We initiate coverage of beer company Budweiser Asia [1876.HK] with a target price of HKD14.5 and a Sell recommendation (34% downside) – ours is the first Sell recommendation since the company’s listing. We believe the company’s business model has serious vulnerabilities.
Deep earnings contraction is likely. The collapse in consumer spending due to Covid-19 is likely to cause a shift from the drinking of beer to the drinking of spirits. Covid-19 is likely to deliver a body blow to beer consumption in Budweiser Asia’s core markets of China and South Korea – there will an aversion to public gatherings in bars even when lockdowns are lifted. In Q1 20, Budweiser Asia’s volumes collapsed 42%.
The company’s cost structure places it in a weak position to withstand this – it has significantly higher fixed costs than those of its core rivals, CR Beer and Tsingtao. Its depreciation expenses will increase the hit to profits caused by Covid-19 restrictions.
Moreover, Budweiser Asia’s stated aim of generating growth through premiumisation seems unrealistic in the current circumstances.
We expect Budweiser Asia’s earnings to contract by 28% and 13% in FY 20 and FY 21 from FY 19. This would be far higher than the contractions experienced by CR Beer and Tsingtao.
Budweiser Asia’s parent is a ‘roll-up company’ that aims to generate growth through acquisition, as opposed to organic growth. Budweiser Asia is looking to replicate ABInBev’s roll-up strategy at a time of disintegrating core earnings growth. There are similarities to Valeant Pharmaceuticals – a roll-up company that collapsed in 2017. 56% of Budweiser Asia’s assets are goodwill and intangibles, indicating the series of acquisitions that it has undertaken.
Budweiser Asia has low free cash flow (FCF) yield and return on invested capital (ROIC) in comparison with Asian liquor players. At 10%, Budweiser’s ROIC is not only below that of listed beer players, but also that of spirits producers. Its FCF yield is just 2%, which is the lowest in its global peer group. The high ratio of goodwill and intangibles to assets suggests the company is intensely vulnerable to an economic slowdown.
Our discounted cash flow (DCF)-based valuation implies 34% downside. On a comparative basis, Budweiser Asia is overvalued on PE, PB and EV/EBITDA metrics. We expect the company’s shares to fall as the frailties of its roll-up-based strategy are exposed.