Declining costs and a continuous product upgrade strategy are expected to drive both the profit margin and net profit of the beer business.
Liquor revenue is expected to resume healthy growth, which in turn will drive improvements in operating leverage.
The “buy” rating was reiterated, and the target price was lowered to HK$39.50 (corresponding 11.0 times 2024 EV/EBITDA).
The outlook for the beer business in 2024 is still optimistic: China Resources Brewery's beer business performed steadily in 2023, with revenue up 4.5% year on year (sales up 0.5%, sales price up 4.0%), and the company remains optimistic about the 2024 beer business outlook. Management pointed out that despite the slow recovery in consumption, sales in the company's beer business maintained positive year-on-year growth in January-January of this year. We believe this is mainly due to reseller channel replenishment. Furthermore, we forecast that the gross margin of the beer business will increase by 2.1 percentage points to 43.5%, following an increase of 1.7 percentage points in 2023, mainly due to continued product upgrades and a downward trend in raw material costs. Although we expect China Resources Beer to increase sales and marketing investment to continue to drive double-digit growth in sales of high-end products, we believe that the increase in gross margin will be enough to offset the increase in operating expenses. We forecast that the operating margin of the beer business will increase from 18.7% in 2023 to 19.9% in 2024.
The operating profit margin of the liquor business is expected to improve structurally in the next few years. Management said that China Resources Brewery's main task in the liquor business was to re-establish a reasonable channel pricing structure, and the launch of new products and sales and marketing support will follow up this year. In 2023, the gross margin of the liquor business was 44%, far lower than the average gross profit margin of 65% in 2020/21 before Jinsha Liquors was acquired. According to our estimates, China Resources Brewery's sales and distribution expenses in the liquor business in 2023 were about 1 billion yuan, accounting for about 50% of division revenue, far higher than Jinsha Liquor's average of 13% in 2020/21.
We believe that the sharp decline in the operating margin of the liquor business (6.2% in 2023, 38.6% after amortization of intangible assets, compared with the average operating margin of 50% for Sands Liquor in 2020/21) partly reflects the weakness of the liquor consumer market, but is also the result of investing large sales and marketing expenses (related to clearing inventory at the channel end, which may include product buybacks, inventory impairment, and increased subsidies to dealers and consumers, particularly in the second half of 2023). However, we believe that the burden faced by the liquor business is a thing of the past. As liquor revenue returns to healthy growth this year, we believe that the business should achieve good operating leverage. We forecast that the operating margin of the liquor business will increase to 11.0%/18.0%/23% in 2024/25/26 from 6.3% in 2023.
The “Buy” rating was reconfirmed; the target price was lowered to HK$39.50. We lowered our target ratio to 11.0 times 2024 EV/EBITDA (previously 11.6 times), which is in the middle of the current stock price trading range of global beer companies and Chinese liquor companies. After the exchange rate change, we got a new target price of HK$39.50 (previously HK$42.00). We reaffirm the “buy” rating.
Risk warning: Raw material costs have risen, product upgrade strategies have not been implemented continuously, marketing expenses have increased, and the liquor business is expanding more slowly than expected.