balance sheets but are experiencing margin deterioration due to poor management. While we like CRB, we believe smaller players such as Yanjing may be further marginalized. Consolidation in the Chinese beer market seems unavoidable, and we see a high chance that the current Big 5 may eventually become a Big 3. High earnings growth for CRB (Buy), TB overvalued (Sell) We rate CRB as Buy and TB as Sell. CRB should benefit from overall market recovery and margin improvement, with its relentless efforts on product upgrading and optimizing operations. We forecast a 7% revenue CAGR and a 22% net profit CAGR in 2016-2019 for CRB, barring any potential acquisition. We use DCF valuation to derive a target price of HKD21.05 for CRB. TB’s share price has been inflated by recent news that Asahi may consider disposing its 20% stake in TB. While we believe it is unlikely that TB could reach any meaningful cooperation agreement with the new buyer, TB’s market share loss trend will not likely change in the near term. Our DCF model suggests a target price of HKD27.22 for TB-H shares (RMB24.22 for TB-A shares). Page 2 Deutsche Bank AG/Hong Kong 2 March 2017 Consumer China Consumer Vol.:1.9% 2016-2020 CAGR Penetration almost hitting a ceiling A mature market with high penetration per capita The Chinese beer market has developed from almost zero in 1980 (well below Useful conversion rates: 1m tons) to a mature market with nearly 50m tons these days, driven mainly 1 ton/1,000 liters/10 HL by penetration (per capita consumption). In 2015, each Chinese person on = 126 24x12 fl. oz. case average consumed 35 liters of beer (or just a little more than 100 standard = 8.52 US beer barrels (bbl) 330ml/12oz bottles). Although this amount is still far below some developed markets such as North America and Western Europe, it is already higher than the global average and other nearby markets such as Hong Kong and Taiwan. Considering Chinese consumers also drink a significant amount of other alcoholic beverages (mainly Chinese baijiu, a kind of hard liquor), the 35-liter average reflects a highly developed market by volume, in our opinion. Figure 1: Total beer consumption in Figure 2: Per capita consumption of Figure 3: Per capita consumption of million tons in China, 2001-2020E beer in China in liters, 2001-2020E beer in liters in main markets, 2015 million tons liter liter 60 40 37.4 37.0 90 50.6 52.0 34.7 80 47.4 35 50 45.4 70 30 60 50 40 35.2 25 40 26.3 30 30 20 17.9 22.7 20 10 20 15 0 10 10 5 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2016E 2017E 2018E 2019E 2020E Source: Euromonitor; Deutsche Bank Source: Euromonitor; Deutsche Bank Source: Euromonitor; Deutsche Bank On-trade highly penetrated, limited upside potential for off-trade A somewhat surprising finding is that, on average, a Chinese person drinks An average Chinese person almost as much beer as an American consumer in on-trade channels (18 liters already drinks almost as vs. 20 liters in 2015), which suggests that the volume potential for beer in on- much beer as a US consumer trade channels is limited. Although the off-trade channel seems more in on-trade channels promising, we believe that this off-trade upside may be difficult to achieve due to drinking habits (mostly dominated by Chinese baijiu).

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