Guinness’  1HFY15  (Jun)  results  were  above  our  and  consensus expectations,  largely  due  to  strong  sales  driven  by  volume  growth, favourable  pricing  and  brand  mix,  and  a  reduction  in  the  amount  of contraband  beers.  Given  the  retracement  of  the  share  price  from  its recent peak of MYR13.32  and the strong quarter, we upgrade our call to BUY (from Neutral) with a revised TP of MYR14.10 (15.6% upside).

Above expectations.  Guinness  Anchor’s  (Guinness)  1HFY15  net profitof  MYR130.7m  (+13%  YoY)  was  above  our  and  consensus’expectations, making up  67.4% and 64.1% of FY15 earnings forecasts respectively.  In  1HFY15,  sales  were  up  10.8%  YoY, on  the  back  of:  i) 6%  YoY  volume  growth;  ii)  favourable  pricing  and sales mix;  and iii)  a reduction  in  the  amount  of  contraband  beers  from  the  intensified enforcement  efforts.  Sequentially,  2QFY15  earnings  rose  39.4%  QoQ, driven by: i) 32.5% increase in sales from seasonal demand; and ii) EBIT margin  expansion  to  19.5%  (1QFY15:  18.7%)  from  ongoing  strategic cost  management.  An  interim  DPS  of  20  sen  was  declared  for  the quarter under review (2QFY14: 20 sen).

Forecasts  and  risks.  In  view  of  the  better-than-expected  1HFY15 results,  we  nudge  up  our  FY15-FY17  earnings  forecasts  by  12-18.6% respectively after updating our sales and margins assumptions. Key risks to our recommendation are: i) weaker-than-expected sales volume; ii) an excise duty hike; and iii) intensified competition from contraband beer.   Investment case.  We replace our DCF valuation methodology with that of a dividend discount model (DDM) (CoE: 8%, TG: 2%) given Guinness’consistent dividend payouts in tandem with earnings growth as well as the  brewery  sector  being  a  fairly  mature  industry.  Our  revised  DDMderived  TP  of  MYR14.10  implies  FY15/FY16  P/Es  of  18.6x/18.3x respectively. As the share price has retraced by 8.4% from a recent peak of  MYR13.32,  we  upgrade  Guinness  to  a  BUY  recommendation  from Neutral  with  a  higher  TP  of  MYR14.10 (from  MYR13.10)  as  valuations are  undemanding  at  FY15/FY16  P/Es  of  15.8x/15.2x,  which  is  below Guinness’  average  five-year  historical  trading  P/E  of  18.7x.  Dividend yields  for  FY15/FY16  remain  decent  as  well  at  5.7%  for  both  financial years.

Briefing Highlights
A  strong  2QFY15.  2QFY15  net  profit  of  MYR76.1m  (+15.2%  YoY,  +39.4%  QoQ) was  stronger than expected, largely due to: i) volume growth from seasonal demand;ii)  ongoing  strategic  cost  management  as  well  as  iii)  a  reduction  in  the  amount  of contraband beer. Indeed, while  the second quarter of the financial year has always been the strongest quarter,  we note that  vis-à-vis  2QFY14, 2QFY15 earnings were up  by  a  robust  15.2%,  largely  due  to  its  improved  cost  efficiencies  and  working capital management. We understand from management that sales performance of all its  core  brands,  namely  Heineken,  Tiger  and  Guinness  were  beyond  expectations with  Tiger  leading  the  pack.  Management  also  added  that  Tiger  is  currently  the leading brand in the market as well.

Impact of the Goods and Services Tax (GST).  Upon   the   implementation   of   the that   under   the   GST  regime ,   businesses   are   entitled   to   claim   an   input   tax incurred   for   its  taxable  supplies.  While  the  impact  of  GST  on Guinness'  earnings remains  unclear,  management  stated  that  Guinness  is  prepared  for  its implementation this  Apr 2015.  It added that  the strong double-digit growth earnings momentum may not sustain after the implementation of the GST,  due to  a potential slowdown in consumer spending.  Management, however, expects the impact to be normalised within six months after the GST is implemented  –  after the market gets used to the new regime.

Strengthening  of  the  USD  has  minimal  impact  on  Guinness.  Since  Guinness’core operation is in Malaysia, its sales are denominated in MYR. We also understand from management that  a  portion  of its raw materials are  denominated  in  the  USD.
However,  management  clarified  that  the  strengthening  of  the  USD  will  have  a minimal  impact  on  Guinness’  earnings  as  the  portion  is  not  substantial  and  it  hasentered into a one-year currency hedging contract annually.

Price hike across its core brands in Dec 2014.  Management revealed that there was a single-digit percentage of price hike across its core brands in Dec 2014. We believe the price hike was in  preparation for  the upcoming GST as under The  Price Control and Anti-Profiteering Regulations 2014, retailers or traders are not allowed to increase  their  net  profit  margin  for  any  goods  or  services  for  18  months  from  Jan 2015 till Jun 2016.

Forecasts  and  risks.  We  believe  FY15  will  likely  be  a  record  year  for  Guinness given its strong 1HFY15 thus far.  However, after  factoring in the potential slowdown in  consumer spending post-GST, price hike across its core brands in Dec 2014  and not  least,  its  ongoing  strategic  cost  management,  we  believe  our  FY16  earnings forecast of MYR233m (+1.4% YoY) is reasonable. We believe the potential slowdown in  sales  post-GST  may  also  be  mitigated  by  the  intensified  efforts  by  the  Royal Malaysian  Customs  and  various  enforcement  agencies  to  eradicate  contraband beers. For FY17, we forecast a 5% YoY growth in its earnings, reflecting the recovery in  consumer  spending  post-GST.  The  key  risks  to  our  recommendation  are:  i) weaker-than-expected  sales  volume;  ii)  an  excise  duty  hike;  and  iii)  intensified competition from contraband beer.

Source: RHB