Highlights

• In the 2016 budget recalibration in January, the government announced that it would be cracking down on parallel imports via the duty free island and the smuggling and sale of contraband beers nationwide. This was subsequently followed by a decade first duty revision and rebasing of duty calculations in March 2016.

• The brewers have thus far produced excellent results on the back of organic volume growth and higher margins from effective cost saving measures. They have largely managed to control the rise in ASP by reducing the ABV. We reiterate our positive stance on the sector as we opine that both measures will serve to benefit the brewers.

Comments

• Our channel checks revealed that the government will step up its effort on the crackdown of contraband/parallel import beers to reduce the leakage in potential government revenue due to its rampant presence in the market.

• Whilst operations have been ongoing, we have noticed and can expect a greater frequency of nationwide crackdowns in the 2HFY16 and into the near future.

• Whilst the curtailing of parallel imports will lower demand from the duty free islands in the short run, the mid and long term prospects are promising and beneficial to the brewers.

• Furthermore, we see the rebasing of excise calculation in a more positive light. To recap, previously the excise duty was calculated as RM7.40/litre + 15% ad valorem tax. Under the new structure duty is calculated on the basis of RM175 per 100% vol/litre.

• The duty hike effect is nullified by the potential to reduce the ABV or “water down” beers under the new structure. This in turn will allow the brewers to protect their margins without having to increase ASP or price in a margin buffer.

• Assuming the government revises the duty base to RM200 per 100% vol/litre from the current RM175 per 100% vol/litre, a 14% hike. To maintain the current duty paid of RM8.75 per litre for a 5% ABV beer, the brewers would need to adjust the ABV to 4.4%, which is well in the range of a full strength beer.

• Mature markets segment beers into 3 categories according to their ABV: low-strength 1.5%-2.7%, mid-strength 2.7%-3.5%, and full-strength 3.6%-5%. To note, our brewers have yet to segment their beers in these categorizations.

Risks

• The overhang of RM56m claimed by customs which is still pending is of more concern in the near term. Consumers reject the tweaked flavour profile of lower ABV beers.

Rating

• OVERWEIGHT
• The ED revision allows the brewers to mitigate price hikes by lowering ABV thus nullifying margin pressure.

• Relatively high dividend yield in “yield hungry” environment.

• Government commitment to crackdown on cont rabands will benefit the legal industry.

Stock Pick

• Forecasts for HEIM and CAB remain unchanged. Maintain our BUY on HEIM (TP: RM18.51). Upgrade our call on CAB to a BUY with a higher TP of RM15.42 (previously RM14.69) as we lower our WACC assumption. We prefer HEIM to Carlsberg due to the latter’s strong domestic presence.

Source: Hong Leong Investment Bank Research - 20 Sep 2016