Many of the consumer stocks have experienced a strong and almost full-blown recovery when the economy gradually reopened since mid-Aug 2021. However, the brewers were laggards, given the pandemic restrictions in place that were less favourable to the brewers. With Malaysia’s recent transition into an endemic phase on 1 Apr, we believe the brewers will benefit from the removal of certain restrictions (i.e. resumption of operations for bars and pubs, normalising of operating hours, reopening of international borders, etc.) that are expected to boost alcohol consumption. We are also not overly concern on the recent jump in raw material prices as we think the brewers would be able to pass this on to consumers, due to the relatively inelastic demand of beer. The brewers “premiumisation push” coupled with better economies-of-scale (arising from the absence of brewery closure), are expected to support the recovery in margins going forward. All in all, we are positive on the brewers, and we upgrade our rating on the brewery sector to OVERWEIGHT (from Neutral previously).

New SOPs a boon to brewers. To facilitate with the nation’s transition towards an endemic phase, the Malaysian government has removed majority of the existing social restrictions which took effect on 1 April. Some of the relaxed restrictions include (i) resumption of operations for bars and pubs; (ii) normalising of operating hours for eateries and pubs; (iii) removal of 50% capacity limit for indoor events; and (iv) reopening of international borders. The resumption of business for bars and pubs is unlikely to translate to a huge boost in sales, as we expect much of them to have already converted to an alternative license during the pandemic to ensure survival. That said, we think that the relaxed SOPs are beneficial to the brewers due to the expected increase in alcohol consumption. This is on the back of (i) longer operating hours for eateries and entertainment outlets (i.e. past midnight); (ii) more mass gatherings, events and weddings; (iii) larger turnout for events; as well as (iii) higher tourist arrivals. We project sales volume for Carlsberg to recover by 17% and 8% in FY22f and FY23f, while we have pencilled in a 17% and 8% recovery in sales volume for Heineken in FY22f and FY23f. In our opinion, the overall consumption of beer will only return to pre - Covid levels in FY23, given the prolonged closure of nightclubs as well as permanent closure of on-trade channels during the pandemic.

Cost inflation… Brewers have seen their production costs creeping up in 2021, with average global prices for barley and aluminium increasing by 31% and 45% YoY, respectively. The ongoing conflict between Russia and Ukraine has further exacerbated the situation, as both countries collectively control c.19% of the world’s barley supply, resulting in barley prices rising by c.34% YTD. The war also threatens the supply of aluminium, sending aluminium prices soaring by 45% YTD. We highlight that raw material and packaging costs accounts for 8.3% and 3.0% of Carlsberg (FY21) and Heineken’s (FY20) revenues, as the companies have been actively managing their costs by way of (i) hedging, (ii) cost optimisation efforts and (iii) working closely with procurement partners. In any case, we are not overly concerned on the brewers’ profitability as we think they have the ability to raise prices, given the relatively inelastic demand for beer.

… but not expecting margin compression. Apart from the brewers’ ability to pass on the higher costs to consumers, we think that the better operating leverage expected in CY22 should also help support margin recovery, as we do not foresee any forced brewery closures. Note that the brewers had experienced a 7 and 11 weeks shutdown in CY20 and CY21 due to lockdowns. The brewers’ “premiumisation push” should also help improve overall margins, as the premium beer segment is more lucrative in nature, partially due to its higher price points (see Figure #3 and Figure #4).

Decent dividend yield. In the recent years, the brewers have typically been maintaining a payout ratio of more than 95%, with the exception of Carlsberg during the pandemic. Carlsberg’s dividend payout declined to 75% and 85% in FY20 and FY21, as the group decided to conserve more cash during the uncertain period. That said, following the expected recovery in alcohol consumption, we forecast that both the brewers will revert to payout ratio of 100% in FY22f and beyond, and that should translate to decent dividend yield of 4.1% and 4.4% for Carlsberg and Heineken, respectively.

Upgrade to OVERWEIGHT. Many of the consumer stocks have experienced a strong and almost full-blown recovery when the domestic economy gradually reopened in mid Aug 2021. However, the brewers were laggards due to the restrictions in place that do not bode well for alcohol sales. Nevertheless, we expect the removal of pandemic restrictions recently (effective 1 Apr) will help boost on-trade sales. With the more upbeat sentiment on the brewers following the nation’s transition to endemicity, we believe investors are more likely to eyeball on near-term growth rather than longer-term earnings, therefore we change our valuation method on the brewers from discounted cash flow (DCF) to a PE-based methodology. We upgrade our recommendations for both Carlsberg and Heineken to BUY, and consequently our rating on the brewery sector is also upgraded to OVERWEIGHT.

• Carlsberg. We tweak our earnings forecasts for FY22-23f downwards by c.3% due to housekeeping changes. However, our TP is raised to RM24.62 (from RM21.43 previously), as we change our valuation method from discounted cash flow (DCF) to PE-based methodology. We value Carlsberg based on a PE multiple of 27.8x (at its 5-year mean) on its FY22f EPS of 88.6sen. Given the upside, we upgrade our recommendation on Carlsberg to BUY.
• Heineken. Our earnings projections for Heineken are kept unchanged, but our TP is lifted to RM24.92 (from RM22.50 previously), due to a switch in valuation methodology (from DCF to PE-based valuation). Our TP represents a PE multiple 25.4x, which is at its 5-year historical mean, based on a FY22f EPS of 98.1 sen. In view of the higher upside, we upgrade our call on Heineken to BUY.

Source: Hong Leong Investment Bank Research - 6 Apr 2022