BUD - Kirin Holdings: Improving Earnings Trajectory With Proactive Management

2023-04-25 04:31:23 ET

Summary

• Kirin Holdings is executing positive price hikes, business portfolio management, and a greater commitment to raising profitability.
• Earnings visibility looks positive, with continued price increases in beverages, steady overseas expansion, and steady performance in pharmaceuticals.
• The shares are trading on PER FY12/2023 15.3x and a free cash flow yield of 4.6%. We believe this is cheap for a turnaround story with an improving earnings trajectory.

Investment thesis

Kirin Holdings ( OTCPK:KNBWY ) is looking attractive as it demonstrates pricing power, active business portfolio management, and greater commitment to raising profitability. With the shares trading on PER FY12/2023 15.3x and a free cash flow yield of 4.6%, we believe the shares are a buy.

Quick primer

Kirin Holdings is a Japanese brewery, non-alcoholic beverage, and pharmaceutical company. The key businesses are Kirin Brewery (with the largest domestic share in the beer-substitute drinks market), Kirin Beverage (the fourth-largest domestic soft drinks maker), and Lion (Australia's second-largest beer company). Exposure to pharmaceuticals comes from the 53.8% stake in Kyowa Kirin ( OTCPK:KYKOF ) with its key drug Crysvita for hypophosphatemia treatment. Other notable assets in the group include a 100% stake in Four Roses Distillery, a 48.6% stake in San Miguel Brewery in the Philippines, and a 32.8% stake in Japanese cosmetics and dietary supplements company FANCL (4921 JP). Peers include Asahi Group ( OTCPK:ASBRF ) and Suntory Beverage & Food ( OTCPK:STBFY ).

Key financials with consensus estimates

Our objectives

The shares in Kirin Holdings have yet to recover to levels before the pandemic. However, consensus forecasts operating profits to reach levels not seen since FY12/2017 in the next two years, indicating that the business is at a potential turnaround. We revisit our sell rating from July 2022 and reassess our view on the stock.

Whilst we previously expected a downward revision to FY12/2022 last July due to increases in raw material prices and fuel costs, the company actually issued an upward revision to guidance in August 2022 . Actual results were in line with expectations, with 9.2% sales growth YoY and normalized operating profit growth of 15.6% YoY. Strong net income growth in FY12/2022 was partly driven by one-off gains in the disposals of its Myanmar Brewery operations, and its joint venture in China.

Change in management style is a positive surprise

Kirin Holdings' management has had a reputation for pragmatic conservatism, and not one of quick response and adaption. It would appear the pandemic, the civil unrest in Myanmar in 2021, and the inflationary cost environment have been literal game-changers. The company has undergone major step-changes over the last 12 months to indicate that management is more nimble and on the front foot, more willing to actively adapt to change and compete.

The biggest positive surprise for us has been swift price increases. With a price hike introduced in October 2022 ranging from 6% to 25% together with cost reduction efforts, the company managed to offset all cost increase impacts on raw materials, transportation, and labor ( page 6 ) in FY12/2022. The company will introduce another price hike ranging from 19% to 23% from May 2023 , showing continued management efforts to maintain margins.

The disposal of the Myanmar operation was an inevitable one given the political situation, but the exit from the Chinese soft drinks business was a surprise with the core reason being limited returns due to intense competition. Kirin preferred to take gains from its investment and allocate capital to new opportunities for growth. Management also wrote down JPY43.0 billion/USD 0.3 billion ( page 7 ) by exiting the low-margin amino acid business (operating under group company Kyowa Hakko Bio), allowing the business to focus on high-margin products such as Citicoline (a material used to treat brain dysfunction, as well as used in health food products) and HMO (human milk oligosaccharide), allowing a better future runway to profitability.

These changes indicate that management is executing in order to raise long-term profitability. It has also become more of a focused business, with its key geographic markets being Japan, the US, and Australia, and its core businesses being food and beverage, pharmaceuticals, and health science.

Earnings visibility looks positive

Kirin's FY12/2023 guidance ( page 9 ) looks conservative to us, with 6% revenue growth YoY and flat operating profit YoY. Whilst there is a negative impact from the Myanmar business being absent, the planned beverage price hike as well as some punchy plans for marketing spend YoY makes us think that management is playing things safe.

One area of weakness that needs to be addressed is the core domestic beer business. The flagship Kirin Ichiban beer as well as the craft beer range underperformed at home versus the market leader Asahi Group in FY12/2022, with management citing the need to win more business via increasing the market pie as opposed to winning share. That being said, recent monthly sales data show that Kirin Ichiban is outperforming strongly YoY, highlighting share gains and the impact of an effective marketing campaign.

Overseas markets saw the strong performance with the Lion subsidiary in FY12/2022, and the company forecasts continued growth both in Australia as well as the US. The US is seeing renewed growth in craft beer with New Belgium Brewing , and pricing strategies and cost optimization plans are said to be in place to drive growth.

The pharmaceutical business remains in a firm position with the overseas growth of Crysvita, with direct sales to start in the US market and sales progressing well in the EMEA region. The product Poteligeo used to treat rare blood cancers is growing, and Kyowa Kirin continues its promising drug development pipeline with Amgen ( AMGN ). The health science operation under Kyowa Hakko Bio remains a work in progress, with management committed to generating returns here by FY12/2027.

Valuation

On consensus estimates, the shares are trading on PER FY12/2023 15.3x, with a dividend yield of 3.2% and a free cash flow yield of 4.6%. Not wanting to overpay for a consumer staple business, we believe these valuations are attractive given recent indications of pricing power, optimizing the business portfolio, and a relatively defensive business.

Risks

Upside risk comes from subsiding cost pressure from inflation, as categories such as fuels and raw materials begin to show signs of price stabilization.

Market share gains in beer both at home and abroad will be a key positive, highlighting market competitiveness and product differentiation. The return of inbound tourism will assist recover drink sales volume.

Downside risk comes from renewed cost pressures, and limitations over future price hikes as customers begin to negatively react.

On-premise alcoholic drink demand does not recover to pre-pandemic levels, due to continued concerns over health and safety.

Conclusion

Kirin remains locked in competition with domestic leader Asahi Group, and overseas markets are dominated by the heavyweights like Anheuser-Busch InBev ( BUD ) and Heineken ( OTCQX:HEINY ). However, it is trying to select its battles and is gaining some ground. With management taking the initiative to generate higher returns and beginning to show signs of success, we believe the shares are a buy.

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