China Brewery Sector 1Q16operations update:premiumisation still the key

What’s new: ABInBev (ABI BB, Not rated) reported its 1Q16 results on 4 May, and highlighted that beer industry sales remain weak YTD in 2016. The top-4 beer players in China have all reported their 1Q16 results in the past 10 days, and we observe that all 4 reported a decline in sales volume (except China Resources Beer [CRB]), but rises in ASPs. All of them reported expansion in either operating margins or EBITDA margins YoY, a trend we expect to continue. We still prefer select staple companies for their market-share gains and potential for ASP rises.

    What’s the impact: Premiumisation still the key: as highlighted in our report on 26 January (Switch focus to the small wonders), we think product mix upgrades will be the major revenue and operating margin driver for China’s food and beverage companies in 2016. We believe changes in market share are now a more important indicator for long-term operating margin upside than short-term ASP changes. We believe foreign brands are better positioned in the beer segment due to young customers’ preference to consume these types of beers.

    Balance sheet and possible M&A: 1) Most domestic beer players have strong net cash balances (eg, Tsingtao: CNY7.6bn at end-December 2015) and looking for M&A targets. However, we see no meaningful M&A targets outside the top-5 players (which in aggregate accounted for more than an 80% market share in China in 1Q16, on our estimates) for volume growth due to their weak brand recognition nationwide. 2) ABinBev targets to complete the merger with Sabmiller (SBB LN, Not rated) in 2H16, implying that CRB’s (291 HK, HKD17.20, Hold [3]) acquisition of a 49% stake in the CR-Snow JV should be completed simultaneously.

    What we recommend: We reiterate our Underperform (4) rating on Tsingtao Brewery (168 HK, HKD29.25) and 12-month TP of HKD26.80 based on a 2016E PER of 19x, as we expect Tsingtao to lose market share continually in 2016-18E. On a relative basis, we still prefer CRB. Key upside risks for the sector: price hikes and EPS-accretive M&A. Key downside risks: greater-than-expected loss of market share to other alcohol, eg, wine and spirits.

    How we differ: For Tsingtao, our 2016 EPS forecast is slightly below that of the Bloomberg consensus, which we attribute to our lower ASP assumptions than other analysts. For CRB, our 2016-17E EPS are 33-43% above consensus, which we believe is due to our factoring in of the earnings enhancement from the pending acquisition of the minority stake in the CR-Snow JV as well as higher operating margins