We expect the brewers to sustain robust earnings growth heading into 2020, underpinned by: (i) absence of excise-duty hikes; (ii) potential sales boost from Visit Malaysia 2020 and declining presence of contraband beer; and (iii) temperate cost environment. Both Carlsberg and Heineken’s medium-term outlooks remain positive, with growth catalysts for the former arising from premiumisation, while the latter stands to benefit from its e-commerce foray and new product launches. We raise our DCF-derived TP for both stocks, in view of increased investor appetite for safe-haven stocks with sustainable yields, ascribing a narrower valuation gap vis-à-vis the local consumer sector and regional peers. We maintain our HOLD on Carlsberg due to its recent share-price outperformance and reiterate our BUY on Heineken.

Resilient Earnings Momentum

Both Carlsberg and Heineken have demonstrated commendable earnings delivery in recent quarters, with double-digit top-line growth registered since 4Q18 in spite of three successive rounds of price hikes over April 2018-April 2019. While this was partially attributable to the clampdown in contraband alcohol (said to command 20-30% of the malt liquor market), the sustainable growth drivers are nonetheless tied to an expanding market size and favourable consumption patterns, in our view.

Industry Volumes to Benefit From VM2020 and Contraband Crackdown?

We believe the brewers are set to register another record sales performance in 2020, with volume sales supported by healthy consumption trends under a captive duopoly malt liquor market. Higher tourist arrivals expected from the Visit Malaysia 2020 campaign, alongside the ongoing clampdown on contraband alcohol, could potentially boost demand growth as well. We expect total earnings to register a growth of 10% in 2020, with margins projected to hold up due to easing production input costs expected.

Now More Bullish on the Brewers

While we maintain our NEUTRAL call on the consumer sector, we are more bullish on the brewers due to its favourable earnings outlook (3-year earnings CAGR of 10%) with sustainable yields. Given the increased market appetite for defensive yield exposure and the valuation discount relative to peers in both the local consumer sector and regional brewery space, we lift our target prices for both Carlsberg (CAB MK – from RM24.60 to RM28.50) and Heineken (HEIM MK – from RM25.00 to RM29.00). However, we maintain our earnings estimates as well as respective HOLD and BUY recommendations. Heineken is our preferred pick as the sector laggard, with implied upside of 15% and higher 2019- 21E yields of c.4-5%

Fundamentals Remain Supportive of Market Expansion

The operating environment continues to be favourable for Carlsberg and Heineken, in our view. With a duopolistic c.95% share of the legal malt liquor market, we expect both brewers to capitalise on the robust growth trajectory seen with domestic beer consumption. This is in line with regional trends, whereby Asian countries are backed by healthy demographic patterns – rising population and affluence, urbanisation – with chilled alcoholic beverages such as beer and cider being well suited to the warm, temperate climate, particularly in Southeast Asia.

Moderating Cost Pressures

We foresee cost pressures, which led the brewers to raise ASPs three times within a year (3-5% in April 2018, 5-8% in September 2018, and 3- 12% in April 2019), to ease over the near term. This follows an absence of excise duty/tax hikes after September 2018’s SST implementation, while we expect moderating key production input costs such as aluminium and malt barley prices. In addition, the minimum wage hike to RM1,200/month at major cities (from RM1,100) is not expected to have a material impact (c.5-6% of revenue). As such, we expect margins to improve going forward with better cost efficiencies.

Potential Positives From Illicit Market Clampdown and Tourism Drive

Heading into 2020, the organic growth in beer volumes could be further supported by the landmark Visit Malaysia 2020 campaign targeting significantly higher tourist arrivals of 30m and receipts of RM100bn for next year. The shrinkage of the illicit market – suggested to be declining in recent times from a pre-existing market share of 20-30% – would also bode well for legal beer volumes. That said, it is difficult to quantify these potential positives given the lack of available tracking data.

Carlsberg: Riding on Premiumisation…

Carlsberg has clawed back its domestic market share from 37% in 2016 to >40% by 2018, after a successful strategy realignment which accelerated volume growth for both its mainstream and premium brands to double digits last year. Although its mainstream products’ growth has normalised since, we are optimistic on its premium segment’s ability to sustain its high growth traction leading into next year on the back of a strong portfolio riding on the premiumisation trend, as consumers continue to acquire new tastes beyond standard brands. Carlsberg’s super premium ‘Brooklyn’ brand, which addresses the rising niche demand for craft beer, has also taken off strongly since its introduction last year

… While Regional Operations Are Seen to Recover

Similarly, we believe Carlsberg’s regional businesses in Singapore and Sri Lanka (through 25%-owned associate, Lion Brewery) are set to deliver better results next year. We are positive on management’s ability to sustain the turnaround of Carlsberg Singapore’s sales performance after an operational shake-up in 2H18, despite stiffer market competition in the country. On the other hand, we expect Lion Brewery, which controls >80% of Sri Lanka’s malt liquor market, to naturally regain its growth momentum after the terrorist bombings in April which led to a momentary dip in sales performance.

Heineken: Positive Foray Into E-commerce, New Product Variants

Carlsberg’s prospects notwithstanding, we believe Heineken is also poised for robust sales growth heading into next year, albeit under a different approach in the form of a new sales channel as well as new product offerings. ‘Drinkies’, Heineken’s e-commerce platform introduced last year which offers chilled drinks delivery within an hour in Klang Valley and Penang, has been steadily gaining reception amongst urban dwellers and should gradually boost the company’s off-trade sales penetration, in our view. In addition, the platform also doubles up as a base for Heineken’s digital presence, complementing the recent launch of its new product variants, namely the non-alcoholic ‘Heineken 0.0’ and easy-to-drink ‘Tiger Crystal’. All in, we believe these should fortify Heineken’s dominance in the mainstream segment while also expanding its addressable market by catering to different preferences – convenience, alcohol intake moderation, and lighter taste profiles.

Valuation & Recommendation

We are more bullish on the brewers in view of an upbeat earnings outlook culminating in our 3-year sector earnings CAGR forecast of 10%. Against a positive backdrop and increased market appetite for sustainable yields, we are raising our target prices for both Carlsberg and Heineken, albeit maintaining their respective HOLD and BUY ratings. Although the brewers are trading above historical forward multiples, we believe they are justified in view of the perceived valuation gap relative to the local consumer sector (c.29x forward PER) as well as regional brewery peers. The latter’s rerating YTD is likely pricing in the region’s high growth potential – reflected in Budweiser Brewing APAC’s end-September listing at 43x consensus forward PER.

Source: Affin Hwang Research - 11 Nov 2019