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Tsingtao Brewery Summary

Core Content and Key Information

Tsingtao Brewery, the second-largest beer producer in China with an 18% market share in 2015, reported a 2.5% increase in net profit after tax (NPAT) in 1Q16, despite a 5.3% decline in sales volume. The company's performance was driven by a 50 basis point (bp) expansion in net margin, primarily due to a significant drop in packaging costs. Tsingtao's principal brand accounted for 54% of total sales volume, with a 7% decline in volume, and high-end brands also saw a 2% drop, attributed to weak channel investment and intense competition.

The company's gross margin expanded 180bp YoY to 34%, a trend similar to its peers, while SG&A expenses fell 2.5% YoY but rose to 23.9% of sales. The tax rate increased by 300bp to 32% due to more subsidiaries turning loss-making and the non-deductibility of their losses.

The analysts retain their estimates for the full-year NPAT, which accounted for 33% of the 1Q16 results, but remain cautious due to uncertainties around the Suntory deal completion in June. The company is rated Underperform with a price objective (PO) of HK$27.0 (A-share RMB24.1) for H-shares, A-shares, and ADRs.

Financial Highlights

Earnings Forecast (CNY Millions)

Valuation (Dec)

Investment Rationale

• Underperform Rating: Due to downside risks outweighing upside potential.
• Market Share Stagnation: The momentum of market share growth in recent years has paused in 2015, with profits from all regions except Shandong declining YoY.
• Non-Core Income: Core operating metrics are deteriorating, with non-core income contributing 50% of reported net profit in 2015.
• Earnings Outlook: Expected to deliver weaker earnings compared to large-cap staple peers.

Key Ratios (2016E)

Valuation Comparison

Price Objective Basis and Risk

Price Objective for A-shares (RMB24.1)

• Derivation: Based on a blend of P/E (20x 2016E EPS) and DCF (RMB23.9).
• Upside Risks:
  • Defensive nature in a bear market.
  • Significant M&A transaction at a reasonable price.
  • Faster-than-expected barley price decline.
  • Higher-than-expected increase in beer prices.
  • Better sales mix improvement.
• Downside Risks:
  • Further slowdown in beer sales.
  • Rising raw material costs.
  • Increasing marketing expenses.
  • Severe competition.

Price Objective for H-shares (HK$27.0) and ADRs (US$17.2)

• Derivation: Based on a blend of P/E (19.0x 2016E EPS) and DCF (HK$27.8).
• Upside Risks: Same as above.
• Downside Risks: Same as above.

Analyst Certification

• Tina Long, CFA: Certifies that the views expressed in this report reflect her personal views and that no part of her compensation was directly or indirectly related to the recommendations or views expressed.

Company Description

Tsingtao Brewery is the second-largest beer producer in China, with a principal brand "Tsingtao" that is the most famous Chinese beer brand. It operates approximately 60 brewing plants with an annual capacity of 13 million tons. The government holds a 30.5% stake, Asahi holds 20%, and Mr. Chen holds 3.6%. ADRs are exposed to currency fluctuations, and dividends are gross less withholding.

Key Observations

• Sales Volume: Has declined for seven consecutive quarters, with Tsingtao's principal brand showing a 7% drop.
• Margins: Improved due to lower packaging costs and a favorable sales mix, but operating and net margins are still under pressure.
• Valuation: Tsingtao's valuation is below the 10-year average, with a 28% discount to its H-share P/E.
• Investment Outlook: Despite the margin improvements, the company's growth prospects are weak, and its earnings are expected to lag behind large-cap peers.