Investeringskommentar, Philip Gorham, CFA, FRM, Analyst, 17 August 2016
Having suffered from a variety of headwinds and false dawns, Carlsberg faces another catalyst of uncertain magnitude and timing, in the shape of a rebound in its key market of Russia. Nevertheless, we regard Carlsberg as the poor relation in the brewing industry, and we think investors should require a wider margin of safety before opening a position in the shares.
With about 16% of its EBIT derived from Russia, before unallocated overhead, Carlsberg is highly leveraged to the Russian beer market, although its exposure has declined from around one third of EBIT just two years ago. During the past few years, the Duma has imposed restrictive measures upon several alcohol categories, including raising the excise tax on beer by 200% and imposing measures more commonly seen in tobacco regulation: an advertising ban and prohibitions on late-night off-trade sales and on sales at kiosks. However, the regulatory picture appears to be stabilising, with no new proposed measures and with excise tax increases set at levels much closer to inflation this year. This, combined with stabilisation in the Ukrainian and Russian geopolitical environment and with improved macroeconomic conditions, could provide a positive inflection point for Carlsberg, though the timing of such an event remains difficult to predict. The firm's Funding the Journey strategy also supports our margin-expansion thesis; this is a self-help program intended to realize DKK 1.5 million-DKK 2.0 million in cost savings.
Despite its opportunities to increase margins, Carlsberg faces some structural challenges. According to projections from the United States Census Bureau, the population segment in Europe (72% of Carlsberg's 2015 EBIT) aged 18-30 will decline at an annual compound rate of 0.6% between 2012 and 2017. This will be a further structural headwind for Carlsberg, which is already facing unfavourable secular trends, such as the shift to the off-trade channel and pricing pressure from large retailers in core markets. For these reasons, we think long-term investors seeking exposure to the brewing industry should look to the stronger players with exposure to faster-growing markets and fatter profit margins
Bulls Say
- Carlsberg's portfolio includes well-known regional brands such as Carlsberg, Baltika, Tuborg, and Holsten.
- Leading positions in western China, Scandinavia, France, and northern Germany give Carlsberg some scale.
- The beer markets of Asia should continue to expand during the next five years, while Eastern Europe could rebound.
Bears Say
- The Russian government's stance on taxes and regulation on beer is unpredictable, and further tax hikes could disrupt volume beyond 2016.
- Several other publicly traded brewers sport superior margins and higher returns on invested capital.
- Carlsberg lacks a dominant global brand like Heineken or Budweiser, which hinders its scale efficiencies.
