Hong Kong Equity | Consumer Goods Company in-depth

Budweiser APAC 百威亚太 (1876 HK) ACCUMULATE

People still Share Price Target Price APAC is the Asia subsidiary of the world’s largest company AB HK$27.0 HK$23.5 InBev. Their market leading position, specifically in premium category has been targeting consumers with a desire to trade up in ongoing premiumization trend. Within their portfolio, Budweiser and have strong brand equity globally China / Consumer Goods/ F&B and are appealing more to Asian consumers searching for higher quality . China is the most important market and the company has a 46.6% market share in 14 February 2020 premium category. But recent outbreak of coronavirus poses sudden and radical challenges. We initiate coverage with HK$27.0 TP, with 15% upside. Matthew Law (SFC CE:BDJ462)  Market leader in China’s premium beers. China drank 488m HL of beer in 2018, making (852) 3519 1299 it the world’s largest market, accounting for 25% of world’s beer consumption. Chinese [email protected] consumers drink 35L per capita vs 60L+ in mature markets, showing great growth potential. The company covers value to super premium beers, allowing them to raise consumer awareness of higher quality beers while also capturing the lower end market. Latest Key Data Total shares outstanding (mn) 13,243  World class beer portfolio. AB InBev owns 50 world famous beers including Budweiser, Market capitalization (HK$mn) 311,220 , Corona and Hoegaarden. The company was ranked first in beer value with Enterprise value (HK$mn) 309,530 footprint in all major markets. They target higher-end consumers as they create high 12M daily average turnover (HK$mn) 499.6 quality beers with their long history in brewing lagers and wheat beers. 12M volatility (%) 20.9 PEG FY19-21E (X) 2.0  Premiumization driving catalyst for growth. The APAC markets are less mature RoE avg FY19-21E (%) 10.0 compared to US and Brazil. This offers great potential as consumers with growing P/B FY19E (x) 3.8 Net debt/equity FY18E (%) net cash disposable income trade up for better beers. Asian countries have a lower consumption

per capita, which has allowed premiumization to offset declining volumes. China offers most upside in premiumization with the highest premium multiple in APAC. Performance (%) 1M YTD 12M  Coronavirus outbreak will hurt sales. Since the coronavirus outbreak in Dec, clubs, bars Absolute (4) (11) (17) and restaurants have been shutting down rapidly across China. This is very impactful on Relative to HSI 0 (9) (23) the company’s sales as China is their largest contributor. Budweiser’s brewery in Wuhan has been shut down as the city has been sealed off while other parts have been dead silent. Beer sales in shops and supermarkets were not as badly affected. Major Shareholders (%) AB InBev 88.7  Challenging environment in Asia. Company does not have a meaningful presence in Vietnam and would need to acquire a local brand to break into the market. ’s challenge is slow bureaucracy with licensing troubles and irregular taxation. Combined Auditor with China’s recent coronavirus outbreak, which is the company’s largest market, our PricewaterhouseCoopers outlook for Asia is challenging for 2020 as consumers are unlikely to go out.  Initiate with ACCUMULATE. Share price has been on a decline since its IPO, as its Price Chart valuation was quite demanding given the growth, but we believe 2020 will be a time for Turnover (HK$mn) Price (HK$) company to focus on its operations with lower interest costs and no more listing expenses to hold them back. We value the company using a 10-year DCF model with TP HK$27.0, implying 15% upside, 29.3x FY20E PE and 3.4x FY20E PB. Investment Summary FY-end Dec 2017 2018 2019E 2020E 2021E Turnover (US$ mn) 6,099 6,740 6,669 7,258 8,007 Chg (%) - 10.5 (1.1) 8.8 10.3 Net Profit (US$ mn) 572 959 1,083 1,356 1,588 Chg (%) - 67.7 12.9 25.4 17.1 EPS (US$) 0.043 0.072 0.082 0.102 0.120 Chg (%) - 67.7 12.9 25.4 17.1 P/E (x) 69.4 41.4 36.6 29.3 25.0 P/B (x) 3.8 3.9 3.8 3.4 3.0 Source: Bloomberg, Orient Securities () P/OCF (x) 29.8 23.6 24.8 17.4 16.4 EV/EBITDA (x) 25.0 20.6 19.3 17.7 15.6 Source: Company data, Orient Securities (Hong Kong)

Orient Securities (Hong Kong) Limited Please read the analyst certification, company disclosure and disclaimer in the last page 1

Hong Kong Equity | China Consumer Goods Company in-depth

World’s largest beer consumption region with rising income Figure 1: Global beer volume growth (mm HL) APAC is the world’s largest beer consumption region 2,500 APAC is the world’s largest beer consumption region, accounting for 37% of global beer 63 71 consumption in 2018 and is expected to contribute 47% of the incremental growth in 2,000 beer consumption volume from 2018 to 2023. In APAC, beer comprises the largest 1,500 volume amongst alcohol and is expected to remain stable over 2018 to 2023. 47% Combined with a 4.2 billion population, Asia’s demographic is continuously more 1,000 1,979 contribution of 2,113 incremental growth favorable with increasing urbanization and spending power. China’s urban population has 500 grown at 2.6% CAGR over 2013-2018 with urban disposable income three times greater

0 than rural population, showing strong potential for consumption growth. 2018 APAC ROW 2023E Figure 2: China’s disposable income per capita (urban vs rural) Source: Company Data, Orient Securities (Hong Kong) (RMB) Urban Rural Urban (YoY) Rural (YoY) 45,000 42,359 12% 39,251 40,000 36,396 11% Figure 3: Global beer volume by region 33,616 35,000 (2018) 31,194 28,843 APAC (ex- 30,000 26,467 10% China), 12.1% 25,000 , 9% North 25.2% 20,000 15,929 America, 14,617 13,432 12.9% 15,000 12,363 8% 10,489 11,422 9,430 10,000 7% 5,000

Others, China, 0 6% 24.9% 25.0% 2013 2014 2015 2016 2017 2018 2019 Source: Wind, Orient Securities (Hong Kong)

Source: Company Data, Orient Securities (Hong Kong) Figure 4: China alcohol market share China’s beer market has shifted from highly fragmented to mostly consolidated (2018) In mature markets such as US and Mexico, market share is dominated by one or two Wine, brands, while less mature markets like India will have many brands splitting up market 3.7% share. In China, the top 5 breweries make up 70% of market up with Budweiser’s Harbin

Spirits, ranked third (16.2%) behind CR’s (23.2%) and Tsingtao (16.4%). From 2013 to 2018, 24.6% the company gained the most market share amongst the top three with 3.3%.

Figure 5: Most popular beers in Asia, EU and NA (red line denotes company owned) Beer, 71.7%

Source: Company Data, Orient Securities (Hong Kong)

Figure 6: China’s urban population growth vs urban population as % of total population 8% Urban population YoY growth 80%

7% Urban population % of total 70% population (RHS) 6% 60%

5% 50%

4% 40%

3% 30%

2% 20%

1% 10% 0% 0%

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1960 Source: Company data, Orient Securities (Hong Kong) Source: World Bank, Orient Securities (Hong Kong)

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APAC consumption per capita shows high potential for growth

Figure 7: China’s beer market size Chinese consumers continuously trading up in ongoing premiumization trend Total mm HL US$ bn China’s beer market has historically been a high volume market with less focus on value 2013 539 70.3 growth. Challenges in establishing national distribution coverage due to poor 2018 488 81.8 connectivity especially away from large city centers has created a market with large

2023E 511 102.9 number of breweries. But now as consumers’ taste change, searching for better quality, Premium & the market has opened up opportunities for imported beers and craft beers. super premium mm HL US$ bn China’s beer market volume is 488 million HL in 2018, making it the largest market 2013 59 23.7 globally, accounting for 25% share of global beer volume. It is also the largest beer 2018 80 41.8 market in the region, accounting for 66% of volume and 41% of value. Despite its massive 2023E 102 62.7 size, China’s PCC is relatively low at 35L per capita, showing great potential for beer

Source: Company Data, Orient Securities (Hong Kong) consumption growth. Macro drivers include reduction in sales tax from 17% in 2017 to 13% in 2019 and growth from lessor developed inland regions.

Figure 8: Per capita consumption vs. GDP per capita for APAC beer markets (Budweiser target markets highlighted yellow)

80 Mexico Australia 70 Mature Markets US New Zealand Brazi 60 l

Vietnam 50 Japan Mid to High Maturity Markets

40 South Korea China 30 Hong Kong Taiwan Philippines Beer per capita (L/year) capita per Beer 20

10 Malaysia Low Maturity Markets India Indonesia 0 0 10 20 30 40 50 60 70 GDP per capita (US$'000)

Source: Company data, Orient Securities (Hong Kong) Overall beer per capita consumption (PCC) in Asia is significantly lower than their global Figure 9: China premium and super peers (Mexico at 74L, US at 71L, Brazil at 60L), giving significant potential room for premium market share by volume (2018) growth in the Asia markets (China 35L).

Company using value over volume to gain market share from competition Others, 21.7% Company, 46.6% China’s beer market has shifted from being highly fragmented to largely consolidated. The top 5 brewers account for 70% of market share by volume, this consolidation was Heineken, 1.7% mainly achieved through acquisition of small local breweries. Although CR Snow and Carlsberg, Tsingtao lead in volume market share, the company is market leader on a value basis, 4.6% driven by Budweiser at number one and Harbin at number four. For premium and super CR Snow, 11.0% premium beers, the company has massive market share of 46.6%, gaining over 6% market share in 5 years to 2018, driven by iconic brands like Budweiser, Stella Artois, Tsingtao, 14.4% Corona and Hoegaarden.

Source: Company Data, Orient Securities (Hong Kong)

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Lagers remain biggest category of beer but growth is poor

Light beers dominant the market but have little growth upside

Lagers continues to be the leading style of beer in Chinese market but new styles like

Figure 10: Lager prices in China dark beers, wheat beers and craft beers are gaining popularity. This new consumption Price trend mainly led by changing consumer tastes and drinking habits and increasing Company Beer (RMB) urbanization and growing spending, resulting in consumer openness to try more varieties and willingness to pay more. Budweiser Harbin ICE 1.7 Harbin King Figure 11: Diverse product portfolio allows targeting different types of consumers Budweiser of Wheat 2.5 Harbin Budweiser Crystal 3.7 China Resources Snow 2.6 China Resources Snow 9° 2.2

Tsingtao Tsingtao 4.0

Tsingtao Augerta 5.2

Yanjing Yanjing 11° 2.5 Carlsberg

Carlsberg Light 4.0 Source: Company Data, Orient Securities (Hong Kong) Heineken Heineken 4.8 Easy drinking beer category is especially important in APAC as beer consumption is Source: JD.com, Orient Securities (Hong Kong)

closely associated with meal occasions in China and South Korea (highlighted red in

Fig.10). The portfolio is targeted specifically to increase market share within this category

while utilizing imported brands to target consumers willing to trade up.

Figure 12: Sales value of by category (US$ m) 2013 2017 2018 2022E 2013-17CA GR 2018-22CAGR Dark beer 478 2,944 3,897 10,052 57.6% 26.7% Lager 65,365 79,584 84,522 106,491 5.0% 5.9% Standard Lager 65,215 49,405 84,344 106,316 (6.7%) 6.0% Premium lager 10,934 23,190 25,994 39,745 20.7% 11.2% Domestic premium lager 8,802 16,842 18,580 27,081 17.6% 9.9% Imported premium lager 2,133 6,348 7,414 12,645 31.4% 14.3% Mid-priced lager 17,813 25,169 27,626 38,804 9.0% 8.9% Economy lager 36,468 31,047 30,725 27,767 (3.9%) (2.5%) Stout 412 2,114 2,585 4,950 50.5% 17.6%

Source: Euromonitor, Orient Securities (Hong Kong)

Shift in consumer taste driving demand for more flavored and stronger tasting beers

Beer industry is shifting focus from gaining market share to providing consumers with better quality products. Premium and super premium beers have become growth engines from 2013 to 2018 and 2018 to 2023, outperforming overall beer market. Premium and super premium beers have also been more resilient to the economic slowdown as consumers seek out products that offer more flavor, strength and variety.

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Targeting mid-income 30-39 demographic willing to trade up

Chinese consumers have been drinking less beer but more expensive beer

Sales of beer in China by volume have been on a decline since 2013 as Chinese Figure 13: Budweiser beer portfolio consumers strive for healthier lifestyle. Economy lagers have seen decline since 2013 and prices in China by category Price is expected to continue to decline beyond 2022. However beer sales value has increased Category Beer (RMB) as consumers choose to drink less but purchase better quality beer. Chinese consumers Core Harbin ICE 1.7 are increasingly searching for mid-price to premium lagers, imported beers and dark

Harbin King beers. In the trend of premiumization, Chinese beer drinkers with high household 2.5 of Wheat Core+ incomes are more likely to have tried different types of wheat and craft beers and liked Harbin 3.5 them, giving companies a demographic of young, middle income consumers to target. Crystal

Budweiser 5.0 Premium A Lancet report has shown that China’s alcohol consumption has been on a rapid rise, Boxing Cat 6.5 due to change in Chinese from previously associated with social 6.0 occasions or business dinners to now associated with personal occasions to relax and Franziskaner 6.2 have fun. China’s alcohol consumption per capita is predicted to exceed the US by 2030 Super Corona 6.6 with 77% of people expected to drink alcohol at least occasionally. Behind this increase in premium Stella Artois 7.4 consumption is driven by core group of 30-39 age demographic that is open minded in Hoegaarden 7.7 Goose Island 11.2 trying new flavors with demand for quality products. Source: JD.com, Orient Securities (Hong Kong) Figure 14: Company’s portfolio heavily targets premium and super premium markets

Figure 15: China’s premium and super premium market share by volume 2013 2018 Company 40.2% 46.6%

Tsingtao 16.1% 14.4%

CR Snow 13.0% 11.0% Carlsberg 4.9% 4.6% Heineken 1.7% 1.7%

Others 24.1% 21.7%

Source: Company Data, Orient Securities (Hong Kong)

Source: Company Data, Orient Securities (Hong Kong)

Ages 30-39 demographic: main group of consumers leading trade up in beers Imported beers are seen as high quality and this generation of beer consumers’ demand Figure 16: China’s population pyramid for a product is better quality, value and service, which has caused an increase in Chinese (2020) consumer taste for imported brands with a desire to trade up. While young people (aged 90+ Female Year (2020) 18-29) drink the most alcohol with highest frequency, it’s the older 30-39 group that has 80-84 Male the spending power and preference for higher quality alcohol. Currently, the 30-39 age 70-74 60-64 group represents the biggest population in 2020 at 118m, up from 101m in 2015. This 50-54 number is expected to remain at 118m level through 2025. 40-44 30-34 The premium multiple in China is also significantly higher than other countries with super 20-24 premium nearly 11.6x value beer compared to only 6.1x in India. Premium beer has 10-14 grown as proportion of total beers consumed, from 10.9% in 2013 to 16.4% in 2018 with 0-4 the trend targeting 19.9% by 2023. There remains a lot of room to grow as mature Source: Worldometers, Orient Securities (Hong Kong) markets like US have representation of 42.1% for premium beers.

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Hong Kong Equity | China Consumer Goods Company in-depth

Craft beers is small but demand is booming in China

Figure 17: Number of new craft

breweries openings in China Nascent craft beers showing great potential amongst younger consumers 35 Craft beer has been steadily gaining popularity in China, mostly in tier one cities around

30 Beijing, and . It is becoming more popular with younger consumers and

25 penetrating into new markets in tier two cities like Hangzhou, Wuhan and Xi’an.

Budweiser acquired Boxing Cat in 2017, a local brewery from Shanghai. They are also 20 actively promoting their Goose Island brand beers in upscale metropolitan outlets and 15 have opened a brewery in Wuhan to produce beers for Boxing Cat, Kaiba and Goose 10 Island brands beers. The acquisition of Boxing Cat is important, as Chinese consumers

5 still prefer domestically made beers and Boxing Cat has shown they’re able to make high

0 quality craft beers. As shown by the company’s dominant market share in premium and 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 super premium category, craft beer’s highest premium multiple to regular beers is one of Source: Ratebeer, Orient Securities (Hong Kong) the main driving forces and the company intends to expand their footprint in this area.

Figure 18: Company’s acquisitions of craft breweries in last 10 years has accelerated to be ahead of the trend

Source: Company Data, Orient Securities (Hong Kong) Craft beer market only accounts for 0.1% of China’s beer market Craft beer currently accounts for a tiny portion of the market with 0.1%, but is seeing Figure 19: Goose Island beer selection and prices triple digit growth in Beijing, Shanghai and Shenzhen and high double digit growth overall. The growth is driven by imported and domestic brands with breweries and brewpubs being an important channel for this niche market. Consumers continuously favor quieter bar scenes over traditional loud clubs, driving on-trade consumption of craft beers as accompaniment to their western food meals.

Goose Island is considered one of the world’s best craft brewers Craft beers are considered artisanal products, utilizing the best ingredients available locally and hand crafted for best quality. Therefore, prices of craft beers are the most

expensive in the super premium category. Goose Island’s largest production beer is its Source: JD.com, Orient Securities (Hong Kong) Goose Island IPA, which is sold at RMB11. Compared to regular lagers, Goose Island IPA is

stronger in flavor, more fragrant, having pronounced freshness, better mouth feel and offers more citrus and tropical fruit flavors. Drinkers have noted an explosive aroma when opened that stimulates taste buds. Goose Island prices are between RMB10-17, making this category a must pay attention to area in driving potential future growth.

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Imported brands lead growth and on-trade drinking on the rise

Consumers drink premium beers through on-trade channels Figure 20: Imported quantity vs domestic beer production YoY in China As China’s consumption of beer has declined, so has domestic production, posting (12 month moving average) negative growth since 2014. Imported beers have also suffered from triple digit growths Imported in 2014 to seeing a decline since 2018. However China’s beer export continues to rise, value 100% Imported indicating that the decline is strictly a factor coming from the domestic consumer. quantity 80% Domestic production Figure 21: Beer sales value growth by on-trade/off-trade 60% Category On-trade/Off-trade 2013-17 CAGR 2018-22 CAGR On-trade 7.2 8.0 Beer 40% Off-trade 4.7 6.4 On-trade 57.6 26.3 20% Dark Beer Off-trade 57.6 28.4 On-trade 5.6 6.3 0% Lager

Off-trade 3.9 5.3

Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-10 On-trade 4.2 (0.7) -20% Flavored lager Off-trade 5.0 (0.2) Source: Wind, Orient Securities (Hong Kong) On-trade 20.6 11.5 Premium lager Off-trade 20.9 10.5 Domestic On-trade 17.5 10.1 Figure 22: China’s beer export YoY (12 premium lager Off-trade 17.8 9.5 month moving average) Imported On-trade 28.6 14.2 30% premium lager Off-trade 49.9 15.0 On-trade 9.4 8.9 25% Mid-priced lager Off-trade 8.2 8.9 20% On-trade (4.1) (3.2) Economy lager 15% Off-trade (3.7) (1.5) 10% Non-alcoholic On-trade (0.2) (1.8) 5% beer Off-trade 0.0 (1.0) On-trade 48.6 17.3 0% Stout Off-trade 59.6 18.8

-5%

Jul-13 Source: Euromonitor, Orient Securities (Hong Kong)

Jan-10 Jan-17

Jun-16

Oct-11 Oct-18

Apr-15

Feb-14 Sep-14

Dec-12

Aug-10 Aug-17

Nov-15

Mar-11 Mar-18

May-12 May-19 -10%

-15% Nowadays, beer consumers want a better experience and have shown a growing desire -20% for stronger tasting beers such as dark beers and premium lagers. Consumers who trade Source: Wind, Orient Securities (Hong Kong) up tend to go out more to restaurants and bars to drink as shown by higher on-trade growth in more expensive categories. On-trade remains the main channel for beer consumption at 68%, but on-trade for premium beers is even higher at 71%.

On-trade and e-commerce channels gaining popularity Figure 23: Beer consumption in China Due to higher cost of entry compared to off-trade channels, on-trade channels provide by location (mm HL) Value and higher average selling price and profitability. On-trade channels are highly relevant for mainstream On-trade Off-trade premium and super premium beers as the majority are consumed on-trade. Value and 2013 208.7 271.7 mainstream beers are still largely consumed on-trade, but their growth has been poor

2018 175.6 232.6 compared to premium and super premium beers. Off-trade channels are much more competitive with lower margins but allow wider coverage of consumers. E-commerce is 2023E 169.4 240.1 Premium & the fastest growing off-trade channel, as consumers prefer the ease of purchase and super access to more choices online. premium On-trade Off-trade

2013 43.5 15.5 Figure 24: Channel distribution for beers in China Channel 2013 2014 2015 2016 2017 2018 64.5 15.8 Grocery retailers 99.0 98.0 96.6 95.3 94.4 2023E 83.5 18.5 Hypermarkets 10.0 11.0 11.1 11.3 11.1

Source: Company Data, Orient Securities (Hong Kong) Supermarkets 33.5 34.0 34.3 35.1 35.3 Small grocery retailers 46.9 46.4 44.7 42.5 41.8 E-commerce 1.0 2.0 3.4 4.7 5.6

Source: Euromonitor, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Korean domestic beers losing market share to imported brands

Dominant market share in Korea beer market Figure 25: South Korea alcohol market Compared to China’s alcohol market that is dominated by beer, Korea’s market is more share (2018) spirits heavy but majority of alcohol consumption is still beer. There are two main Wine, 1.2% companies supplying beer, Hite-Jinro and Oriental Brewery (OB), the latter of which is

Beer, owned by the company. OB is the clear market leader with 60% market share, and has 56.1% grown its market share by 3.4pp from 2013-2018 thanks to strong brand equity, while its main competitor Hite has lost 18% market share to new entrants such as Lotte, Heineken Spirits, 42.6% and Asahi during the same period.

As Korean regulations for beer have a much lower requirement for malts, many brewers

Source: Company Data, Orient Securities (Hong Kong) use less than 10% malt by substituting with rice and corn in their beers to save cost. Despite consumers change in taste and demand for better quality beers, domestic brewers have stuck with their existing style and kept a low malt percentage, creating a Figure 26: South Korea beer market void that was filled quickly by imported brands as shown by their market share loss. share by volume (2018) Others, Asahi, 10.7% Figure 27: South Korea beer market by volume (2018 vs 2015) Heineken, 1.7% 2.0% 2013 2018 Change Lotte Chilsung, Company 56.4% 59.8% 3.4pp 4.5% Hite 39.4% 21.4% (18.0pp) Company, Hite, 59.8% Lotte Chilsung n.a. 4.5% 4.5pp 21.4% Heineken 0.7% 2.0% 1.3pp Asahi 0.8% 1.7% 0.9pp Top five 97.3% 89.3% (7.9pp)

Source: Company Data, Orient Securities (Hong Kong) Source: Company Data, Orient Securities (Hong Kong)

Figure 29: Oriental Brewery vs Hitejinro beer portfolio (abv %) Figure 28: Korea’s beer market size Total mm HL US$ bn

2013 20 13.6

2018 20 14.5

2023E 22 17.4 Premium & super premium mm HL US$ bn Source: Company Data, Orient Securities (Hong Kong)

2013 1 1.9 OB and Hite-Jinro keeps making low abv beers despite demand for higher quality 2018 5 5.4 While overall beer market saw 0.6% 5-year CAGR decline from 2013 to 2018, overall value increased by 1.3%. In same period, volume of premium and super premium beers 2023E 9 8.7

Source: Company Data, Orient Securities (Hong Kong) grew 26.8% while value grew 22.7%, offsetting the decline in value and mainstream beers. Despite a changing consumer preference for stronger tasting, higher quality beers, Figure 30: Korean all-malt beers both OB and Hite-Jinro continue to focus mainly marketing their low abv lagers.

Similar to China’s beer market in last five years where consumption continues to trend

down while sales value was able to maintain a slight growth, premium and super premium beers are driving this drink less but drink better phenomenon. The all-malt beers that these domestic brands launched have not been successful, as consumers still view them as cheap and low quality.

Source: Company Data, Orient Securities (Hong Kong)

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New tax reform unlikely to deter consumers from buying imports

Germany and seeing highest growth amongst imported beers South Korea’s imported beers registered CAGR of 28% from 2013-2018, compared to Figure 31: Korea convenience store 18% CAGR from 2008-2013. This change in growth can be slightly misleading as some of promotion for imported beers (4 for the growth driving countries are not indicative of actual consumer demand. China is 10,000 won) Korea’s second biggest supplier of beers, which the USDA attributes to Chinese tourists travelling to Korea as well as non-immigrant Chinese residents working in Korea. A more important point is some multi-national breweries bring their products made in China into Korea for lower cost. The US is the fourth largest supplier, but the main reason for its climb in position is related to AB InBev switching from local brewing in Korea to imports from its American breweries. Therefore actual consumer demand for imported beers we believe would be closer to 22-23% CAGR from 2013-2018, which is still very high.

Imported beers gaining market share as consumers demand higher quality Source: kkull.net, Orient Securities (Hong Kong) Imported beers are applied a 30% tariff when entering into South Korea. Japan is the

only major trading partner of Korea that has yet to establish a free trade agreement. However, Japan’s logistics advantage being geographic neighbors to Korea and their aggressive pricing has made themselves the leading imported brands. Figure 32: Beer import sales value to South Korea by country Figure 33: Total beer import vs YoY growth

(US$ m) Ireland Netherlands Belgium Germany US China Japan (US$ m) Imports YoY 100% 350 60% Korea has signed free trade agreements 90% 300 with EU, US, Australia, China that has 50% 80% driven sharp rise in imported beers 250 40% 70%

60% 200 30% 50% 150 20% 40% 30% 100 10% 20% 50 0% 10% 0% 0 -10% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: Company data, Orient Securities (Hong Kong) Further loosening of tariffs on imported beers to offer consumers more choices Figure 34: Korea’s import tariff In 2014, South Korea and European Commission signed a free trade agreement that calculation for US beers would eliminate almost all tariffs on imported goods, including beers. Each year the beer Tax Sum tariff would be reduced by 3.75% for 7 years. Due to the signing of this agreement, there Taxable item rate (US$) has been a significant increase in European beers being imported to Korea. Invoice value $1.0 Import tariff 0% $0.0 Leveling the playing field for domestic brands, imports still viewed as superior Liquor tax 72% $0.72 On June 5th, 2019, the South Korean government announced a reform to its beer tax

Education tax 30% $0.216 system from price-based to volume-based to address imbalance between domestic and Value added tax 10% $0.194 imported beers. Previously, domestic beers were taxed on manufacturing costs, sales, marketing, promotion costs profit and general expenses while imported beers were only Customs 8% $0.08 taxed on import price, making them cheaper to consumers than domestic brands. The Total $2.21 average liquor tax for domestic beer was 848 won vs. 709 won for imported beer in 2018. Source: USDA, Orient Securities (Hong Kong) The old 72% liquor tax will be replaced by an 830 won per liter liquor tax, which we imagine would not change consumer’s view on prices of imported beers.

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Craft beers have barriers lifted to compete against large scale

Imported beers continue to gain market share from domestic beers Figure 35: Number of new craft The new tax system will cause a slight increase in imported beer and slight decrease in breweries opening in Korea domestic beers, but consumers view imported beer as different category from domestic 25 beer. Consumers who drink imported beers are unlikely switch to domestic beer just

20 from a slight reduction in price. Imported beers are expected to still be popular amongst consumers who enjoy better quality beers with diverse selection. 15 Figure 36: Korea domestic vs imported beer market share 10 (million liters) 2014 2015 2016 2017 2018 Lager 1,728 1,798 1,725 1,823 1,883 5 Domestic lager 1,641 1,674 1,561 1,487 1,482 Imported lager 87 124 164 336 401 0 % of domestic lager 94.9% 93.1% 90.5% 81.6% 78.7% 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Source: Ratebeer, Orient Securities (Hong Kong) % of imported lager 5.1% 6.9% 9.5% 18.4% 21.3%

Source: Euromonitor, Orient Securities (Hong Kong)

Figure 37: The Hand and Malt beer selection

Belgian Wit (5.0%/ IBU 9) Slow IPA (4.6%/ IBU 40) Belgian Dubbel (7.2%/ IBU 21) Extra Special Ale (5.7%/ IBU23) Mocha Stout (5.0%/ IBU28)

Malty sweet brewed from English-style Ale with rich malty Belgian-style white ale with Pronounced hop with floral, Korean Yeot (candied sugar) Milky chocolate stout with rich taste and subtle hops. A beer refreshing tartness citrus and tropical flavors with dark fruits, caramel and malt and coffee flavors for any occasion spice flavors

Source: Company data, Orient Securities (Hong Kong) Craft brewers to see more consumer interest from lower prices Besides domestic and imported beers, the main beneficiaries are craft breweries. The Figure 38: Microbreweries regulatory new volume-based tax system will make craft beers cheaper than before as the biggest reforms in Korea resistance from consumers in buying craft beers have been the high prices. The Year Regulation change acquisition of The Hand & Malt comes at a time when Korea is introducing regulatory Microbreweries are allowed reforms to lower entry barriers and allow small-scale breweries to enter the market. to distribute products Craft breweries account for less than 1% of market share in Korea 2015 outside their premise to non-affiliated restaurants and pubs Due to reforms to lower entry barriers and encourage more microbreweries, the number Microbreweries are further of craft breweries has increased significantly since 2015. Previously, craft breweries could allowed to distribute to 2018 only sell their beers within their premise, which made it difficult to gain consumer’s grocery retail stores and wholesalers attention. With relaxed rules on distribution and manufacturing size, craft breweries are Source: USDA, Orient Securities (Hong Kong) ready to enter the public market to provide consumers more unique choices. Along with newly implemented volume-based tax, craft beers will be cheaper for consumers to buy. Figure 39: Korea beer license regulations Regular license Small-scale license Fermentation Minimum: 5,000L 250,000L tank Maximum: 75,000L Directly owned retail outlets, on premise retail outlets (restaurants/pubs), off premise retail All regular distribution channels Distribution outlets (supermarkets/liquor stores) and wholesalers

Source: USDA, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Heineken has stronghold on mid-to-high end market in Vietnam

Figure 40: Vietnam alcohol market share Highest PCC in APAC’s growing markets (2018) Vietnam is one of the largest and fastest growing beer markets in APAC. Its alcohol market is a heavily dominated by beer, with 94%. Vietnam’s annual consumption in Asia ranks third behind China and Japan. Vietnamese people also drink a lot of beer Wine, 0.4% compared to their APAC peers with PCC of 50L, making it the highest PCC amongst the Spirits, Beer, 5.2% company’s target markets. With favorable demographics in young, growing, urbanizing 94.4% population, Vietnam’s beer market is expected to grow at 9.0% CAGR from 2018-2023 while volume is expected to grow at 3.9%.

Source: Company Data, Orient Securities (Hong Kong) Figure 41: Sabeco and Habeco’s beer portfolio consist of mainly low abv lagers

Figure 42: Vietnam’s population pyramid (2020)

90+ Female Year 2020 80-84 Male 70-74 60-64 50-54 Source: Company Data, Orient Securities (Hong Kong) 40-44 30-34 The beer market in Vietnam is mostly controlled by two local players (Sabeco & Habeco) 20-24 and two foreign players (Heineken & Carlsberg), combined they make up 91% of the 10-14 market share. But the situation is more complicated as Sabeco and Habeco are both 0-4 owned by the Ministry of Industry and Trade, a state-owned enterprise that is trying to Source: Worldometers, Orient Securities (Hong Kong) encourage foreign entities to invest in these companies. This has led to loosening of previous regulations restricting foreign companies from owning more than 49% of a local company. Currently, Carlsberg owns 17% of Habeco, while ThaiBev and Heineken own Figure 43: Vietnam beer market share 53.4% and 3.93% of Sabeco respectively. by volume (2013 vs 2018) 2013 2018 Habeco struggles show young consumers view domestic brands as economical beers SABECO 38.7% 40.1% Between the two domestic brewers, Habeco is having more difficulties positioning itself Heineken 20.0% 31.2% in the market, seeing revenue and profit declines as their target mid-end customers are

HABECO 17.0% 12.1% moving towards high-end products leading to significant market share losses. Habeco has stated that competition is fierce in local beer market as foreign brewers have entered Carlsberg 8.6% 7.5% into the north where Habeco has traditionally performed well in and has led to the Sapporo 0.8% 2.2% company rebranding their logo in 2018 to appeal to younger consumers. However Others 14.9% 6.9% consumers still view both local brewers as economical beers while Heineken and Source: Company data, Orient Securities (Hong Kong) Carlsberg are viewed as better tasting and higher premium beers.

Figure 44: Habeco old and new logo Premium market growing a lot quicker than low-end beers Low-end economical beers have grown in low single digit CAGR from 2013 to 2018, while premium and super premium beers have grown at 20%. This is mainly driven by 8% GDP per capita 10-year CAGR that has given consumers more power to move up in purchases. Heineken has become so dominant from top to bottom of price range, have multiple

brands to target different prices. Heineken owns 67% of high-end segment with Tiger Old logo New logo

Source: Company data, Orient Securities (Hong Kong) contributing 40% and Heineken contributing 27%. The company has gone on to make a beer specifically to cater the Vietnam market, called Heineken Silver that is less bitter, easy to drink, while still having the Heineken famous full bodied taste.

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Hong Kong Equity | China Consumer Goods Company in-depth

Government policies favor spirits over

Figure 45: India alcohol market share (2018) Consumer preference shifting in an underdeveloped market A mainly spirits market, India has an incredibly low beer PCC of 2L. Consumers have Wine, 0.9% Beer, historically preferred high alcohol drinks like whiskey and rum, as it is less expensive 47.0% relative to beer. Despite being a small market, India’s beer consumption has grown at 24.6% CAGR over 2013 to 2018 with project volume CAGR of 12.9% over 2018 to 2023 as Spirits, 52.1% consumers have shifted from strong beers to more easy drinking and low alcohol beers.

Source: Company Data, Orient Securities (Hong Kong) Budweiser holds significant market share in India with number two position in market, mostly targeting premium market. The company beer portfolio is diverse, offering low-end to high-end beers with intention to focus growth through category expansion Figure 46: India beer market share by through Beck’s Ice in core+ and Budweiser 0.0 in non-alcoholic drinks. volume (2013 vs 2018) 2013 2018 United Figure 47: APAC target markets size (2018 & 2013-2018 CAGR) Breweries 51.3% 48.5% Value and Premium and Super Company 23.9% 23.0% (US$ bn) Mainstream premium Total China 40.0 (-3.0%) 41.8 (12.0%) 81.8 (3.1%) Carlsberg 6.4% 13.0% South Korea 9.1 (-4.9%) 5.4 (23.2%) 14.5 (1.3%) Mohan Vietnam 9.4 (3.3%) 7.9 (19.8%) 17.3 (9.1%) Meakin 2.9% 2.3% India 7.4 (6.1%) 1.6 (35.3%) 9.0 (8.8%) Som Distillery & Source: Company Data, Orient Securities (Hong Kong) Brewery 1.4% 1.8% Beer market growth stagnated by unfavorable government policies Others 14.1% 11.4%

Source: Company data, Orient Securities (Hong Kong) 2016 and 2017 were difficult times for beer companies in India. Beginning with the state wide ban of alcohol in Bihar in April 2016, beer companies have had to shut down plants in the state where thousands of people lost their jobs. Additionally, raw materials in Figure 48: India alcohol policy changes warehouses where tax has been paid became obsolete. Following, Bihar, other states like Date Policy change Alcohol banned in state Tamil Nadu and made statements that they will become alcohol free to some degree, of Bihar and Haryana forcing global beer companies to reconsider investing in the market. Apr-2016 increased tax on beer by 2% through the VAT Beer is taxed higher than wine and spirits Restaurants and hotels banned from serving For every 100 rupee spent on bottle of beer, 60 goes to the government and 20 goes to Apr-2017 alcohol with 500m of the retailer. This makes selling beer in India, one of the most expensive countries in the state highways world to do so. Moreover, alcohol taxes are levied independently by each state with New goods and services some choosing to outright ban alcohol. While alcohol does not fall under goods and Jul-2017 tax (GST) on retaurants set between 12-18% services tax (GST), raw materials are taxed under GST and has been raised from 12-15%

Source: Quartz, Orient Securities (Hong Kong) to 18%, combined with freight and transport GST charges that were also raised on 15% to 18%, these significant costs increases are passed on to customers. Figure 49: Beer prices in India

Price Premium and super premium beers target high-end consumers Company Beer (INR) India has one of the lowest affordability of beer relative to its GDP per capita. Beer is also Kingfisher Kingfisher 100 Kingfisher Ultra 110 7-8% more expensive per unit of alcohol than spirits. This makes beer a luxury item in Carlsberg Carlsberg 100 India, consumed primarily by upper middle class. Followed with annual tax increases, Carlsberg Tuborg 95 which helps drive state revenue, beer becomes increasingly out of reach for mass market. Budweiser Budweiser 140 Therefore companies entering the market like Budweiser must target the premium and Budweiser Haywards 95 super-premium beer drinking customers as they are less price sensitive. Budweiser Corona 390

Budweiser Stella Artois 420 Heineken Heineken 140 B9 Bira 91 260 Source: magicpin.in, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Global peers comparison Company Heineken CR Snow Breweries Carlsberg Asahi Molson Coors Headquarters Amsterdam, NL Beijing, CN Copenhagen, DK Tokyo, JP Denver, US Europe: 45% Japan & RoW: 48% US: 67% Americas: 29% Western Europe: 58% Western Europe: 14% Europe: 18% Market coverage Asia: 13% China: 100% Eastern Europe: 17% Eastern Europe: 28% Canada: 13% Africa, Middle East & Asia: 25% Australia: 10% International: 2% Eastern Europe: 13% Global: 3.0% Global: 5.8% Japan: 37% Global: 11.2% Nordics: 54% Global: 5.1% Market share Global: 6.5% Italy: 20% Italy: 34% : 28% US: 24% (volume) China: 23% Poland: 34% UK: 16% Italy: 8% Canada: 32% Czech: 45% UK: 10% UK: 4% Heineken (Global) Carlsberg (Nordics/Asia) Asahi Super Dry (Japan) Coors Light (US & Canada) Main products Tiger (SE Asia) Snow (China) Tuborg (Nordics) Peroni (Italy) Molson Canadian (Canada) (main market) Birra Moretti (Italy) Kronenbourg (France) Pilsner Urquell (Czech) Miller Lite (US) Premium: 30% Premium: 0% Premium: 14% Premium: 54% Premium: 14% Target markets Mainstream: 50% Mainstream: 10% Mainstream: 75% Mainstream: 41% Mainstream: 36% Economy: 20% Economy: 90% Economy: 11% Economy: 5% Economy: 50% FY18 Sales US$24,934m US$4,618m US$9,280m US$8,084m US$10,770m (US$ m) FY18 Sales volume 234mm HL 113mm HL 133mm HL 136mm HL 97mm HL (mm HL) FY18 Unit price $106 $41 $70 $59 $111 (US$/HL) FY18 Operating US$3,396m US$112m US$1,384m US$976m US$1,632m profit (US$ m) FY18 Operating 13.6% 2.4% 14.9% 12.1% 15.2% profit margin (%) Employees (FY18) 85,610 40,000 40,500 28,055 17,750

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Hong Kong Equity | China Consumer Goods Company in-depth

Competitive product portfolio with high market coverage

One of top company in APAC, targeting consumers with desire to trade up

Budweiser Brewing Company APAC is a part of the AB InBev Group that has been

separated and was listed in Hong Kong on Oct 2019. It is the largest and one of the most Figure 50: Internal region split profitable beer companies in APAC, holding over 50 world famous beer brands, including APAC West APAC East Budweiser, Stella Artois, Corona, Hoegaarden, Cass and Harbin. The company was ranked China South Korea Vietnam Japan first in beer value and is the clear number one market share leader in the premium and India New Zealand super premium category by volume and value in China in 2018. Rest of APAC exports

Source: Company data, Orient Securities (Hong Kong) The company separates its operations into APAC East and APAC West. APAC West accounts for 74-79% of total revenue with China being the biggest contribution. APAC East comprises of South Korea, Japan and New Zealand as their Australia business has been divested to Asahi. Figure 51: Company milestones Year Milestone Each target market poses its own unique opportunities and challenges Entered into China market, The company considers China, South Korea, Vietnam and India as their target markets, 1984 providing technology to Zhujiang Brewery (now associate) seeing strong potential in their premium and super-premium categories. There is an Established Budweiser brewery in 1995 overarching theme driving the company’s APAC growth story, which is a constant trading Wuhan, China Entered into South Korea market up amongst consumers for more high-end beers due to favorable macroeconomics and 1998 through JV with Doosan Group to desire for better quality and stronger tasting beers. The target markets were selected operate Oriental Brewery (OB) based on size, maturity and opportunity with each having different angles for growth. SAB entered into India market 2003 with JV with Anheuser-Busch acquires Harbin 2004 China’s market is the biggest in APAC with a clear premiumization trend that is offsetting Brewery Group SAB entered into Vietnam the decline amongst mass market beer consumption. Consumers in China are open 2006 through JV with Vinamilk minded in trying new flavors with an already relatively high PCC (35L). This shows that InBev combines with beer is already a cornerstone of Chinese consumers’ alcohol consumption, but compared 2008 Anheuser-Buscch to form AB InBev to western countries with PCC that often exceeds 60L, there is ample room for growth.

Source: Company data, Orient Securities (Hong Kong) South Korea has always favored import beers due to irregular tax on domestic beers that made them more expensive. While this has been rectified last year, the impact is expected to be minimal. Consumers’ perception of domestic beer is still inferior to Figure 52: APAC beer volume market import brands, considering them cheap and low quality compared to imported beers. sizes by country (2018) The country has also signed multiple free trade agreements with China, US and EU in the (mm HL) 600 last ten years that has lowered tariffs on imported beers, which has made domestic beers 500 even less attractive for consumers. 400 300 200 Amongst the four target markets, Vietnam has the highest PCC with beer being the mass 100 predominant alcohol of choice. The two largest local players (Sabeco & Habeco) have not 0 transitioned successfully in attracting young consumers, giving room for import brands to fill the void. High GDP growth has allowed consumers to trade up, allowing the premium

Source: Company Data, Orient Securities (Hong Kong) and super-premium category to heavily outpace value and mainstream category.

The least attractive market in our opinion is India. Mainly because of unfavorable

government policies, inconsistent state tax codes, harsher tax comparative to spirits,

annual tax increases on alcohol and sporadic banning of alcohol in different states. In

addition, India has the lowest PCC amongst major APAC markets at an abysmal 2L. The

direction of the consumer market is uncertain, with some saying strong beer is being

traded for lighter taste, yet spirits continue to be very popular.

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Hong Kong Equity | China Consumer Goods Company in-depth

Margins trending up on premiumization and improving efficiency

Margins have been improving on better efficiencies and consumers trading up The company has been steadily improving its efficiencies which will benefit more from Figure 53: Gross profit vs GPM the continuous premiumization trend in APAC. Premium beers are expected to grow (US$ m) Gross profit 1,200 Gross margin (%) 56 significantly faster than overall beer market in the region. Premium beers in APAC are

1,000 54 expected to grow at 8.5% CAGR in 2018-2023, compared to 2.4/1.7% for mainstream and discount beers respectively. The shift in mix to premium beers will drive higher value 800 52 growth, which has allowed the company to improve its margins from top to bottom. The 600 50 1,036 1,037 1,059 1,005 dip in 4Q18 margins is due to marketing cost incurred during 2018 Russia world cup. 400 785 830 48 642 200 46 Economies of scale is also achieved through better utilization of its brewery facilities, the company owns 56 breweries and 61 distribution centers spread across Asia. But we see 0 44 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 potential for brewery consolidation. India has 15 breweries which is a lot relative to its

Source: Company Data, Orient Securities (Hong Kong) market size while larger markets such as South Korea and Vietnam have only 3 and 2 breweries respectively. This is due to difficulty in acquiring licenses in India and company wants to preemptively position itself to capture market growth. Figure 54: Operating profit vs OPM

(US$ m) Operating profit Third party distribution preferred over direct sales on lower logistics costs Operating margin (%) 500 25 Their customers include distributors, large retailers and other customers. Distribution is 450 400 20 made through B2B through distributors who on-sell downstream to their customers, but 350 the company also does B2C to engage with consumers directly. They have a sales team of 300 15 250 10,000 employees with products sold to 6,000 distributors in APAC. 438 200 395 398 403 10 345 150 271 100 5 There are 25 AB InBev brands imported to APAC on exclusive deals such as Stella Artois, 50 80 Corona, Beck’s, which makes it challenging to manage all these different brands. Pricing 0 0 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 is generally set at recommended nationwide retail prices that are subject to adjustments Source: Company Data, Orient Securities (Hong Kong) depending on local competitive environment. Company relies on their 6,000 distributors (75/25 split in West/East) to distribute 90% of their products, with rest done through direct sales. Both have similar margins but former is the preferred distribution channel. Figure 55: Volume vs ASP (mm HL) Volume ('000 US$) 35,000 ASP 9 Figure 56: Company’s key growth drivers for APAC markets 29,463 30,000 28,002 28,113 27,525 Comprehensive product portfolio with brewing champion pedigree 8 Best positioned to capture ongoing premiumization and trading-up trend in APAC 25,000 22,311 22,116 Driving industry trend of premiumization with long-term commitment in China, 8 20,000 16,469 South Korea and India 15,000 7 Strong marketing capabilities through close understanding of consumer insight and product innovation 10,000 Source: Company Data, Orient Securities (Hong Kong) 7 5,000

0 6 Revenue per hl offsetting decline in volume 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 In their third quarter results, Budweiser noted a challenging environment in China’s Source: Company Data, Orient Securities (Hong Kong) market right now. While revenue in China grew 5.1% driven by 7.0% revenue per hl growth, volume was down 2.3% in 9M19 due to shipment phasing in 2Q19 and softness in China nightlife channel, leading to a roll back in price increase that was implemented in April 2019 in hopes to revitalize the domestic beer industry during the economic downturn. Premium segment also saw a decline in volume due to softness in nightlife channel, but Budweiser continues to invest in this area and in other occasions such as meals and consumer passion points such as music and sports. Super Premium saw double-digit volume growth, led by Corona and Hoegaarden. The inclusion of Blue Girl into their Super Premium portfolio is expected to deliver strong growth potential.

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Hong Kong Equity | China Consumer Goods Company in-depth

Locally made import brews will lift gross margin

Premium beers offer highest margins compared to Super-premium in China

The category within each market that offers the highest margins is different. In China,

this belongs to Budweiser in premium beers, as they’re able to brew these locally Figure 57: Price ladder in China without incurring significant transportation cost that super-premium beers like Corona Price to Net Gross consumer revenue margin would have to incur. However compared to AB InBev, the company’s gross margin is still Super premium 5.0x 7.0x 9.0x behind AB InBev’s 60% and one of the reasons is licensing and royalty fees for using Premium these brands that AB InBev would not have to incur. Additionally, brands that are 2.5x 3.0x 5.0x Core+ imported, such as Corona and Stella Artois are essentially purchased as customers at a 1.5x 1.5x 1.6x Core & cost paid marked up to AB InBev, which also lowers the overall gross margin. Value 1.0x 1.0x 1.0x

Source: Company Data, Orient Securities (Hong Kong) Gross margin will improve with more imported beers produced locally To mitigate these margin pressure, the company is constantly looking for opportunities to make these import brands locally. In 2019, Hoegaarden and Corona were starting to be produced in China on small scale. Once they observed strong consumer demand for these brands, production will ramp up and is expected to be 100% produced in China in 2020. This will further help the company raise its gross profit margin. Company also sees potential in Blue Girl, which is ranked third in China, where consumers are paying above Figure 58: Import beers brewed locally Imported beers brewed price point compared to Corona due to strong brand equity. locally Budweiser, Corona, In the South Korea market, none of the imported brands are locally made, but due to the Hoegaarden brewed China recent tax changes benefiting domestic beers, the company expects to be brewing locally with potentially Blue Girl Hoegaarden and Budweiser there as their main priorities. This is expected to take place Everything is imported in 2020. In Vietnam, Budweiser is brewed locally and is the main marketed product for South Korea and not brewed locally the company. Beck’s Ice in the Core+ category is imported that offers price diversity. In Budweiser is brewed India, Beck’s Ice and Budweiser are main import brands also targeting different audience. Vietnam locally but Beck’s Ice is imported for now Currently, Budweiser and Haywards are brewed locally in India. Budweiser and Haywards is brewed India Malt hedging to avoid incurring fluctuation costs in raw materials locally but Beck’s Ice is Margins have steadily improved overtime and a lot comes down to cost control as raising imported for now

Source: Company Data, Orient Securities (Hong Kong) beer prices can be difficult if macroeconomics is not doing well. Raw materials make up majority of CGS, including malted barley, hops, yeast and water. The company engages in

fixed-price purchasing contracts and commodity derivatives to hedge against commodity

price fluctuations. This has helped them maintain stable margins that have been

improving incrementally over the past two years.

In addition to raw materials hedging, company also engages in FX hedging for Figure 59: IPO and restructuring transactional level. There is still a translation loss or gain each year that can be quite related costs substantial as shown by US$931m FX gain in 2017 and US$495m FX loss in 2018. But (US$ m) 2017 2018 9M19 these are only translational and not reflective of company’s performance. From the Restructuring 45 39 7 combined financials of AB InBev allocated to APAC, company recognized net hedging IPO 0 0 85 income of US$36/14m for 2017/2018 respectively. Source: Company data, Orient Securities (Hong Kong) IPO and restructuring expenses to be finished in 2019 Company so far has incurred US$85m in IPO expenses as non-recurring items and US$45m to be capitalized related to the IPO. There is also restructuring expense starting from 2017 of US$91m so far. The company noted there will be no carryover of either two expense items in 2020.

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Hong Kong Equity | China Consumer Goods Company in-depth

APAC West continues to be the long-term growth driver

Figure 60: Capex vs capex as % revenue Receivables and payables are aligned to help company’s cash flows

(US$ m) PPE Comparing the receivable days to payable days shows that the company has significant 700 10% control over collecting payments from customers and making payments to distributors. 9% Land and 600 9% buildings 9% The company requires wholesalers to pay upfront, which brings in large chunk of money 500 % revenue 8% for cash, hence the significant amount of contract liabilities on their balance sheet. The 400 7% company’s receivable days are short at around 30-40 days, while their payable days are 300 6% very long at 200-300 days, giving them cash flow flexibility most companies don’t have. 200 5% 100 5% 4% No external debt, funding made through AB InBev 0 4% 2017 2018 1Q18 1Q19 Being under AB InBev allows the company to benefit from better financing terms. Source: Company Data, Orient Securities (Hong Kong) Therefore company holds no external debt. Company expects to incur US$15-20m of finance expense each year as part of the funding cost for capex.

Figure 61: Capex utilization Admin and hardware/software US$600m annual capex for expansion and commercial investments Logistics and commercial investments Breweries and facilities Beer brewing is in an asset heavy industry, where heavy capex is needed to build up 100% 6% 7% 3% 90% breweries for manufacturing beers. The company spent roughly US$600m in 2017 and 80% 30% 2018 building up its breweries and facilities and will need to continuously do so as its 70% 46% 60% 70% operations grow. We forecast future capex to be at similar level each year, which should 50% be enough to grow their capacity and expand their logistics distribution network barring 40% 30% 64% any M&A acquisitions that may occur (we forecast a 2022 acquisition of US$600m for its 47% 20% Southeast Asia expansion). Capex utilization is expected to be split 50/50 between 10% 27% 0% commercial investment and supply growth. 2017 2018 1Q19 Source: Company Data, Orient Securities (Hong Kong) Marketing expense forecasted to increase for 2022 World Cup advertising The World Cup is the biggest event in sporting that relates to beer drinking. Viewership Figure 62: Sales and marketing expense exceeded 3.5B in the 2018 Russia World Cup with each ad costing upwards of US$1m. vs sales and marketing as % of revenue Company reported sales and marketing expense of US$1.4B in 2018, representing 21.1% (US$ m) Sales and marketing 2,000 24% % revenue of revenue, we expect there to be gradual improvement from 2019-2021 at an average of 1,800 23% 18% of revenue. We forecast sales and marketing to reach US$1.8B in 2022, with the 1,600 22% 1,400 21% incremental increase mainly attributed to 2022 World Cup. 1,200 20% 1,000 19% 800 APAC West will continue to be the main revenue growth driver 18% 600 With strong uptick in Chinese consumers trading up for premium beers and the highest 400 17% 200 16% premium multiple amongst Asian countries, the premiumization trend is offering the 0 15% greatest potential in China. We forecast APAC West to grow at 11.3% CAGR from 2017 2018 2019E 2020E 2021E 2022E 2023E Source: Company Data, Orient Securities (Hong Kong) 2019-2022E, outpacing APAC East’s 7.3% CAGR. In long run, APAC West will continue to maintain this high growth with possible acquisition in Southeast Asia that would further Figure 63: Revenue growth forecast improve the growth rate of this region. 14% APAC East APAC West

12% Distribution expense we expect to see steady gradual improvement, from 8.0% of 10% revenue in 2018 to a flat 7.0% by 2025E. Admin expense is unlikely to see much room for 8% further improvement. We forecast it to stay at a flat 5.5% from 2024E onwards. Sales and 6% marketing will plateau at 17.5% of revenue minus the years where World Cup are held 4% which would increase their expense to a maximum of 18-20% of revenue. The company’s 2% effective tax rate is around 28%, which is also the same figure we used for forecasting 0% 2018 2019E 2020E 2021E 2022E future tax expenses. -2%

Source: Company Data, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Initiate with ACCUMULATE at HK$27.0 with 15% upside

DCF valuation Figure 64: WACC We base our valuation on a 10 year DCF model with a WACC of 9.1% (3.2% risk free, Risk-free rate 3.2% 11.7% risk premium, 0.7 beta) and using a terminal growth rate of 3%. Our target price of Market risk premium 11.7% HK$27.0 implies 29.3x FY20E PE and 3.4x FY20E PB. Beta 0.7 CoE 9.2% Our model assumes that there financing will be done through debt, as the company has CoD 4.0% a short listing history and has not done any share placement or share issuance. With AB D/V 1% InBev as their largest shareholder, the company has an easy line of credit that will be E/V 99% leveraged to lower their financing rates. Tax rate 28% WACC 9.1% Recent coronavirus outbreak in Wuhan has caused disruption in company’s operations in Source: Company Data, Orient Securities (Hong Kong) China. They have shut down their Wuhan brewery as the city is currently sealed off. Clubs,

bars have been shut down while restaurants have been heavily affected with half closing

down but supermarkets and convenience stores are not as badly affected.

Figure 65: DCF forecast

(RMB m) 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E EBITDA 2,014 2,157 2,439 2,580 3,015 3,339 3,712 3,919 4,442 4,875 Change in working capital (499) 61 (156) 26 (112) (44) (84) (49) (112) (50) Others 52 0 46 20 40 35 44 5 21 29 Operating cash flow 1,567 2,218 2,329 2,626 2,943 3,330 3,672 3,875 4,351 4,854 Capex (488) (602) (610) (2,308) (595) (597) (599) (659) (659) (659) Taxes paid (421) (528) (618) (653) (798) (917) (1,049) (1,136) (1,315) (1,472) Net finance expenses 14 46 65 90 115 145 177 211 250 293 Share of profits of associates 22 29 43 58 74 93 113 135 160 187 Other income and expenses 49 249 257 298 325 363 401 448 498 556 Free cash flow 743 1,413 1,465 111 2,064 2,417 2,714 2,873 3,285 3,758

Source: Company data, Orient Securities (Hong Kong) Since listing in Oct 2019, share price has been on a decline which is a culmination of overvalued IPO prices and poor 3Q performance. Stock is currently trading at 30x FY20 PE, which is demanding compared to its peers and for its earnings growth. We initiate coverage with ACCUMULATE rating, implying 15% upside based on our DCF-based HK$27.0 target price. Share price upside is reflective of company’s potential growth captured from the number one market share position in China’s premium categories and overall strong presence across multiple mid maturity markets that will provide strong growth and margin improvement potential. Figure 66: DCF sensitivity

(HK$) Terminal growth

2.0% 2.5% 3.0% 3.5% 4.0%

8.1% 28.7 30.5 32.6 35.2 38.4

8.6% 26.4 27.8 29.5 31.6 34.1

9.1% 24.4 25.6 27.0 28.6 30.6 WACC 9.6% 22.6 23.6 24.8 26.1 27.7 10.1% 21.1 21.9 22.9 24.0 25.3

Source: Company data, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Valuable table, PE PB bands

Figure 67: Valuation table

Bloomberg Price Mkt Cap PER (x) PEG (x) EV/EBITDA (x) P/B (x) Yield (%) ROE (%) Net Gearing (%)

Company Code (Local Ccy) (US$mn) 18A 19E 20E 18-20E 18A 19E 19E 18A 18A

CHINA RESOURCES BEER HOLDING 291 HK 38.55 16,075 96.5 52.2 35.0 1.1 35.3 6.2 0.6 5.2 net cash

HEINEKEN NV HEIA NA 103.25 64,648 23.6 22.1 20.3 2.9 13.6 3.2 3.1 14.2 10

CARLSBERG AS-B CARLB DC 1014.5 22,469 21.9 19.6 17.6 2.6 11.6 3.8 2.5 14.8 38

ASAHI GROUP HOLDINGS LTD 2502 JP 5107 22,466 16.4 14.3 12.9 na 10.6 1.5 1.9 12.4 120

THAI BEVERAGE PCL THBEV SP 0.78 14,095 13.3 11.8 10.9 0.4 17.1 3.4 3.1 19.7 174

Source: Orient Securities (Hong Kong), Bloomberg

Figure 68: PE chart Figure 69: PE standard deviation

HK$40 65

60 55.0x HK$35 +1 sd

55 50.0x

HK$30 45.0x 50 average

40.0x 45 HK$25

35.0x 40 -1 sd HK$20 35

HK$15 30 2019 2019

Source: Bloomberg, Orient Securities (Hong Kong) Source: Bloomberg, Orient Securities (Hong Kong)

Figure 70: PB chart Figure 71: PB standard deviation

HK$34 6.0

HK$32 5.1x 5.5 +1 sd

HK$30 4.7x 5.0 HK$28 4.3x average HK$26 4.5

3.9x HK$24 4.0 HK$22 3.5x -1 sd

HK$20 3.5

HK$18 2019 3.0 2019

Source: Bloomberg, Orient Securities (Hong Kong) Source: Bloomberg, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Peers comparison table

PER (x) PEG (x) EV/EBITDA (x) P/B (x) Yield (%) ROE (%) Net Gearing (%)

Company Ticker Price (Local ccy) Mkt Cap (HK$ mn) 18A 19E 20E 18-20E 18A 19E 19E 18A 18A

Global listed

CHINA RESOURCES BEER HOLDING 291 HK 38.55 125,063 96.5 52.2 35.0 1.1 35.3 6.2 0.6 5.2 net cash

HEINEKEN NV HEIA NA 103.25 502,964 23.6 22.1 20.3 2.9 13.6 3.2 3.1 14.2 10%

TSINGTAO BREWERY CO LTD-H 168 HK 43.4 63,262 36.8 28.6 24.7 1.5 13.6 3.2 1.5 8.1 net cash

CARLSBERG AS-B CARLB D 1014.5 174,811 21.9 19.6 17.6 2.6 11.6 3.8 2.5 14.8 38%

SAPPORO HOLDINGS LTD 2501 JP 2724 15,191 48.6 26.6 25.2 na 11.7 1.2 1.6 2.5 209%

ASAHI GROUP HOLDINGS LTD 2502 JP 5107 174,787 16.4 14.3 12.9 na 10.6 1.5 1.9 12.4 120%

BEIJING YANJING BREWERY CO-A 000729 5.92 18,567 82.6 68.6 58.1 na 12.2 1.4 0.4 1.4 net cash

THAI BEVERAGE PCL THBEV SP 0.78 109,657 13.3 11.8 10.9 0.4 17.1 3.4 3.1 19.7 174%

MOLSON COORS BEVERAGE CO - B TAP US 55.5 93,957 12.2 14.0 13.7 na 12.9 6.4 4.1 1.8 70%

Average of global listed peers 39.1 28.7 24.3 1.7 15.4 3.4 2.1 8.9

Source: Bloomberg, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Financial Statements & Forecast

Income Statement (consolidated) Balance Sheet (consolidated)

FY-end Dec (US$ m) 2017 2018 2019E 2020E 2021E FY-end Dec (US$ m) 2017 2018 2019E 2020E 2021E Revenue 6,099 6,740 6,669 7,258 8,007 Current assets 2,873 2,680 2,923 4,256 5,877 APAC East 1,462 1,585 1,568 1,647 1,779 Inventories 371 417 382 400 420 APAC West 4,637 5,155 5,101 5,611 6,228 Trade receivables 697 580 844 752 900 Cost of sales (2,944) (3,240) (3,134) (3,411) (3,683) Derivatives 7 12 7 7 7 Gross profit 3,155 3,500 3,535 3,847 4,324 Cash & eqv. 1,761 1,667 1,677 3,092 4,543 Distribution expenses (516) (540) (500) (544) (600) Other current assets 37 4 13 5 7 Administrative expenses (404) (395) (416) (435) (480) Non-current assets 13,887 13,182 13,079 13,091 13,110 (1,401) (1,421) (1,200) (1,306) (1,401) Property, plant & equipment Sales and marketing expenses 4,040 3,790 3,675 3,679 3,682 Operating profit 834 1,144 1,418 1,560 1,842 Intangible assets 1,819 1,718 1,718 1,718 1,718 Finance cost (net) (51) (18) 14 46 65 Goodwill 7,046 6,718 6,712 6,712 6,712 Share of profit of associates 8 17 22 29 43 Interest in associates 367 403 408 410 412 Other income and losses 88 112 50 250 258 Other non-current assets 615 553 566 572 586

Profit before tax 879 1,255 1,504 1,885 2,207 Total assets 16,760 15,862 16,002 17,346 18,987 Income tax expense (307) (296) (421) (528) (618) Current liabilities 4,544 4,468 4,347 4,366 4,419 Net profit 572 959 1,083 1,357 1,589 Trade payables 2,567 2,547 2,568 2,557 2,567 FX exchange 926 (500) - - - Accruals and other payables 1,288 1,284 1,337 1,357 1,404 Minority interest (2) 1 1 1 1 Due to related parties 485 405 114 110 112 Profit attributable to shareholder 1,500 458 1,082 1,356 1,588 Other current liabilities 204 232 328 342 336 Non-current liabilities EBITDA 1,446 1,759 2,014 2,157 2,439 1,869 1,222 1,238 1,207 1,206 EBIT 834 1,144 1,418 1,560 1,842 Due to related parties 1,018 473 466 450 440 EPS (US D) 0.043 0.072 0.082 0.102 0.120 Deferred tax liabilities 449 408 416 400 400 DPS ( USD) - - - - - Other non-current liabilities 402 341 356 357 36 Total liabilities 95 187 251 302 366 Cash Flow (consolidated) Share capital 10,328 10,153 10,398 10,398 10,398 FY-end Dec (US$ m) 2017 2018 2019E 2020E 2021E Reserves - - - 1,356 2,945 Operating profit 834 1,144 1,418 1,560 1,842 Minority interest 19 19 19 19 19 Depreciation & amortization 612 615 596 597 597 Total equity 10,347 10,172 10,417 11,773 13,362

Change in working capital 73 (32) (499) 61 (156) Total liabilities & equity 16,760 15,862 16,002 17,346 18,987 Others (188) (43) 52 0 46 1,331 1,684 1,567 2,218 2,329 Key Ratios Operating cash flow Capex (373) (472) (488) (602) (610) FY-end Dec 2017 2018 2019E 2020E 2021E Acquisitions/disposals - - - - - Growth (%) Investments (232) (36) (5) (2) (2) Revenue - 11 (1) 9 10 Others 73 36 (7) (3) (3) Gross profit - 11 1 9 12

Investing cash flow (532) (472) (500) (607) (615) EBITDA - 22 14 7 13 Borrowings (1) (778) 90 3 (19) EBIT - 37 24 10 18 Dividends paid (16) (394) - - - Net profit - (69) 136 25 17 Others (170) (65) (637) 250 10 EPS - 68 13 25 17 Financing cash flow (187) (1,237) (547) 253 239 Margins (%) Free cash flow 1,071 1,609 743 1,413 1,465 Gross profit 52 52 53 53 54 EBITDA 24 26 30 30 30 Net cash flow 612 (25) 520 1,865 1,952 EBIT 14 17 21 22 23 Semi -Annual Breakdown Net profit 9 14 16 19 20 FYa(consolidated)-end Dec (US$ m ) 3Q18 4Q18 1Q19 2Q19 3Q19 Others (%) 1,912 1,317 1,606 1,916 1,822 Effective tax rate 35 24 28 28 28 Revenue Gross profit 1,037 642 830 1,059 1,005 Dividend payout ratio - - - - - Operating profit 398 80 345 438 403 ROE - 9 7 11 12 Pre-tax profit 434 99 352 497 421 ROA - 5 6 7 8 Tax (105) (40) (112) (133) (164) Net profit 329 59 240 364 257 Key Assumptions Gross margin (%) 54.2 48.7 51.7 55.3 55.2 FY-end Dec 2017 2018 2019E 2020E 2021E Operating margin (%) 20.8 6.1 21.5 22.9 22.1 Volume growth (%) - 2.4 2.9 2.9 2.9 Effective tax rate (%) 24.2 40.4 31.8 26.8 39.0 ASP growth (%) - 7.9 (3.8) 5.8 7.3 Net margin (%) 17.2 4.5 14.9 19.0 14.1 EPS (US$ ) 0.025 0.004 0.018 0.028 0.019 DPS (US$) - - - - - Source: Company data, Orient Securities (Hong Kong)

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Hong Kong Equity | China Consumer Goods Company in-depth

Analyst Certification I, Matthew Law (Law Shun Kei), being the person primarily responsible for the content of this research report, in whole or in part, hereby certify that: (1) all of the views expressed in this report accurately reflect my personal view about the subject company(ies) and its (or their) securities; (2) no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report, or our Investment Banking Department; (3) I am not, directly or indirectly, supervised by or reporting to our Investment Banking Department; (4) the subject company(ies) do(es) not fall into the restriction of the quiet period as defined in paragraph 16.5(g) of SFC Code of Conduct; (5) I and my associates do not deal in or trade in the stock(s) covered in this report within 30 calendar days prior to the date of issue of the report; (6) I and my associates do not serve as an officer(s) of the listed company(ies) covered in this report; and (7) I and my associates have no financial interests in relation to the listed company (ies) covered in this report.

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