HINKF - Heineken: The Worst Is Behind

2023-12-13 01:51:00 ET

Summary

• Risks seem noted; this leaves us space for a positive re-rating.
• HEINY's CFO provides positive volume trends and cost drivers efficiency for 2024.
• Heineken's margin recovery story should help the company narrow the valuation gap compared to European Staples. Our buy is then confirmed.

Here at the Lab, we are back to comment about Heineken (HEINY). Following a non-positive Q2 , we believe the worst was behind us. Ahead of the Q3 results, Wall Street analysts were increasingly worried about the 2023 guidance, and the Heineken core operating profit outlook at the low end was taken well. While Q4 performance is forecasted to be soft, our internal team is increasingly optimistic for 2024, and we confirmed a buy rating target backed by a Margin Recovery Story , beer premiumization at scale, pricing power coupled with higher volume, and Emerging Market exposure. As a reminder, we should also report that the beer industry has historically remained resilient during macroeconomic pressure and elevated inflation. With our forward-thinking analysis, we now go beyond 2023, highlighting key findings from Heineken's recent CFO industry conference below.

Why are we supportive?

1. Half of the Q3 volume decline was related to Vietnam and Nigeria. Despite that, the company reported that "in half of its markets, volume trends are improving." Looking at the Nielsen data, Q4 volume is soft, and we also expect promotional activity in the Christmas period. For this reason, we arrived at 2023 top-line sales at €30.2 billion. Despite that, we see support from LatAm to counterbalance Vietnam (we estimated a mid-single-digit volume decline). Beer pricing activities remain healthy in the area, with beer inflation at 5-7%, compared to Brazil's CPI at 4.8% and food CPI in deflationary status. Heineken is exhibiting a plus 4% pricing power annually amid cost deflation (with ABI, which delivered a 500 basis point margin increase in the South America region in Q3). This should support Heineken's profitability revelry in the period. Here at the Lab, we also remain favorable on LatAm volume demand. In addition, by year-end, we should see tailwinds from FX in the Americas division;
2. Post-CFO update, we are keeping our market share gain in critical countries. In our estimates, Heineken will return to growth in Q2 2024 with an acceleration in H2. Even without considering a volume recovery story in Nigeria and Vietnam, we believe Europe, South Africa, and Mexico will improve sequentially. In Mexico, Heineken is gaining market share ex Oxxo, while in South Africa, Heineken's integration with Distell should support expanded distribution gains. In addition, Europe volume trends are relatively subdued but progressively improving with the company's price increases settling in across all markets. The CFO also confirmed that higher prices had impacted volume growth, and Heineken lost some promotional slots in the retail space; however, this is not the case anymore;

3. Aside from our 10% growth in core operating profit at the margin level, we believe a cash conversion improvement will mark Heineken's next visible two-year period. In the medium-term horizon, this should be helped by reversing working capital trends from lower inventory costs. Post-CFO call, we estimate a core operating profit of €4.5 and €4.8 billion in 2023 and 2024, respectively. On a marginality, our EBIT margin sequentially increased from 15% in 2023 to 15.5% in 2024;

4. We estimate that Heineken might also be seen as a deleveraging story while increasing its DPS. In our numbers, with the current FCF and working capital reverse, we arrived at a yearly net debt of €15 billion in 2023. In 2024, rolling forward our model, Heineken's net debt could be lowered by almost €2 billion. 2024 FCF yields well to support the dividend yield (6% vs. 2%). Following the Q3 results and updating our numbers, our 2024 EPS reached €5.5.

Conclusion and Valuation

Heineken's earning risks appeared well flagged and priced in by consensus expectations. At the Lab, key European markets and Brazil's performance leave room for positive catalysts. Reversal working capital and COGS easing coupled with our expectation for a core operating profit growth could translate into >10% EPS growth compared to European Staples average of approximately 7%. Even if we are forecasting volatility in FX and a potential consumer slowdown, a margin recovery story and premiumization development should help Heineken narrow its valuation gap compared to the European Staples. Here at the Lab, Heineken will likely guide a conservative mid-to-high single-digit organic EBIT growth in 2024. The company trades a 10% P/E discount to European staples and -17 % to ABI. Heineken's equity value discount to peers looks extremely undeserved due to the company's superior medium-term top-line growth and margin recovery story. In addition, Mare Evidence Lab's reverse DCF suggests the company is pricing an organic revenue growth of +4.5%. This implied volume growth of +1.5%. However, we believe volume should be at least 1% higher. Following Wall Street's disappointing downgrades in the past months, the buy-side is already anticipating a cautious Fiscal Year 2024 outlook. Even considering that, with a P/E target of 19x and an EV/EBITDA of 10x, we arrived at a valuation of €105 ( from €120 per share ), maintaining our buy rating target. Downside risks include FX volatility, Vietnam weakness, tourism still below past levels, market share losses, innovation from comps with higher industry competitiveness, and value disruptive M&A.

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