Consumer Staples / China 168 HK Consumer Staples / China 15 August 2014 Tsingtao Brewery Tsingtao Brewery Target (HKD): 53.80 Downside: 10.5% 168 HK 14 Aug price (HKD): 60.10 Initiation: losing its fizz 1 Buy • We see risks to the consensus EPS forecasts, with a deterioration 2 Outperform in product mix weighing on Tsingtao’s operating-profit margin 3 Hold • 2015E valuations of 28x PER and 15x EV/EBITDA do not look 4 Underperform (initiation) attractive compared with the sector average 5 Sell • Initiating coverage with an Underperform (4) rating and target price of HKD53.80 How do we justify our view? M&A growth is over. Although valuation is unattractive compared Tsingtao has a strong net-cash with the sector average of 20.3x and position (2014E: CNY6.6bn), we Tsingtao’s past-5-year average of believe its sales-volume growth and 25.2x. valuation can no longer be Anson Chan supported by M&A as has been the ■ Risks (852) 2532 4350 case over the past 5 years. This is The main risks to our view include [email protected] because most of the large breweries price hikes and EPS-accretive M&A. have already been acquired. Alison Law, CFA (852) 2532 4308 How we differ. Our 2015-16 EPS [email protected] Share price performance forecasts are 5-6% below those of the Bloomberg consensus, as we (HKD) (%) assume higher selling expenses for 70 105 ■ Investment case 66 100 We initiate coverage of Tsingtao the mass-market products. 62 96 Brewery (Tsingtao), the second- 58 91 largest beer maker in China with a ■ Catalysts 54 86 17% share of the market in 2013, We see the following as derating Aug-13 Nov-13 Feb-14 May-14 with an Underperform (4) rating. catalysts: 1) falls in ASPs, as Tsingtao B (LHS) Relative to HSI (RHS) secondary-brand sales growth Market-share gains come with (2013-16E CAGR: 13%) continues to 12-month range 54.70-67.75 pain. The company has seen rapid exceed that of the main brand (6%), Market cap (USDbn) 10.48 market-share gains since 2010, but 2) a loss of market share in the high- 3m avg daily turnover (USDm) 6.28 end segment to foreign brands, and Shares outstanding (m) 1,351 these have come at the expense of Major shareholder Tsingtao Brewery Grp (30.5%) deterioration in its brand portfolio 3) the launch of the Shanghai-Hong (more mass-market products). With Kong Stock Connect programme, Financial summary (CNY) all the main players moving to which should divert investors from Year to 31 Dec 14E 15E 16E challenge Tsingtao’s leading position Tsingtao’s H shares to A shares. Revenue (m) 31,907 35,132 38,101 in the high-end beer segment, the Operating profit (m) 2,245 2,556 2,807 ■ Valuation Net profit (m) 2,105 2,320 2,528 company is striving to expand its Core EPS (fully-diluted) 1.558 1.717 1.871 mass market-brand products, which We have a 6-month target price of EPS change (%) 19.5 10.2 9.0 have a low gross margin of about HKD53.80, based on a 2015E Daiwa vs Cons. EPS (%) 0.2 (5.4) (6.1) 25% (compared with 40% for its EV/EBITDA multiple of 14.3x, which PER (x) 30.6 27.8 25.5 principal brand). With its ASP likely is at a 5% discount to the stock’s past- Dividend yield (%) 1.0 1.1 1.2 5-year average 12-month forward DPS 0.467 0.515 0.561 to remain flat and selling costs PBR (x) 4.2 3.7 3.4 rising, we forecast the operating EV/EBITDA, to reflect the limited EV/EBITDA (x) 17.4 15.2 13.6 margin to drop from 7.4% for 2013 earnings-growth potential from M&A. ROE (%) 14.3 14.2 14.0 to 7-7.3% over 2014-15. At 28x 2015E PER, the stock’s Source: FactSet, Daiwa forecasts De See important disclosures, including any required research certifications, beginning on page 22 Consumer Staples / China 168 HK 15 August 2014 Contents Market-share gains from low-margin products ............................................................................. 6 Upgrade of its brand portfolio has ground to a halt ................................................................... 6 Pressure on its ASP and profit margins .......................................................................................7 Fewer M&A opportunities .............................................................................................................. 9 Financial analysis .......................................................................................................................... 12 Earnings growth should pick up in 2014 ................................................................................... 12 Valuation ....................................................................................................................................... 14 Valuation looks stretched .......................................................................................................... 14 Investment catalysts and risks ................................................................................................... 16 Company background ................................................................................................................ 16 Appendix – the beer industry in China ......................................................................................... 17 Volume growth prospects .......................................................................................................... 17 ASP trend ................................................................................................................................... 17 Cost cutting potential ................................................................................................................. 18 Market consolidation continues ................................................................................................ 18 - 2 - Consumer Staples / China 168 HK 15 August 2014 1 Buy How do we justify our view? 2 Outperform 3 Hold Growth outlook 4 Underperform (initiation) Valuation 5 Sell Earnings revisions Tsingtao: recurring net profit (CNYm) and change YoY (%) Growth outlook We forecast Tsingtao’s recurring net profit to rise by 3,000 25% 20% YoY for 2014 to CNY2.1bn, 10% YoY for 2015 to 2,500 20% CNY2.3bn, and 9% YoY for 2016 to CNY2.5bn 19% 20% (compared with 2% YoY for 2012 and 0% YoY for 2013). 2,000 15% 1,500 This should be supported by a volume growth CAGR of 10% 10% 13% and an increase in non-operating financing income 1,000 9% over the period. We expect the ASP to decline slightly 500 5% over 2014-16 (vs. 2013 levels) as the product mix shifts 2% to mass-market secondary brands. That said, we believe 0 0% 0% in the long-term pricing power of Tsingtao’s core brand. 2011 2012 2013 2014E 2015E 2016E Recurring net profit (LHS) one-off gain (LHS) YoY (RHS) Source: Company, Daiwa forecasts Tsingtao: 12-month forward EV/EBITDA (based on H-share price) Valuation We believe Tsingtao’s previously strong valuation was 80 supported by its frequent M&A activity and continuous ASP hikes, both of which have now ground to a halt. 60 The stock is trading at a 2015E EV/EBITDA multiple of 15.2x (compared with an average for breweries globally 40 of 10.4x based on the consensus forecasts), and we 20 believe this already prices in the faster volume and earnings growth likely in China. 0 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Our target price target is based on a 2015E EV/EBITDA Sep-09 Dec-09 Sep-10 Dec-10 Sep-11 Dec-11 Sep-12 Dec-12 Sep-13 Dec-13 EV per share (HKD) 8x multiple of 14.3x, a 5% discount to Tsingtao’s past-5- 10.5x 13.5x year EV/EBITDA. This discount is the same as the 15.5x 18x discount experienced in 2012, when its operating-profit Source: Daiwa, Bloomberg consensus EBITDA margin also came under pressure due to competition. Consensus EPS-forecast revisions Earnings revisions The Bloomberg-consensus EPS forecasts for 2014 and 2.50 2015 trended down in 2Q14 as industry sales volume growth slowed QoQ. Our EPS forecasts are in line with 2.30 those of the consensus for 2014E, 5% lower for 2015E, and 6% lower for 2016E, as we are less optimistic on 2.10 Tsingtao’s sales-volume growth outlook. 1.90 1.70 1.50 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 2014E 2015E Source: Bloomberg - 3 - Consumer Staples / China 168 HK 15 August 2014 Financial summary Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales volume growth YoY - Principal 25.4 22.9 18.0 14.7 7.5 4.9 8.0 6.0 brand Sales volume growth YoY - Other 38.3 (1.8) 0.0 (1.2) 15.8 14.0 16.0 12.0 brands Average selling price (CNY / tonne) 2,933.3 3,005.2 3,088.8 3,187.5 3,204.8 3,191.6 3,186.9 3,190.1 Gross margin % 34.4 35.2 33.3 31.6 32.0 32.5 32.9 32.9 Sellling and distribution expense ratio 19.3 19.7 19.1 19.1 19.8 20.8 20.9 20.8 (%) Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Beer 17,761 19,614 22,790 25,318 27,767 31,331 34,498 37,403 others 266 284 368 463 524 576 634 697 Other Revenue 00000000 Total Revenue 18,026 19,898 23,158 25,782 28,291 31,907 35,132 38,101 Other income 00000000 COGS (11,832) (12,898) (15,441) (17,635) (19,236) (21,527) (23,564) (25,570) SG&A (4,483) (4,997) (5,599) (6,200) (7,183) (8,135) (9,011) (9,724) Other op.expenses (68) (72) (17) (1) (2) 0 0 0 Operating profit 1,643 1,931 2,101 1,945 1,870 2,245 2,556 2,807 Net-interest inc./(exp.) (65) (5) 36 178 251 290 271 304 Assoc/forex/extraord./others 93 125 301 360 543 336 336 336 Pre-tax profit 1,671 2,051 2,438 2,483 2,665 2,871 3,163 3,447 Tax (440) (539) (657) (639) (692) (761) (838) (913) Min. int./pref. div./others (49) (64) (60) (86) (2) (5) (5) (5) Net profit (reported)