Why is the long-awaited shift beginning to emerge? On one hand, the development environment of the beer industry has changed. In 2014, China's beer industry output experienced its first negative growth in history, with a decline of 0.96%, and in 2015, the decline further widened to 5.06%. Meanwhile, imported beer has taken advantage of the situation, with annual import growth rates of 50-80% over the past four years, capturing a 1.3% market share. New categories such as premixed drinks are also encroaching on the beer market. For domestic producers, as the pie continuously shrinks and the high-end market is eroded, the decades-long strategy of grabbing share is increasingly losing its significance. On the other hand, over the past year, due to changes in major shareholders, management, or equity incentives, most companies (China Resources, Zhujiang, Chongqing) have shown a clear attitude to improve performance and increase market value. It is expected that more companies (Yanjing, Tsingtao) will join this trend. Even Budweiser, the only 'disruptor' in the industry over the past two years, may shift its focus to enhancing profitability due to global performance declines and slowing domestic volume growth.
What is the significance of the shift in corporate strategic goals? Because we have drawn lessons from the development history of the beer industry in developed countries such as the United States and Japan, we firmly believe in 'share first, the survivor wins.' Since the inception of China's beer industry, we have consistently adhered to a strategy of grabbing share, leading to a decline in the industry's gross margin from 40% to 27% over the past fifteen years. In recent years, the gross margins of listed companies have remained below 40%, with net margins (excluding non-recurring items) ranging from 1% to 4%. The beer industry is the only food and beverage sub-sector that has not experienced consumption upgrading in the past decade. However, judging from the growth rate of imported beer, the trend of demand upgrading is evident. If domestic enterprises can promptly shift their strategies, they will be able to share in the industry's huge profit pie; otherwise, they may miss the historical opportunity and end up with nothing.
Where will profit improvement come from? How much room is there? First, the industry's price per ton is returning to a reasonable level. Although the overall industry revenue and production/sales volume were still bottoming out in Q1 2016, the trend of product upgrading and rising price per ton is becoming increasingly evident. In 2015, all six major beer giants operating in China that we tracked achieved an increase in price per ton. Second, the persistently high expense ratios are beginning to decline. If industry competition eases, companies' gross margins and sales expense ratios are expected to improve significantly, and net margins are likely to rise substantially. Third, raw material prices are falling. Starting in November 2015, we mentioned in multiple in-depth reports on beer companies that, benefiting from the decline in barley prices, the gross margins of beer companies in 2016 are expected to improve by about 1 percentage point. Compared with international beer giants, which maintain gross margins of around 60% and net margins of around 15%, the beer industry's net margin is relatively low, leaving ample room for improvement. Within the food and beverage sub-sectors, the baijiu industry has gross and net margins of 70% and 30%, respectively; leading dairy companies can achieve net margins close to 10%; and the condiment industry has net margins of around 10%. The beer industry's net margin is relatively low, indicating significant potential for future improvement.
Investment recommendations. We believe that, from the bottom up, there are already signs of easing in the competitive behavior of various companies, but there is a lack of major events or data to confirm this. Investors accustomed to left-side positioning can begin to pay attention, while those favoring right-side positioning should also be ready to wait for further signals, such as events like strong alliances, management changes, corporate financing, or statistical data from the industry or listed companies. We continue to recommend Yanjing Beer, which has expectations for state-owned enterprise reform; Chongqing Beer, which has a clear trend of product structure upgrading; and China Resources Beer, which has a low net margin but a strong willingness to improve. We also suggest paying attention to Tsingtao Beer and Zhujiang Beer.
1Why is the long-awaited shift beginning to emerge? After beer industry output peaked in 2013, 2014 saw the first negative growth in China's beer industry history, with a decline of 0.96%. In 2015, industry output was 47.157 million kiloliters, a year-on-year decline of 5.10%. Except for AB InBev and China Resources Snow, which saw slight increases in sales volume, Tsingtao Beer, Yanjing Beer, Chongqing Beer, and Zhujiang Beer all experienced declines of varying degrees. In Q1 2016, industry output continued to decline by 4%. Among them, Tsingtao and Yanjing were roughly in line with the industry, Budweiser saw a slight decline, and only China Resources Beer saw a slight increase in sales volume. At the same time, imported beer has taken advantage of the situation, with annual import growth rates of 50-80% over the past four years, capturing a 1.3% market share. New categories such as premixed drinks are also encroaching on the beer market. Facts have proven that the industry as a whole has entered a relatively sluggish phase, and the method of continuously investing in expenses to increase market share is no longer viable. For domestic producers, as the pie continuously shrinks and the high-end market is eroded, the decades-long strategy of grabbing share is increasingly losing its significance.
AB InBev has always been the biggest 'disruptor' in China's beer industry (with heavy expense investment and aggressive market expansion policies). Once Budweiser, the industry's biggest 'disruptor,' changes its strategy, the disorderly competition in the market will be greatly alleviated. First, after acquiring SABMiller, Budweiser's global market share is close to 40%, while the second-place Heineken has less than 10%. In China, Budweiser is also restricted by the Ministry of Commerce due to antitrust laws, making it difficult to initiate acquisitions of large companies such as Snow, Tsingtao, and Yanjing. Moreover, its progress in building its own production capacity in China in recent years has not met expectations. Second, since 2014, Budweiser's statements about its China strategy have no longer placed the pursuit of higher market share as the top priority. On the contrary, in the past two years, AB InBev has been emphasizing the promotion of high-end brands in China. Finally, unlike large state-owned enterprises such as China Resources, Tsingtao, and Yanjing, AB InBev, as a multi-listed company, has shareholders with high demands for profit returns. Therefore, we have reason to believe that AB InBev will shift its focus to 'seeking profit.'
In Q1 2016, after years of stable growth in the Chinese market, AB InBev delivered a less-than-ideal financial report. Budweiser's sales volume in China declined for the first time, with operating revenue down 3.31% year-on-year and price per ton down 2.36% year-on-year. At the same time, domestic beer companies achieved operating revenue of 18.137 billion yuan in Q1 2016, a year-on-year decline of 1.50%; net profit attributable to shareholders was 1.059 billion yuan, a year-on-year increase of 39.13%, mainly benefiting from a substantial 180% year-on-year increase in China Resources Beer's profit. In Q1 2016, China Resources Snow and Chongqing Beer saw positive year-on-year growth, while Yanjing Beer was basically flat.
Over the past year, due to changes in major shareholders, management, or equity incentives, most companies (China Resources, Zhujiang, Chongqing) have shown a clear attitude to improve performance and increase market value, and this has already been reflected in Q1 2016 (China Resources, Chongqing). It is expected that more companies (Yanjing, Tsingtao) will join this trend. The industry's only 'disruptor,' Budweiser, may also shift its focus to enhancing profitability due to global performance declines and slowing domestic volume growth. In the future, the industry's competitive landscape may reach a state of equilibrium, and the industry will shift from 'grabbing share' to 'grabbing profit.'
2What is the significance of the shift in corporate strategic goals? Once upon a time, overseas beer giants such as AB InBev and SABMiller expanded through mergers and acquisitions, grabbed share, and then implemented a series of cost-cutting measures such as layoffs, rapidly improving their net margins. Drawing lessons from the development history of the beer industry in developed countries, and firmly believing in 'share first, the survivor wins,' China has consistently adhered to a strategy of grabbing share since the inception of its beer industry. In recent years, the gross margins of listed companies have remained below 40%, with net margins around 4%. When overseas giants entered the Chinese market, multiple giants launched fierce share wars. However, unlike overseas beer companies, state-owned enterprises face numerous restrictions on cost-cutting. The means of large-scale mergers and price reductions to gain market share have trapped Chinese beer giants in a vicious cycle of heavy investment and stagnant net margins. On one hand, they invest expenses to enter competitors' advantageous regions; on the other hand, they must defend the new territories they have fought hard to win.
In 2015, the five major listed beer companies in Greater China (with China Resources Beer's data converted to RMB) achieved operating revenue of 76.263 billion yuan, a year-on-year decline of 2.49%; net profit attributable to shareholders was 3.576 billion yuan, a year-on-year decline of 15.44%. Over the past six years, the net margins of Chinese beer companies have continuously declined, hitting a new low in 2015, with none of the five companies exceeding 6%. The lowest was Zhujiang Beer at less than 3% (Chongqing Beer mainly had negative net profit due to asset impairment losses), far below the levels of 2010, indicating significant room for future improvement.
The beer industry is the only food and beverage sub-sector that has not experienced consumption upgrading in the past decade. However, judging from the growth rate of imported beer, the trend of demand upgrading is evident. If domestic enterprises can promptly shift their strategies, they will be able to share in the industry's huge profit pie; otherwise, they may miss the historical opportunity and end up with nothing.
3Where will profit improvement come from? How much room is there? 3.1 From 'drinking more' to 'drinking better' First, the industry's price per ton is returning to a reasonable level. Although the overall industry revenue and production/sales volume were still bottoming out in Q1 2016, the trend of product upgrading and rising price per ton is becoming increasingly evident. In 2015, all six major beer giants operating in China that we tracked achieved an increase in price per ton. The fastest growth was Chongqing Beer, with double-digit growth; the slowest was Zhujiang Beer, with growth close to 1%.
From the perspective of high-end product sales, the trend of product upgrading in the industry is also very evident. Tsingtao Beer's high-end value-added categories in 2015 increased by 78% compared with 2010; Chongqing Beer's mid-range product, the Chongqing Beer brand, is continuously replacing the Shancheng brand; Yanjing Beer's canned and draft beer products also grew rapidly in 2015.
3.2 Expense ratios are expected to decline across the board Second, the persistently high expense ratios are beginning to decline. Troubled by rising sales expense ratios and administrative expense ratios, the comprehensive expense ratios of beer companies have been increasing year by year. In 2007, it was only 21.74%, but by 2015 it had reached 25.53%. Among them, the sales expense ratio increased by 3.34 percentage points compared with 2007, the administrative expense ratio increased by 1.47 percentage points, and the financial expense ratio decreased by 1 percentage point.
In the past two decades of China's beer market, due to the limitations of beer companies' sales radius and the synergies brought by cost savings, mergers and acquisitions have always been a major tool for rapid corporate growth. From 2006 to 2009, acquisition prices in the domestic beer industry were relatively stable, with an average price of around $360 per ton. Subsequently, Carlsberg's acquisition of Chongqing Beer at $2,190 per ton created a peak in beer industry M&A in recent years, and subsequent acquisitions by Carlsberg and AB InBev of Chongqing Beer and Jilin Jinshibai also exceeded $1,000 per ton. Starting in 2015, with the reduction of high-quality targets, the frenzy of M&A in China's beer industry has also slowed. China Resources Beer's buyback of SABMiller's 49% stake was only $163 per ton.
The reduction in industry M&A, the gradual completion of self-built production capacity, and the decline in interest rates in recent years have all significantly reduced the interest expense ratio in the beer industry. Due to the need for past M&A and self-built production capacity, the beer industry required large-scale investment. However, starting in 2015, Chongqing Beer, China Resources Beer, and Budweiser all took the lead in closing factories, leading to a reduction in industry interest expenses and a significant decrease in the interest expense ratio. Similarly, the industry's shrinking net margin and recent changes in industry events have also prompted companies to shift from 'grabbing share' to 'seeking profit.' As industry competition trends ease, we believe the industry's sales expense ratio is also expected to slow.
We only counted marketing expenses under the sales expense accounting item. Most companies have a marketing expense ratio of 4%, while Tsingtao Beer is around 8%. If we consider the distribution expenses incurred from buy-one-get-one promotions included in operating costs, the actual figure would be much larger than the current disclosure level. If industry competition eases, companies' gross margins and sales expense ratios are expected to improve significantly, and net margins are likely to rise substantially.
3.3 Falling barley prices help gross margins bottom out and recover Third, raw material prices are falling. The gross margins of the five listed companies in Greater China have been declining in recent years. In addition to the persistently high barley prices, price wars between industries have also affected the gross margins of various companies. In Q1 2016, changes in the industry have quietly begun. The four companies that disclosed Q1 reports all saw year-on-year increases in gross margins (excluding the impact of accounting restatements, Chongqing Beer's gross margin also increased slightly). Starting in November 2015, we mentioned in multiple in-depth reports on beer companies that, benefiting from the decline in barley prices, the gross margins of beer companies in 2016 are expected to improve by about 1 percentage point. According to data from the General Administration of Customs, at the end of 2015, barley prices were $250 per ton, compared with $280 per ton at the end of 2014, with a low point in 2015 of less than $240 per ton. In Q1 2016, the gross margins of various companies in their Q1 reports have already significantly improved. Among them, Tsingtao, Yanjing, and Zhujiang Beer saw year-on-year increases in gross margins of more than 1 percentage point, while Chongqing Beer increased slightly.
Compared with international beer giants, which maintain gross margins of around 60% and net margins of around 15%, the beer industry's net margin is relatively low, leaving ample room for improvement. Within the food and beverage sub-sectors, the baijiu industry has gross and net margins of 70% and 30%, respectively; leading dairy companies can achieve net margins close to 10%; and the condiment industry has net margins of around 10%. The overall beer industry's net margin is relatively low, indicating significant potential for future improvement.
4Investment recommendations We believe that, from the bottom up, there are already signs of easing in the competitive behavior of various companies, but there is a lack of major events or data to confirm this. Investors accustomed to left-side positioning can begin to pay attention, while those favoring right-side positioning should also be ready to wait for further signals, such as events like strong alliances, management changes, corporate financing, or statistical data from the industry or listed companies. We continue to recommend Yanjing Beer, which has expectations for state-owned enterprise reform; Chongqing Beer, which has a clear trend of product structure upgrading; and China Resources Beer, which has a low net margin but a strong willingness to improve. We also suggest paying attention to Tsingtao Beer and Zhujiang Beer.
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