Thai Beverage - RHB Invest 2017-04-10: Drink To Your Heart’s Content

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THAI BEVERAGE PUBLIC CO LTD Y92.SI

Thai Beverage - Drink To Your Heart’s Content

• We initiate coverage on ThaiBev with a BUY and a TP of SGD1.10 (17% upside). 
• We expect to see an upturn for ThaiBev now that the 100-day mourning period is over; following the Songkran festival, we expect alcohol consumption to normalise. 
• Furthermore, the group is likely to use the new Excise Tax Act amendment as an opportunity to raise prices, thereby seeing a margin uplift in its alcohol segments. 
• Further inroads into Vietnam via acquisitions would be a key catalyst to the stock price.

Investment Thesis 

Brewing a higher profitability in its beers segment 

Beers is the second largest segment of ThaiBev. 

• As at FY16, the beers segment contributed 32% of ThaiBev’s revenue and 16% of EBIT. It is the second largest segment after the spirits business. We believe this segment would be the key that spurs ThaiBev’s FY17F revenue and EBIT on the back of rising margins and further gains in market share. 
• By FY19, we expect the beers segment to contribute 34% towards its topline and 22% of operating profit.

Substantial upside in margins given the low base. 

• Chang beer was re-launched in 2015. Despite the successful rebranding exercise that brought ThaiBev’s market share to 40% in 2016 from 28% in 2015, we note its operating margin is still much lower at 7% compared to its regional peers – Heineken Malaysia (Heineken) (HEIM MK, BUY, TP: MYR19.30) and Carlsberg Malaysia (Carlsberg) (CAB MK, NEUTRAL, TP: MYR15.40) – which were able to achieve an average operating margin of about 18% in FY16.
• Heineken and Carlsberg each have more than 40% market share in Malaysia’s beer market for at least the past seven years. We believe this factor has given the two brands significant operating leverage and pricing power to hold up their respective high operating margins.
• We note that ThaiBev has only managed to achieve a 40% market share in Thailand just last year. As such, we think there could be a substantial upside to the group’s margins as it gains pricing power and improves on its operating leverage through sustained high market share in the medium term: 
  1. We expect to see gross margin expansion in the short-run. The new Excise Tax Act amendment is likely to take effect in September this year. The amended legislation would change the base for computing excise tax from the existing ex- factory price and cost, insurance and freight (CIF) values to the “recommended retail price”. Historically, management used this opportunity to raise prices more than the excise tax in order to improve gross margin. Furthermore, as the market share of Chang beer strengthens, we believe the company would be in a better position to raise prices.
     In addition, we believe ThaiBev is able to reduce its bottle cost as the percentage of recycled bottles increases with higher sales volumes. We understand from management that each recycled bottle is THB3 cheaper than a new bottle. At the moment, 60% of the bottles used are recycled compared to 40% last year. Management cited that the number could potentially go as high as 80% in the long run when sales volume increases.
     As at 1QFY17 (Sep), the gross margin has already risen to 23% (up from 21.2% in 2016 and 18.7% in 2015) as management locked in lower raw material and packaging prices for the year. Therefore, we can safely assume a higher gross margin going forward once ThaiBev raises the average selling prices.
  2. In the medium term, we should also see its operating leverage improving as volume grows. ThaiBev’s beer facilities are operating at about 60% utilisation rate at the moment. Per unit fixed cost would decline as we expect continued growth in volumes.

Continued growth in market share. 

• As mentioned earlier, ThaiBev successfully regained the bulk of the market share (40% in 2016) after the re-launch of its Chang beer. Nonetheless, the group aims to be the No 1 beer player with more than 45% market share by 2020F. Hence, we believe there is still potential for a further upside in market share.
• According to management, Chang’s market share is under-represented in the food service restaurant channels as it was previously identified as an economy beer that is more often consumed off-trade. Following the strong rebranding exercise, management thinks there is a good opportunity for Chang to penetrate food service restaurants. 
• We believe the company would strengthen its distribution via this channel in FY17. As such, we expect Chang to expand faster than the industry’s annual growth rate of 3-4% via aggressive marketing and strengthening of its distribution network through the food service restaurant channels.

Earnings expectations. 

• If we were to annualise FY16’s numbers, we would expect beer sales to grow by 7% CAGR over FY16-FY19F mainly on the increase in market share. 
• Compared that against 2016’s annualised EBIT, beer would contribute 5.3ppts out of the group’s 7.1% growth in FY17F, based on our forecast. This is mainly due to the weak performance in the spirits segment during the mourning period of the late King Bhumibol Adulyadej in 1QFY17. 
• On a 3-year basis, we project operating profit to grow much stronger at 21% CAGR.

Spirits – staging a comeback in 2018 

Spirits – ThaiBev’s largest segment. 

• Spirits contributed 55% to ThaiBev’s topline and 93% of EBIT in FY16. It is a stable cash cow, generating an average of THB26bn of EBITDA pa for the group.

Spirits sales to make a comeback in FY18F. 

• The segment is expected to see a short- term blip as the suspension of festive and entertainment activities during the mourning period affected spirits consumption. 
• While Thailand does not have any publicly available statistics on spirits consumption, we note the Bank of Thailand’s (BoT) statistics that the decline in alcohol volumes (using beer volume as a proxy due to limited information available) has slowed down from -17% in Oct 2016 to -8.7% in Feb 2017. Therefore, in line with management’s expectations, we believe that on-trade activities should start to normalise after the Songkran festival, thereby bringing up spirits consumption.

Price hike and margin increase. 

• In addition, the company is expected to raise prices thereby increasing gross margins upon the excise tax hike in 2H17. ThaiBev is the country’s No 1 player in the spirits industry with a market share of over 80%. The volume share of the second leading player – Pernod Ricard – is at a far cry from ThaiBev’s, at only 2%. Hence, we believe ThaiBev would be able to raise prices and also its margins without severely impacting its volumes. 
• The full-year impact would then be reflected in FY18F. If we were to annualise FY16’s numbers, we would expect spirits to register a 2% CAGR in revenue and 3% CAGR in EBIT over FY16-FY19.

Non-alcohol beverages may be the next big thing 

Future engine of growth. 

• At the moment, the non-alcohol beverages segment is still in its investment phase and loss-making. As at FY16, this segment contributed 9% to revenue. Management is likely to focus on growing its topline and market share. The company expects this segment to turn EBIT positive by end-2018. 
• We understand that excluding some one-off advertising and promotional expenses in 2015, the segment’s 9M16 EBITDA has improved by 58% YoY. Thus, we project losses in the segment to narrow significantly across FY17-18.

Narrowing losses as a result of the growth in bottled water sub-segment. 

• Bottled water has been the fastest growing sub-segment amongst the non-alcohol beverages, registering more than 10% growth in volume last year. It also has the highest profitability within the non-alcohol beverage segment. 
• With an expansion plan for this sub-segment in sight, we believe that the narrowing losses of the non-alcohol beverages segment would be led by the growth of bottled water.

Crystal is the second largest player in the bottled water market with 14.5% market share. 

• Given the strong growth in this sub-segment (Figure 14), ThaiBev plans to set up new production lines in the North-East and South of Thailand. This would raise annual production capacity to 800m litres (from 600m litres). Production lines in these new regions would also help to reduce logistical costs for transporting water. By 2020, the group plans to bring its annual drinking water capacity to 1.1bn litres.
• While the Metropolitan Waterworks Authority of Thailand says that tap water is safe to drink, most tourist forums advise against it and urge tourists to drink bottled water instead. Most Thai residents, especially in Bangkok, do not feel it is safe to drink tap water directly. 
• With the rising affluence, people are likely to buy more bottled water. With that, we expect the water sub-segment to continue delivering about 10% annual growth in volume in FY17-20.

More collaborations with F&N. 

• The Frasers Centrepoint Limited (FCL)/Fraser & Neave (F&N) asset swap is imminent. During the last analyst briefing, CFO Sithichai Chaikriangkrai, stated that the asset swap would be completed by FY17. Moving forward, we believe that there are opportunities for more collaborations between ThaiBev and F&N given the wide range of non-alcohol beverage products that both companies hold respectively.
• In 2016, F&N began distributing the Oishi tea range, COLA and Ranger in Malaysia. Within one year, Oishi is already leading the green tea segment in Malaysia. F&N has also begun distribution of Oishi tea in Singapore. 
• We understand that management has plans to expand Oishi into new markets like Laos and Cambodia. Since this is outside of Thailand, we believe that distribution could be done by F&N as the latter has a proven track record in promoting Oishi.
• On the other hand, ThaiBev has also launched 100Plus in Thailand in 2015. We think there are other potential products that ThaiBev could distribute in Thailand including F&N’s Nutrisoy and Nutriwell drinks.

Potential acquisition to boost earnings 

Acquisitions, the gateway to Vietnam. 

• President and CEO, Mr Sirivadhanabhakdi, has publicly expressed his interest to acquire SABECO and raise F&N’s stake in Vinamilk should the opportunities arise.
• SABECO is the leading beer company in Vietnam, with about 46% market share while Vinamilk is Vietnam’s largest dairy producer with close to 50% market share.
• Since the details of the deal remain uncertain, we have not factored in the SABECO acquisition into our numbers. On Vinamilk, we only account for F&N’s current 17.7% stake. Nonetheless, we are positive on ThaiBev should the acquisitions go through as they give strong inroads into the Vietnamese market.

Vietnam’s strong beer drinking culture. 

• Vietnam is ASEAN’s third largest population member state of 94m people with a beer drinking culture. Its per capita consumption of beer stands at a staggering 40.5 litres per year, way above Asia’s average of 17 litres per capita. Based on Euromonitor’s estimates, the market is projected to grow at 6% CAGR to 2020.
• Vietnam’s beer market is dominated by SABECO with its Saigon beer, 333 export beer and Saigon Lager. Should the acquisition go through, ThaiBev would not only gain ownership of market leading brands but also a strong distribution access for its existing beer and spirits portfolio.
• F&N’s management has highlighted that acquisitions outside of Thailand would be undertaken by F&N rather than by ThaiBev. Given that ThaiBev expects to consolidate F&N after an asset swap, we would not be surprised if ThaiBev decides to use F&N as an investment vehicle to acquire stakes in SABECO instead.

Strong growth prospect for Vinamilk. 

• Vinamilk is Vietnam's largest company by market capitalisation and also the country’s largest dairy company, with over 50% market share in various milk categories. It is one of the fastest growing companies due to its strong distribution network in a country which is seeing a rising consumption of dairy products.
• F&N currently owns 17.7% stake in Vinamilk. While F&N has already established a footprint in Vietnam to import, market and distribute F&N products, we believe Vinamilk’s distribution strength complements F&N’s existing non-alcohol beverages product range. F&N has also announced that it is looking to raise its stakes when the opportunity arises.

More acquisitions to come. 

• The potential acquisitions mentioned above come about as a result of the Vietnamese Government's intention to reduce its stake in state-owned enterprises through a privatisation drive. We understand that growth through acquisitions is also in line with F&N’s goals to rebuild itself into a regional food & beverage power house. This is especially after it sold its stake in Asia Pacific Breweries (2012) and Myanmar Brewery (2015). F&N’s management also cited that any M&A to be undertaken would likely be earnings accretive.
• Currently, F&N is in a net cash position and has ample debt capacity. Going forward, we believe ThaiBev would use F&N as an investment entity to acquire companies with good distribution networks in the ASEAN region.
• SABECO’s leading beers are Saigon and 333 export.

Valuations 

Initiate coverage on ThaiBev with a BUY recommendation. 

• Our TP of SGD1.10 is based on an SOP valuation and implies 26x FY17F P/E, in line with peer average. This represents a 17% upside from the current share price. 
• We use this valuation methodology to take into account the company’s stake in F&N and FCL.

Undervalued compared to peers. 

• Currently, ThaiBev is trading at 22x FY17F P/E, which is below its peer average multiple of 26x. We believe the stock could be substantially re-rated when the impending acquisitions go through.

Key Risks 

Slower-than-expected recovery in consumption. 

• In 1Q17, ThaiBev saw an 11% decline in spirits volume due to the suspension of festive and entertainment activities during the mourning period. Management thinks that the Songkran festival would help to improve the negative sentiment and expects consumption to normalise thereafter. 
• We expect on-trade activities to start showing improvement after the 100-day mourning period, thereby bringing up spirits and non-alcohol beverages consumption. 
• Our earnings forecasts would face a downside risk if the Songkran festival is unable to uplift the consumption levels.

Intensified competition. 

• Since the re-launch, market share of Chang beer has grown stronger to 40% from 28%. Brand loyalty to the new Chang is also evident when the beer’s volume was in line with market performance in 1QFY17 (Oct-Dec) even with the retaliation from Singha Corp Co Ltd (Singha), which did a facelift for its Leo beer and introduced a new brand – U beer. 
• Our ground checks show that marketing activities for U beer remained limited with no advertisement in mass media so far. However, Chang may find it hard to defend its market share if Singha decides to channel more resources to fight for market share.

Susceptible to tax hike. 

• Thailand has a very high alcohol excise tax rate of about 55% as well as strict alcohol consumption regulations due to the Government’s determined intentions to curb excessive alcohol consumption. 
• If ThaiBev is unable to pass this cost onto the consumers, its profitability would be compressed.

Execution risk on M&As. 

• ThaiBev is likely to undertake an aggressive M&A strategy to achieve its “Vision 2020” goal. However, the company faces potential earnings dilution if it overpays for new businesses or is unable to reap the desired synergies from the new acquisition.

FCL/FNN swap would lead to a 7% decline. 

• FCL is trading at a lower multiple of 11x FY17F P/E compared to F&N’s 30x FY17F P/E. 
• Based on our estimate, the FCL/F&N asset swap would lead to a 7% decline in ThaiBev’s PATMI in FY17F.

Juliana Cai CFA RHB Invest | http://www.rhbinvest.com.sg/ 2017-04-10

RHB Invest SGX Stock Analyst Report BUY Initiate BUY 1.10 Same 1.10