GAB – Fundamental Analysis (18 Aug 2015)

At the time of writing, I owned shares of GAB.
Changes:
  1. 18 Aug 2015 – First write up of GAB using new style, and covers FY15 Q4 results.

Important: MYR in ‘000s except per share data

Business Profile

GAB is principally engaged in the production, packaging, marketing and distribution of beverages, primarily alcoholic. GAB’s principal business is in the production, packaging, marketing and distribution of beer, stout and malt-based drinks under the Guinness, Anchor Smooth, Anchor Strong, Tiger, Heineken, Kilkenny, Anglia Shandy, Malta, Paulaner and Strongbow brands.

GAB with its portfolio of iconic international brands, is the leading brewer in Malaysia. GAB brews, markets and distributes:

  • World-acclaimed iconic Asian beer TIGER BEER, and its doubly refreshing variant TIGER RADLER;
  • The World’s No. 1 stout GUINNESS;
  • The World’s No. 1 international premium beer HEINEKEN;
  • The all-time local favourite ANCHOR SMOOTH and its strong beer variant ANCHOR STRONG;
  • The premium Irish ale KILKENNY;
  • The Real Shandy ANGLIA;

GAB also produces the wholesome, premium quality non-alcoholic MALTA. GAB’s brand portfolio also includes the World’s No. 1 cider STRONGBOW, the No. 1 German wheat beer PAULANER, Japan’s No. 1 100% malt beer KIRIN ICHIBAN, the World’s No. 1 Ready-To-Drink alcoholic beverage SMIRNOFF ICE and the award-winning double fermented Belgian craft beer AFFLIGEM.

To understand more about the product portfolio, you can refer to page 22-40 in Annual Report 2014 or here.

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Raw materials are sourced from the US, UK and Europe. Labels and stickers come from Singapore. Besides packaging and raw material costs, excise duties to the government are its biggest cost item, making up 50% of total revenue. Excise duties were last raised in the 2006 Budget by RM1.40 per litre to RM7.40 and propelled Malaysia into having the second highest duty on beer in the world after Norway. The excise taxes are imposed on a “per litre of alcohol basis” and would thus be felt evenly across all segments, including wine and spirits (whiskey, rum, brandy, etc.) Another tax taken into account is the ad valorem taxes (15%) which are based on the monetary value of the beer. This means the tax burden on more expensive brands are higher. Other taxes would be import duties (RM5.00 per litre) and sales tax (5%). The current utilisation rate at GAB’s plant is 70% and its remaining capacity will be able to cater to newer premium brands in the future. Hence, no major capital expenditure is expected in the coming 2 to 3 years.

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Source: http://cdn1.i3investor.com/my/files/dfgs88n/2013/09/30/1479298907-1524512752.pdf

The following chart shows the market shares of the available brands in Malaysia’s MLM

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Source: iCapital 7 Mar 2014

Ownership

GAB mainly owned by its parent company and few foreign fund institutions.

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Cost Advantage (Moat: Wide)

  • GAB and CARLSBG are the only major players in Malaysia. They basically have the say in pricing even if they are under highly regulated environment.
  • Lower raw material cost
    • Raw materials make up 3-6% of total cost, and the prices of wheat and malt barley have declined by 23% and 20% respectively since Jan 2013. Hence, this should benefit GAB and CARLSBG, although not substantially, as raw material is not a major cost component (beer taxes make up 50-60% of total cost).
  • Growing premium brand sales
  • The typical 2-3% annual increase in average selling prices (ASP).

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Switching Costs (Moat: Narrow)

  • GAB and CARLSBG are the most popular brand here. Switching cost is not high.

Network Effect (Moat: Narrow)

  • The more people drink beers, the higher revenue GAB is.
  • The rise in contrabands in the market have come to a worrying level

Intangible Assets (Moat: Wide)

  • Formula of making breweries
  • Network of distribution
  • High customer loyalty

Efficient Scale (Moat: Wide)

  • Highly regulated
  • GAB and CARLSBG are the largest permitted breweries producer in Malaysia.

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In the past 5-10 years, GAB managed to maintain more than 38% of ROIC and more than 30% of CROIC. By MorningStar’s definition, GAB has a very wide economic moats.

Profitability

In the past 5 years, even if GAB facing challenges in market and economy, GAB’s EBITA has been increased from RM246.2m (FY11) to RM352.6m (FY15).

GAB’s latest EBITA margin is 20.2%. By Moody’s benchmark, its EBITA margin can be rated as Ba.

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Leverage & Coverage

Refer to the following charts, GAB’s leverage and coverage are very healthy.

  1. Debt/EBITDA – 0.20x (FY15) (Aaa)
  2. EBIT/Interest – 99.72x (FY15) (Aaa)
  3. Retained Cash Flow to Debt – 255% (FY15) (Aaa)

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Liquidity

Trend of cash conversion cycle ranged from 18 to 30 in the past 5 years. No red flag identified. We have to compare this with CARLSBG. Please refer the comparison section.

In tandem with consistently improving earnings and flat capital expenditure, GAB’s FCFF has been consistently improving from RM166.4m (FY11) to RM269.1 (FY15).

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FY15 Q4 Results

FY15 revenue increased by 8.6% to RM.7b because of 6.7% growth in volume. Despite the challenging operating environment in FY15, GAB provided continuous support and effective enforcement against contraband beers by the authorities. This results in the recovery of the legal Malt Liquor Market (MLM). GAB improved its efficiency where its EBITA margin improved from 17.6% (FY14) to 20.2% (FY15). However, net profit growth was slower at 8.1% due to a higher effective tax rate of 26.7% (vs FY14:25.4%).

4Q15 revenue declined 3.7% to RM397.6m because of poor consumer sentiments and spending in reaction to the GST implementation. However, EBITA increased by 10.9% to RM352.6m which the Group attributed to timing of promotional spending and better cost management. However, net profit of RM44.0m was only 11.6% higher due to a higher effective tax rate of 32.8% (vs 3Q15:25.0%).

In term of cash flow management, GAB has optimized its working capital movement resulting in lower working capital of RM62mil. The lower working capital results in higher operating Cash Flow for GAB. The lower working capital is permanent, and hence, shall persist for the future reporting period’s i.e. FY16 and FY17.

GAB successfully implemented several initiatives in F15 to deal with a number of challenges in the operating environment such as low consumer sentiment, post-Goods and Services Tax (GST) inflationary pressure and unfair competition from contraband. GAB successfully prepared for GST implementation with a holistic commercial approach which minimised the impact of GST for consumers and its business partners. Continuous engagement with distributors, trade associations and outlets ensured a smooth transition for GAB’s business partners.

In addition to increasing investments in brand building, GAB stepped up focus in innovation to meet changing consumer needs. New variants of cider i.e. Strongbow Gold, Strongbow Elderflower and Strongbow Honey were successfully launched. The Company also optimised value beer opportunities in light of low consumer sentiment.

The Board has proposed a final single tier dividend of 51 sen per 50 sen stock unit for the financial year ended 30 June 2015. If approved, the total dividend payment for the financial year ended 30 June 2015 will amount to 71 sen per 50 sen stock unit.

Growth Drivers

  • 5 Feb 2015 – GAB announced the addition of a new super premium brand –Kirin Ichiban – to its portfolio. This follows the group’s signing of a 5-year partnership deal with Kirin Brewery which is under the purview of Kirin Holdings Co., Japan’s biggest beverage maker. (Kirin Holdings has a 15% stake in Asia Pacific Breweries and a joint venture agreement with Heineken International, which are GAB’s parent companies.)
  • 25 Aug 2014 – GAB’s focus on FY15 would be on better cost management by enhancing its efficiency and capability, while the product strategy would see better innovation with more quality new addition to its product portfolio.
    • In FY15, GAB plans to manage its cost more prudently by improving operational efficiency. Besides, the Group also expects to increase its portfolio by introducing more new products through innovation. New products launched in FY14, including Kirin Ichiban, the best-selling super premium brand in Japan and Smirnoff Ice, the world number 1 RTD brand which received good response, which was reflected in 4Q14 sales growth of 10.8% QoQ. Meanwhile, GAB would still be counting on its core brands, namely Heineken, Tiger and Guinness moving forward in sustaining the sales volume. Although GAB did not reveal the sales figure of the brands, we gathered that Heineken recorded the best sales growth among the core brands, followed by Tiger and Guinness in FY14.
    • 6 Feb 2015 – Net profit on the other hand experienced a larger quantum of growth at 13.1% thanks to cost efficiencies, optimization and improvement in productivity across all aspects of the group’s operations.

Issues/Risks/Challenges

  • 7 Mar 2014 – A beer brand that could make a bigger threat to GAB’s brands is the Tsingtao beer. The Chinese based company, Tsingtao Brewery Co Ltd, has set up its first overseas plant in Bangkok, Thailand as a significant step towards globalisation for its brand. With the plant coming into operation in early 2013, tariffs can be avoided, logistics can be shortened and freshness of the beer is better. It will also lower tax rates for Tsingtao Beer in the Southeast Asian markets. The Tsingtao brand is No 2 in China and the actual influence it can have on Malaysian consumers from the factors mentioned, is yet to be seen.
  • The other threat is coming from the newer premium brands under Carlsberg’s portfolio. As consumers wish to taste new brands, Asahi Super Dry and Kronenbourg have given them the opportunity to explore. These premium brands would go head on with GAB’s Heineken.
  • In terms of foreign exchange, as GAB is primarily exposed to US$ and Euro, an expected strengthening of the US$ and Euro or weakening of the Ringgit could affect its margins. However, GAB uses forward contracts to hedge this risk.
    • Less than 5% of GAB’s total costs (excluding duties) are exposed to mainly USD. If the strength in USD against MYR sustains, GUIN could face some margin pressure in the medium term. However, foreign exchange exposure is less than 10% of total cost and 50% of foreign exchange exposure is naturally hedged.
  • Contrabands – a rising concern
    • According to GAB, the rise in contrabands in the market have come to a worrying level. Based on an independent market research, in 2010, the number of outlets distributing contrabands in peninsular were around 848, most of which were in Johor. This figure has climbed by a staggering 2.3x to 1966 outlets in 2013, with growing presence in urban areas.
    • These contrabands, which are found across all traditional and modern trades channels pose a serious threat to duty paid brewers as their selling price is usually below duty costs. For instance the selling price for a can of 500ml beer ranges between RM5.50 and RM7.00 when duties alone (inclusive of RM5/litre for imported beers) is RM7.53 for a 500ml can of beer.
    • Contrabands are not necessarily illicit beers. They could also be legitimate beers which are smuggled out from breweries locally and abroad, hence, avoiding these duties. While the government is taking an initiative to curb contraband sales, management highlighted the steep rise implies weak execution in contrary to illicit tobacco, which is expected to show a decline for the current year.
  • Excise duty hike for the brewery sector has remained unchanged at RM7.40/litre (+15% ad valorem) since 2005. However, in November last year, GAB paid an additional 3% in effective duty tax. This explains the weakened operating margin in 2Q14 and 3Q14 as highlighted earlier.
    • According to management, the duty hike was simply a revision of the current excise duty valuation. The old valuation methodology includes duty paid on exfactory billing price by Guinness Anchor Berhad (GAB) to its sales arm Guinness Anchor Malaysia (GAM) – duty on production, a norm practiced globally. However, under the new valuation regime, the same duty will also be imposed on A&P, royalties and other related costs incurred by GAM. Consequentially, the additional duty paid by the group amounted to RM18mn, which is 3% higher than it would have paid.
    • Despite the intense negotiations by the group, customs have decided to keep the revised valuation methodology. Given the weak consumer sentiment, management did not pass on the cost to consumers, causing an 80% decline in PBT in FY14.

Seasonal or Cyclical Factors

The business operations of the Group are generally affected by festive seasons.

Shareholder Return

The table below is a simulation of shareholder return. Assumptions:

  1. Commission paid is ignored in this simulation.
  2. The current price is as of the time of writing.
  3. Unit purchased is 1,000.
  4. Stock price as of 18 Aug 2015 was 12.98.
Time Frame Date Bought at Original Value Dividend Received Dividend Yield % Unrealized  Gain/Loss Current Value Total Return CAGR %
3-Y 16/08/2013 18.52 18,520.00 2,080.00 13.7% -5,500.00 12,980.00 15,100.00 -6.6%
5-Y 18/08/2010 8.15 8,150.00 3,670.00 45.0% 4,830.00 12,980.00 16,650.00 15.4%
10-Y 18/08/2005 5.65 5,650.00 5,780.00 102.3% 7,330.00 12,980.00 18,760.00 12.75%

The following chart shows that dividend per share increasing almost every year.

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GAB is a good stock for you to buy for very long term or permanently.

Valuation

EY% Valuation

Historical EY%:

  • Trailing:
    • FY15 (EPS: 0.709) – 15.55 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.693) – 15.19 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY16 (EPS: 0.749 ± 5%) – From 15.61 to 17.25 (Uncertainty Risk: LOW to MEDIUM)
    • FY17 (EPS: 0.786 ± 5%) – From 16.38 to 18.10 (Uncertainty Risk: LOW)
  • EPS applied to reach the current stock price (12.98): 0.592

Industrial Avg. EY%:

  • Trailing:
    • FY15 (EPS: 0.709) – 12.80 (Uncertainty Risk: HIGH)
    • R4Q (EPS: 0.693) – 12.50 (Uncertainty Risk: VERY HIGH)
  • Forward:
    • FY16 (EPS: 0.749 ± 5%) – From 12.84 to 14.19 (Uncertainty Risk: MEDIUM to HIGH)
    • FY17 (EPS: 0.786 ± 5%) – From 13.48 to 14.89 (Uncertainty Risk: MEDIUM to HIGH)

5-Y DCF

  • Good Scenario (12.0% – 14.0%): From 16.03 to 17.15 (Uncertainty Risk: LOW to MEDIUM)
  • Bad Scenario (9.0% – 11.0%): From 14.46 to 15.49 (Uncertainty Risk: MEDIUM)
  • Bad Scenario (6.0% – 8.0%): From 13.02 to 13.96 (Uncertainty Risk: MEDIUM to HIGH)
  • Ugly Scenario (2.0% – 4.0%): From 11.29 to 12.13 (Uncertainty Risk: VERY HIGH)
  • At current price (12.98), based on RDCF, assumption of FCFF growth rate in the next 5 years is 6.2%.

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In my opinion, fair value of GAB range from 14.7 to 15.7. Uncertainty risk is from Low to Medium.

Peer Comparison – GAB vs. CARLSBG

Profitability

Trend of EBITA growth of GAB and CARLSBG is uptrend despite of challenges in the market and the industry. EBITA Margin of GAB is much higher than CARLSBG, but CARLSBG margin is getting closer to GAB.

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ROIC and CROIC

In terms of efficiency in generating earnings and free cash flow, CARLSBG’s efficiency is higher than GAB. This is mainly due to CARLSBG invested capital is lower than GAB. Nevertheless, both of them are excellent.

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Leverage

Leverage of GAB is higher than CARLSBG, but both are in very healthy level.

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Liquidity

CARLSBG’s CCC is much lower than GAB, and in fact, CARLSBG’s historical CCC were below 0. This means CARLSBG using other people money to run business. I believe that GAB has a different and loose credit terms.

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Which is Better?

If merely based on comparison of financial figures as above, I believe that CARLSBG has higher efficiency than GAB. Also, looking at the trend of CARLSBG’s ROIC and CROIC, I believe that CARLSBG has stronger growth momentum in the future.

Going Forward

Result was encouraging as the Group’s initiatives and strategy in mitigating the impact of persistent weak consumer sentiment throughout the year played an important role in sustaining the earnings growth, through engagement with distributors, innovation in launching new products and commitment in brand building investments. Management has spotted normalization of sales volume post-GST starting in July and is also confident that the momentum can be sustained with marketing campaigns and launchings of new products. These are essential as volume growth and cost efficiency will be vital for the earnings growth moving forward as GAB will be restricted from increasing prices before 4QCY16 due to the Anti-Profiteering Act. (Kenanga 17 Aug 2015)

For FY16, it will be challenging for GAB to pass on large price increases to consumers in view of

  1. The softer environment
  2. Anti-profiteering act which prohibits price increases if it increases profitability excessively.

I will continue to hold and accumulate GAB in the future.

Resources

Excel – http://1drv.ms/1NpOBms

Notes – http://tinyurl.com/n75kles

4Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4828713

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