CABGY - Carlsberg: Risk In Consensus Downgrading Earnings

Summary

• I believe there is an increased uncertainty in the 2023 outlook due to weakening demand in Europe and the timing of China's recovery.
• Management focus seems to be on increasing gross profit per hl to counteract higher operational expenses in 2023.
• I see risk to consensus earnings downgrading due to near- to mid-term uncertain growth outlooks.

Summary

What I took away from Carlsberg's ( CABGY ) earnings was the increased level of uncertainty on the 2023 outlook, owing to the possibility of weakening demand in Europe and the timing of the China recovery. Also, increasing gross profit/hl seems to be the focus in the near term given an expected increase in OPEX in 2023 due to higher logistics costs, inflation, and marketing investments. Given the lag between COGS inflation and comps, I expect EBIT will be under greater pressure in H1 than H2. That said, management appears cautiously optimistic that it can meet the 2023 organic EBIT guidance and counteract cost inflation pressures. However, I do not think the current valuation of 10x NTM EBITDA has enough margin of safety, given the near- to mid-term uncertain growth outlooks, which all carry risk to consensus downgrading earnings.

Earnings Overview

The results that CABGY reported for FY22 were in line with expectations. While organic volume growth of 1.2% in 4Q22 fell short of the 2.3% expected by consensus, organic revenue growth of 10% and organic EBIT growth of 12.2% in FY22 were both in line with expectations. For FY22, reported EBIT was 1% lower than consensus, with a miss in Asia due to China and a partial offset by Europe. Management has also commented that they foresee an increase in expenses due to higher logistics costs, inflation, and marketing investments, and their goal is to increase gross profit/HL in all regions to offset these.

Western Europe

In FY22, the region's organic revenue growth was 13.8%, thanks to total volume growth of 5.4% and price & mix growth of 8%. Positive price and mix adjustments made in the 1/4Q bolstered regional pricing and profitability. More specifically, CABGY reported high-single-digit volume growth in Denmark and Sweden, sales in France increased by double digits supported by an increase in demand for more expensive brands. Also in the United Kingdom, volume growth was in the low double digits, but results were notably mixed between a robust first half and a decline in the second.

Management has signaled that they anticipate Western Europe's EBIT to fall in 2023, and the goal is to increase gross profit per hl to combat this. Thus, I anticipate management will make greater efforts to negotiate price increases in Western Europe. There are still a few agreements, like the one with France, that need to be finalized before the start of H1 in the region can begin. Management did point out that this is a common experience amongst comparable businesses, and that they foresee reaching a resolution by the end of February. However, it is still too soon to assess the impact of price increases on demand, and on-trade demand softened in Q4 in some markets, which can't necessarily be attributed to inflation.

Asia

For FY22, the Asia division saw an organic growth of 18.8 percent in sales. It's remarkable that CABGY was able to increase its market share thanks to its Big Cities strategy and the success of its international premium brands, even as the Chinese beer market shrank slightly. Vietnam saw a 25% increase in volume for CABGY in FY22, while India saw a 30% increase, Laos saw a 20% increase, and Cambodia saw an almost 30% increase.

Undoubtedly, investors and market participants are keeping an eye on the China recovery story. The rate of China's recovery, in my opinion, is still unclear. Management was satisfied with key metrics such as sell-in before Chinese New Year and inventory levels at quarter's end. However, managers noted that some CNY events had to be postponed and that customers might be wary of drinking after a spate of illnesses. As such, the net-net result is pretty unclear at this point in time. That said, I am more likely to look on the bright side, as CAGBY's marketing effectiveness was not at 100% due to some spend being held back in Q4 due to the restrictions, and management has plans to increase investment by adding 15 cities to its Big Cities strategy this year. When exactly these will be reflected in the profit and loss statement is, however, unclear.

Capital Allocation

CABGY will not initiate a new share buyback program in Q1 after the current one ends in 2022. Management is planning to increase their stake in their India beer business by 33% in 2023, which I expect will cause no problems with the balance sheet. More importantly, I think there is potential for a share buy-back to resume once the deal is finalized.

Guidance

Management has given an organic EBIT growth range of -5% to 5% for FY23 and warned of low-teens input cost growth with increased pressure in H1. Also, there would be a negative impact of DKK550 million from transactional FX on FY23 EBIT.

Conclusion

In conclusion, there are several near-term uncertainties that could rock the boat here. For instance, the European business's ability to raise prices and combat volume loss, and the China business timing of recovery. Given the risks, and where CAGBY is trading today (in line with historical average), I do not see sufficient margin of safety in the stock for me to take this leap of faith. In fact, on the flip side, if CAGBY were to miss versus expectations in the next 1 or 2 quarters, we might see a cheaper entry point.

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