Brewery: Uncertainties Linger

• Post recent meetings with the brewers, we gather that c.80% of on-trade outlets have reopened to date, with the remaining 20% being premises that are still prohibited from reopening amid the RMCO.
• We caution that existing RMCO measures on certain nightlife channels may well stretch into the early part of 2021, heightening the risk of further permanent outlet closures, in our view.
• For 2020-22E, we lower our earnings forecasts by 3-8% for Carlsberg and 3-16% for Heineken, largely to factor in overall lower volume demand. Postrevision, we downgrade Heineken to SELL (TP: RM19.00) and reiterate our SELL call on Carlsberg (TP: RM19.40).

An Estimated 80% On-trade Premises Have Reopened to Date

We gather that on-trade establishments have gradually recovered from the trough (20% open during the MCO) with c.80% having reopened. Specifically, traditional ontrade (coffee shops, hawker centres) have seen a better reopening rate of 90% as compared to modern on-trade channels (karaoke, pubs, nightclubs) at c.70%. The remaining c.30% consists largely of nightlife premises with a sole liquor licence, and are still prohibited from reopening during the RMCO period.

Heightened Risk of Further Outlet Closures

With the loan moratorium coming to an end, we foresee a heightened risk of on-trade business closures, especially those that are still prohibited from reopening. We envisage on-trade operations to remain at existing levels of c.80% for the rest of 2020, with the remaining 20% at risk of permanently shuttering. For 2021, we estimate volume sales to shrink c.10% against pre-Covid/2019 levels as reduced social gatherings and the absence of foreign tourists are likely to weigh on top of outlet closures.

Focusing on Cost Optimisation and E-commerce Initiatives

Near term, both brewers will look to implement stricter cost control measures as well as prudent commercial spending to mitigate the profound impact of Covid-19. We understand that new launches (either new variant/packaging/brand) are still in the pipeline for Carlsberg, which should create some excitement in an otherwise lacklustre year. Heineken, on the other hand, will be accelerating its e-commerce offerings via Drinkies, having expanded its footprint from 3 to 7 regions in the country.

Lowering TP for Both, Heineken Cut to SELL

We incorporate 2020-22E earnings cuts of 3-8% and 3-16% for Carlsberg and Heineken, respectively, accounting for the prolonged restrictions on on-trade establishments. Post-revision, we lowered the target price for Carlsberg to RM19.40 (from RM21.90) and Heineken to RM19.00 (from RM21.30). With macro conditions remaining frail and given a lack of near-term catalysts, we do not rule out further downside risk to our earnings estimates, should existing RMCO measures remain in place beyond 1H21. All in all, we reiterate our cautious stance with a SELL rating on Carlsberg, and downgrade Heineken to SELL (from HOLD).

Trying Times for the Brewers

An Estimated 20% of On-trade Premises Remain Shut

The brewers were negatively impacted by the pandemic, with 1H20 revenue contracting 23% and 26% for Carlsberg and Heineken, respectively. This largely came as a result of severe disruption especially in on-trade channels (estimated twothirds of revenue) on top of the suspension of brewery operations during the MCO. We gathered that on-trade channels have gradually recovered from the trough during the MCO (c.20% in operation), with c.80% having reopened. Specifically, traditional on-trade (coffee shops, hawker centres) has seen a better recovery rate at 90% while modern on-trade (nightclubs, pubs/bars) lags behind at c.70%. The remaining 30% of modern on-trade largely consists of nightlife outlets with a sole liquor licence, and are still prohibited from reopening during the RMCO period (10 June – 31 December 2020).

Heightened Risk of On-trade Channel Closures

With the loan moratorium coming to an end in September, we foresee a heightened risk of on-trade business closures, especially those operating on a sole liquor licence that have yet to reopen. According to data compiled by the newly formed Klang Valley Pub, Night Club, and Bar Association, an estimated 20% of entertainment outlets within Klang Valley have shuttered permanently since the imposition of the MCO in March 2020. Overall, we envisage on-trade recovery to remain at the existing 80% of pre-Covid levels for the rest of 2020. We caution that the stringent RMCO measures (social distancing, shorter operation hours), may well stretch into the early part of 2021, as mass availability of an effective vaccine is not expected until late 1H21. In addition, with large scale social gatherings still discouraged and foreign tourists remaining absent (1H20: -68% yoy), alcohol consumption will likely be kept subdued for much of 2021.

Estimating C.10% Decline in Volume Sales for 2021

For 2021, we estimate top line sales to recover to c.90% of pre-Covid/2019 levels, premised on the assumption that 80% of on-trade outlets stay open versus pre-Covid levels. To recap, 2Q20 saw yoy top-line contraction of 40.2% (Carlsberg) and 50.5% (Heineken), dragging earnings down by 75% for Carlsberg and thrusting Heineken into a core net loss. We reckon that the proportionately bigger drag on earnings was a result of the slump in on-trade sales, which likely fetch better margins (partly on lower packaging related costs), in our view. In terms of the bottom-line, we project 2021 to see a drag of 15-20% (against 2019), resulting from the decline in the more profitable on-trade segment.

Spike in Off-trade Sales Expected to Normalise

Meanwhile, off-trade sales (supermarket, hypermarket and convenience stores) had slightly offset the dismal on-trade performance in 1H20. Driven by an increase in home consumption during the MCO, off-trade volume saw a spike in sales, with some outlets seeing 20-40% higher sales against the same period last year. That said, offtrade sales (estimated at one-third of revenue) is expected to normalise going forward, as consumption gradually shifts back to on-trade premises. We are encouraged that the brewers have expedited their shift toward online channels, although volumes remain insignificant at this juncture. Carlsberg products are available on 3rd party platforms (Shopee, Lazada, Happy Fresh) while Heineken carries its products on its dedicated e-commerce channel through Drinkies in addition to 3rd party platforms.

Focusing on Cost Optimisation and E-commerce Initiatives

Near term, both brewers will look to implement strict cost control measures as well as prudent commercial spending, to mitigate the profound impact from Covid-19. As part of Carlsberg’s plans to prepare for a post Covid-19 landscape, we understand that the management will reallocate spending with a focus on digital campaigns, ecommerce and off-trade consumption. New launches (either new variant/ packaging/ brand) are still in the pipeline for Carlsberg heading into 4Q20, which should create some excitement in an otherwise lacklustre year. On the other hand, Heineken will be accelerating its e-commerce offerings via Drinkies.com, having now expanded its geographical footprint from 3 to 7 regions in the country.

Valuation and Recommendation

Likely a More Protracted Recovery

Overall, we project the earnings of Carlsberg and Heineken to contract 30% and 37%, respectively, for 2020E, largely due to the pandemic. Heading into 2021, we have lowered our earnings growth estimates to 20% (Carlsberg) and 26% (Heineken) from 30% and 45% respectively, as we expect a more protracted earnings recovery as the strict measures that are still in place could stretch into 2021. In addition, lingering uncertainties in the labour market as well as shrinking consumer disposable incomes may further drive more cautious spending on alcohol products. Elsewhere, dividends have so far been pushed back, but we note that both managements remain committed on their dividend pay-out rate of 100% of net profit.

Retaining Our Cautious Stance; TPs Revised Lower

We incorporated 2020-22E earnings cuts of 3-8% and 3-16% for Carlsberg and Heineken, respectively, broadly to factor in weaker demand for alcohol consumption (further details under “Stock Calls” section below). Post revision, we lowered our 12- month target price for Carlsberg to RM19.40 (from RM21.90) and Heineken to RM19.00 (from RM21.30). With the operating environment remaining challenging and given a lack of near-term catalysts, we do not rule out further downside risk to our earnings estimates, should existing operational restrictions remain in place beyond 1H21. All in all, we reiterate our cautious stance on the brewers; maintaining a SELL rating on Carlsberg, and downgrading Heineken to SELL (from Hold).

Key Risks

Upside risks to our call include: i) earlier-than-expected mass rollout of an effective vaccine for Covid-19, ii) an improvement in consumer spending and ii) a sharp decline in raw material prices

Source: Affin Hwang Research - 25 Sept 2020