Corporates Food, Beverage & Tobacco / Denmark Carlsberg Breweries A/S Rating Type Rating Outlook Last Rating Action Long-Term IDR BBB+ Stable Affirmed 16 May 2019 Short-Term IDR F1 Upgrade 16 May 2019 Click here for full list of ratings Financial Summary (DKKm) Dec 2016 Dec 2017 Dec 2018 Dec 2019F Dec 2020F Dec 2021F Revenue 62,614 60,655 62,503 64,598 68,303 69,637 Operating EBITDAR 13,265 13,618 13,688 14,143 14,631 15,039 Operating EBITDAR Margin (%) 21.2 22.5 21.9 21.9 21.4 21.6 Free Cash Flow Margin (%) 6.4 9.8 8.1 3.3 4.0 3.2 FFO Adjusted Net Leverage (x) 3.4 2.1 2.0 2.3 2.4 2.4 Source: Fitch Ratings, Fitch Solutions The ratings reflect Carlsberg Breweries A/S’s strong business profile as the third-largest international brewer globally and Fitch Ratings’ expectation that the company will be able to maintain the improved credit metrics it achieved after deleveraging in 2016-2018. This expectation is underpinned by the company’s conservative financial policy and clear capital allocation principles. The rating continues to incorporate some room for bolt-on M&A as we believe the group will continue to pursue growth opportunities in Asia. Based on our assessment of Carlsberg’s financial flexibility, we assigned the higher of the two short-term options (F1) for the current rating profile in May 2019. Any material weakening in financial flexibility, financial structure or operating environment conditions could lead to the assignment of the lower of the two short-term rating options for the current long- term profile. Key Rating Drivers Deceleration in Organic Growth: Carlsberg’s organic sales growth is likely to decelerate in 2019-2022 from an exceptionally high 6.5% reported in 2018. This is due to the absence of one-off supporting factors, such as favourable weather in Northern Europe, the World Cup in Russia, and a volumes rebound in India, and our conservative expectation on increasing competitive pressures in some of Carlsberg’s markets. We forecast organic growth of around 3% in 2019, gradually moving towards the lower end of the 2%-4% range targeted by the company’s SAIL’22 strategy. Growing Asian Markets: Fitch expects Carlsberg’s organic growth to come primarily from Asia due to more favourable market fundamentals than in mature western Europe and sluggish eastern European markets. We project organic growth in the region in the mid- to high-single-digits over 2019-2022, supported by the premiumisation of demand and growing per-capita consumption in certain markets. The forecast also assumes increasing competition in Vietnam and potentially higher competitiveness of Chinese market leader China Resources Beer (Holdings) Company Limited (NR) after it forms a strategic partnership with Heineken NV (NR) to exclusively use its brands in China. Scope for M&A: Carlsberg’s rating allows for an increase in bolt-on M&A due to the company’s conservative capital structure and healthy free cash flow (FCF) generation. We believe most of this will take place in Asia, where Carlsberg aims to exploit opportunities. Our rating case assumes it acquires a controlling stake in Vietnamese brewer Habeco in 2020, which would strengthen Carlsberg’s position in this promising market and would be a defensive move in light of growing competition from Heineken and Thai Beverage Public Company Limited (BBB-/Negative) after it acquired Sabeco in 2017. We would consider any larger, debt-funded M&A as event risk; if it materialised, it could put downward pressure on the rating. Carlsberg Breweries A/S 22 May 2019 1 Corporates Food, Beverage & Tobacco / Denmark Stable to Improving Profit Margins: We expect Carlsberg to maintain or improve its medium-term EBITDA margin, despite a 50bp contraction in 2018, due to cost discipline and a more profitable sales mix. Despite the end of its three- year efficiency programme, the group is likely to focus on savings and internal resources to support brands and improve profit margins. However, the dilutive impact of bolt-on M&A could distort projected profit margins. For instance, Habeco’s 10.6% EBITDA margin is much lower than Carlsberg’s 21.4% (2018). We would expect Carlsberg to improve Habeco’s profitability after taking a controlling stake, but the group margin is likely to stay below 2018 levels for two to three years. Conservative Financial Policy: Carlsberg’s ratings benefit from the company’s commitment to a conservative capital structure. Adherence to its financial policy enhances Carlsberg’s financial flexibility to reduce shareholder remuneration if the internal leverage target is being endangered. The maximum net debt/EBITDA ratio of 2x corresponds to Fitch’s FFO adjusted net leverage of 2.7x, which is comfortably below our negative rating sensitivity of 3x. Potential for Increased Shareholder Distributions: In the absence of appropriate M&A targets, we expect Carlsberg to continue to return excess cash to shareholders through share buybacks and dividends to avoid leverage declining below a targeted minimum 1.5x. In 2019, Carlsberg announced a DKK4.5 billion share buyback programme and a 13% increase in dividends to move its internally calculated leverage to 1.5x in 2019 from 1.3x in 2018. The programme is in two tranches and we believe that the second one could be put on hold or cancelled in the event that M&A opportunities materialise and push leverage beyond the higher end of management’s target range. Moderate Leverage: After three years of deleveraging, Carlsberg now has one of the lowest leverage ratios among Fitch-rated alcoholic beverages producers. We expect FFO adjusted net leverage (2018: 2.0x) to remain below 2.5x over the medium term thanks to the company’s healthy cash flow generation, which is sufficient to cover increasing shareholder remuneration and bolt-on M&A. Third-Largest International Brewer: Carlsberg’s rating reflects its market position and scale as the third-largest international brewing company globally with operations in Europe and Asia. We view as credit-positive the company’s ability to diversify geographically over the past five years and decrease its dependence on the Russian beer market, which has been challenged by stringent industry regulation and decreasing consumer spending. In 2018, Carlsberg generated only 12% of its revenue and 16% of its operating profit in Russia (2012: 21% and 40%, respectively). The revenue contribution from Russia is now on par with China. Carlsberg Breweries A/S 22 May 2019 2 Corporates Food, Beverage & Tobacco / Denmark Rating Derivation Relative to Peers Rating Derivation Versus Peers Peer Comparison Carlsberg is smaller and less geographically diversified than Anheuser Busch InBev NV/SA (ABI, BBB/ Stable), the world’s largest beer company that has a comparatively stronger business profile and superior profitability. However, Carlsberg is rated one notch higher than ABI due to its more conservative financial policy and capital structure, while ABI’s leverage is more representative of a ‘B’ category rated issuer. Furthermore, Carlsberg exhibits a more conservative financial structure than US-based beer producer Molson Coors Brewing Company (BBB−/Stable) and global spirits companies Diageo plc (A−/Stable) and Pernod Ricard S.A. (BBB/Positive). Diageo is rated one notch higher than Carlsberg, despite higher leverage, as it has a stronger business profile. Diageo is the largest spirits company globally with geographically diversified operations and strong brands across different spirits categories. Parent/Subsidiary Linkage No Parent/Subsidiary Linkage is applicable. Country Ceiling No Country Ceiling constraint was in effect for these ratings. Operating Environment No operating environment influence was in effect for these ratings. Other Factors Not applicable Source: Fitch Ratings Navigator Peer Comparison Issuer Business profile Financial profile Management Industry Quality of Operating and Corporate Operational Brand Market Financial Financial Name IDR/Outlook Environment Governance Profile Portfolio Position Diversification Profitability Structure Flexibility Carlsberg Brew eries A/S BBB+/Sta a n a n bbb n bbb n a- n bbb+ n bbb+ n a n a n Diageo plc A-/Sta aa- n aa- n a- n a+ n a n a n a n bbb+ n a n Becle, S.A.B. de C.V. BBB+/Sta bb+ n bbb n bbb n bbb n bbb- n bbb- n a- n a n a- n Pernod Ricard S.A. BBB/Pos aa- n a n bbb+ n a n a- n a n a n bbb- n bbb+ n Anheuser Busch InBev NV/SA BBB/Sta a+ n a- n bbb+ n a- n a+ n a- n a n b+ n bbb- n Molson Coors Brew ing Company BBB-/Sta aa n bbb+ n bbb- n bbb n bbb n bbb n bbb+ n bb n bbb- n Source: Fitch Ratings Importance Higher Moderate Low er n n n Rating Sensitivities Developments That May, Individually or Collectively, Lead to Positive Rating Action We do not envisage any positive rating action in the foreseeable future unless Carlsberg further materially strengthens its business profile. Below are the parameters we would consider for an upgrade: – Maintenance of leading positions in core markets and mid-single-digit organic revenue growth; – Group EBITDAR margin above 25% (2018: 21.9%) and FCF margin sustained above 5% (2018: 8.1%); – FFO-adjusted net leverage sustained below 2.0x (2018: 2.0x). Developments That May, Individually or Collectively, Lead to Negative Rating Action – A severe decline in operating performance from key markets or much stronger remuneration of shareholders, coupled with an increased M&A appetite, causing FFO adjusted net leverage to increase on a sustained basis above 3.0x; – An erosion of the FCF margin below 3.0%; – A shift in financial policy towards higher levels of net debt/EBITDA from the current target of below 2x.