Investors are concerned that beer premiumisation trend has witnessed a slowdown over the past quarters. In particular, unfavourable weather and softened dine-in traffic weighed on beer consumption sentiment in 2Q24. However, despite near-term headwinds, we think the road to beer premiumisation strategy will move forward and not retreat in the longer run, with reference to the development history of more mature markets.

For 2024, it is quite visible that domestic breweries' profitability will be stronger, driven by 1) higher ASP, 2) relief on input cost pressure, and 3) improved operational efficiency. For Tsingtao Brewery, with respect to the concrete earnings growth trajectory, its current valuation seems attractive with a margin of safety, and we think that pessimism has been priced in to a large degree. Set BUY on Tsingtao-H and Tsingtao-A.

Key Factors for Rating

Upgrading the product mix. Tsingtao Brewery (or the "Company") has a clear brand strategy to grasp the beer premiumisation trend in China. Tsingtao Classic, which is well-positioned in the sub-premium market, may continue to act as the biggest contributor to structural upgrades. In 1Q24, White Beer sustained DD% YoY growth, boosting the Company's competitive edge in the premium market.

However, Tsingtao Draft faced short-term challenges due to volume decrease of canned SKUs, together with a high comparable base. The management believes that penetration of canned beers is still significantly low in China, compared with mature markets. For the mass market, the Company targets to gradually its local brands and other low-end brands to Laoshan, and strengthen cooperation with distributors. Overall, we expect volume contribution from mid-to-high-end beers to reach 44% in 2024.

Improved profit margins. In 1Q24, the Company's revenue was down 5.2% YoY to RMB10,150m, and shareholders' profit was up 10.1% YoY to RMB1,597m.

Specifically, total sales volume fell 7.6% YoY to 2.18m KL, while ASP rose 2.6% YoY to RMB4,647 per KL. Remarkably, performance of mid-to-high-end beers was more resilient, with volume down 2.4% YoY to 0.96m KL. Due to higher ASP and lower material costs, GPM increased 2.0ppts YoY to 34.4% in 1Q24. Coupled with effective expenses control (e.g. S&D expenses ratio was down 1.0ppt YoY), NPM increased 2.2ppts YoY to 15.7%.

Beer market in China faced challenges in 2Q24. In 4-5M2024, the combined output volume of China's breweries above designated size was 6.299m KL, down 7.4% YoY. According to our estimation, Tsingtao Brewery's sales volume should record MSD% YoY decline in 2Q24, due to softened consumption sentiment (esp. in restaurant channels), along with rainy weather conditions (esp. in Guangdong and Fujian). The Company may take measures to manage stock pressure. Going forward, demand for beer products may increase as hot weather returns; ahead of big sporting events such as the Olympic Games, beer sales turnover may speed up recovery during July-August, with healthier inventory levels.

2024 outlook. Management looked for positive YoY growth in sales volume for 2024. However, as distributors appeared to be slightly cautious about re-stocking before the coming peak season, we expect its total sales volume to fall 1% YoY in 2024, with Tsingtao main brand up 2.0% YoY and secondary brand down 5.0% YoY. According to our estimation, in 2024, mix upgrades (ASP: up 3.5% YoY) and cost tailwinds (COGS per tonne: down 1.2% YoY) will combine to lead to a better GPM, which could allow some room for continuous investments in brand building and offline marketing. Meanwhile, management may further optimise its capacity layout in Shandong and other regions, with an emphasis on scale production of higher-end beers.

Key Risks for Rating

Risks: 1) unfavourable weather conditions; 2) weaker-than-expected recovery of on-premise channels; 3) intensified market competition, esp. in the mid-to-high- end (i.e. RMB6-8) beer segment; and 4) increase in input cost pressure.

Valuation

We forecast the Company's total revenue and EBITDA to achieve a 3-year CAGR of 3.4% and 13.2% from 2023 to 2026, respectively. Our 2024-2026 EPS forecasts are RMB3.67/4.07/4.53. We set TP for Tsingtao-H at HK$70.90, based on 18.0x 2024E P/E, with a BUY rating. Applying a price premium of 35%, we derive TP of Tsingtao-A as RMB89.00, which is equivalent to 22.5x 2024E P/E.