2023-07-11 22:03:06 ET
Summary
- Carlsberg A/S is a Danish company that produces and sells beer and other beverages.
- Revenue growth has been mild in the last decade but changing dynamics in the industry should support improvement (Premium and non-alcoholic beverages).
- Margins are sticky and attractive. Inflation is causing short-term issues.
- Carlsberg's valuation does not imply upside at the current price.
Investment thesis
Our current investment thesis is:
- Carlsberg is a great business with a leading position in Europe and Asia. Europe is weakening but remains a strong region. Asia is growing rapidly, improving margins Y/Y.
- Inflation is causing issues for the business but it is doing well to offset this partially with pricing.
- Growth will be supported by premiumization and non-alcoholic beverages.
- Carlsberg is trading at a premium to its historical average multiple, to a degree where we cannot see upside at the current price.
Company description
Carlsberg A/S ( CABGY ) is a Danish company that produces and sells beer and other beverages. Its product range includes core, craft, and specialty beers, as well as alcohol-free brews, which are sold under various brand names such as Carlsberg, Tuborg, and Baltika. The company exports its products to around 100 countries across the globe.
Share price
Carlsberg's share price has trended up in the last decade, returning over 100% to shareholders across this period. This is a reflection of a gradual improvement in financial performance.
Financial analysis
Presented above is Carlsberg's financial performance for the last decade.
Revenue
Carlsberg has had a mild decade, growing revenue at a CAGR of 1%. This does hide a period of underperformance on the top line, during which time Carlsberg experienced <5% growth in 6 consecutive years. The business is subject to significant FX risk due to its globalized operations but nevertheless, has struggled.
Carlsberg is a leading beer business in Europe and Asia primarily, with 50% of its revenue derived from Western Europe, 34% from Asia, and 16% from CE Europe. The company is no. 1 or 2 in 21 markets across these regions, reflecting its market-leading position. The inner ring represents revenue by geography, reflecting the inferior profitability in Western Europe relative to Asia.
Although this suggests quality diversification, the business is essentially highly reliant on Europe's economy. Culturally the countries are very different, but we have seen economic convergence in the last 2 decades, suggesting the macro impact on the industry will be the same for the majority of its markets.
These are highly attractive markets due to the level of alcohol consumption. If we consider global alcohol consumption in 2023, these regions are 2 of the 4 key markets (Alongside North and South America).
This being said, the concerns around growth may lie with the change in consumption within these regions.
According to Our World in Data, Alcohol consumption in Europe has declined per person between 2000 and 2018. This has been offset by population growth but is a sign that the market is weakening somewhat. As population growth continues to slow in Europe, this could be a concern for Carlsberg.
This has been partially offset by growth in Asia, which has seen a large increase in alcohol in specific countries, such as Thailand and Vietnam. This is driven by strong tourism, as well as a change in consumer behaviors.
This has been a success story for Carlsberg, as the business has done a great job of expanding into the region and gaining market share. In Vietnam, for example, the company has c.40% market share and 27% volume growth through its Hue Brewery brand. Our view is that this segment will continue to drive growth for the business, as tourism and domestic demand trends up. In FY19, Asia represented 28%, it is likely this segment will push toward 40% in the coming years.
The slowdown in Europe is partially driven by concerns around health and wellness. Consumers are looking for low-calorie and low-alcohol options, with many reducing consumption oblivious to the fact there are alternative options. This has led to the emergence of non-alcoholic and low-alcohol beers, which are gaining popularity among health-conscious consumers. The problem has been the difference in taste but continued innovation and an increase in market participants is contributing to the gap closing. The key now is to improve marketing to "sell" these products as a genuine alternative. This could be incredibly accretive for Carlsberg as it can keep those who want to reduce/stop drinking consuming, as well as expand its market enormously. Currently, 3% of Carlsberg's total volume is non-beer, a rapid increase given the size of its alcohol operations. As an example, there is a large population on earth, most of whom do not consume alcohol. This segment has the opportunity to target them.
The issue for Carlsberg is that the segment is highly competitive. This is not surprising given how attractive it has the potential to be. The bullish factor for Carlsberg is that it has market-leading brands for which it can launch Zero/non-alcohol options, such as its Carlsberg Zero, which has no alcohol and is half the calories of its traditional option. Further, the company has the resources to invest in R&D, to develop the best/most comparable flavor. The weakness comes with the fact new entrants are specializing in these segments, creating a relationship with its target market that a large corporate fails to do. Like we have seen with many industries during a period of transition, the new entrants are disrupting. As an example, I googled "best non alcoholic beer" and clicked the first 3 links, as someone exploring this may do. Only a single Carlsberg brand was present among over 50 different options. M&A is likely to be the preferred route if the correct opportunity presents itself. Brooklyn Brewery, a highly regarded alcohol-free beer brand sold its European rights to Carlsberg , that based on reviews, is Carlsberg's best non-alcohol option. As the industry consolidates, however, we think Carlsberg is positioned well to at least maintain its current position, but only because of how strong its brands are and its ability to acquire smaller competitors.
Finally, the other key trend we have identified in the Beer market is "Premiumization". Having covered Diageo ( here ) and in the process of researching AB InBev, we have discovered this idea of Premiumization is seemingly invading the alcohol industry. Consumers are increasingly willing to pay more for high-quality beer, seeking to experience different and improved flavors. This is part of a changing way of consuming, as it is becoming part of an "experience" rather than just having a drink before a sporting event. This is a bigger trend in the spirit segment in our view, but the beer market is certainly being disrupted. Currently, premium brands encompass 16% of total volume, with a higher growth trajectory.
To summarize where we are currently. Carlsberg's regional split is a reflection of its current growth struggles. Europe is no longer the fast-growing region it once was, and as this region is Carlsberg's largest market, the company has struggled. Asia has partially offset this, which is why we are not seeing a clear decline. The wild card in the industry is non-alcohol and premiumization. These are both trends that Carlsberg has responded to and gained a foothold. Our view is that revenue growth will pick up, primarily as Asia and these "wild cards" continue to outperform the beer market as a whole.
Moving onto the financial side of revenue. Presented below is the volume sold in the last 5 years. As a side note, the growth in other beverages relative to Beer is a reflection of our analysis above.
As noted, the volume of beer has declined, as has the total volume. Carlsberg has been able to grow revenue during this period as a result of a shift toward premium brands, which have higher margins, as well as pricing action. The average revenue per million hl was DKK 470m in FY18, compared to DKK 560m in FY22. Pricing action can only go so far, which means kickstarting volume improvement in Europe specifically is key.
Further, the Russian Invasion of Ukraine has materially impacted the business. Firstly, the company owns the second-largest beer brand in Ukraine, which has seen its performance nosedive. Additionally, Management has taken the decision to exit Russia completely, resulting in a DKK 10BN impairment loss.
Economic considerations
We are currently experiencing heightened inflation globally as interest rates attempt to tackle this. This has caused a decline in discretionary spending, as consumers move defensive with their finances. This has the potential to be damaging for Carlsberg if consumers reduce their social spending. So far, demand has shown itself to be surprisingly robust, which is one of the reasons inflation has been slow to decline. Should this occur, the business would not just be hit by the social decline, but also by reduced tourism.
Margin
Carlsberg's margins have remained relatively flat across the historical period. EBITDA-M has remained between 19-23% for the entire decade, with greater volatility in NIM due to non-trading items.
What is slightly concerning is the slippage in the most recent year, with GPM and EBITDA-M declining to a decade low. This is a reflection of inflationary pressures impacting the business. Management's response to this has been positive pricing action, which has somewhat offset the impact. Our expectation is for inflationary pressures to ease in the coming year but it remains uncertain if Carlsberg can return to its prior levels.
Inflation aside, we believe there will be a positive margin impact of improving sales to Asia relative to Europe, which comes with a noticeably better OPM.
Q1 results
In the most recent quarter, organic volume growth was driven by Asia, as Europe remains weak. This continues to support our analysis of the geographical impact of having a strong Asian presence. Further, premium category volume continues to improve, although interestingly, alcohol-free beverages have seen a decline. The premium segment suggests the macro concerns are not an issue. The decline in alcohol-free is more likely to be a reflection of how popular they have become post-Covid, with a correction rather than a decline.
Asia is likely supported by the end of China's zero-covid policy at the end of 2022, which following a rapid rise of cases, has likely resulted in the end of the virus in the country. This should continue to drive Asian growth Y/Y.
Revenue growth has remained robust, driven by both channel mix and continued pricing. This is a reflection of Carlsberg's brands' value, as continued price hikes are not impacting volume materially.
Balance sheet
Carlsberg is reasonably financed, with an ND/EBITDA ratio of 1.5x. This gives the business good headroom to be flexible, allowing for M&A or increased distributions based on circumstance.
Speaking of distributions, Management has been very aggressive in the last 3 years, with record levels of dividends and buybacks. The company generated DKK 8.9BN in FCF during FY22 and has DKK 8.1BN in cash, suggesting these levels are sustainable alongside deleveraging and other activities.
Outlook
Presented above is Management's outlook for the coming year.
Interestingly, Management is forecasting the potential for a decline. This looks to be a conservative view given the level of uncertainty in the market. If the company was to come in below 3% growth, we would be very disappointed. Asia, premium segment growth, and potentially non-alcohol development should be enough to support positive growth.
Outlook
Presented above is Wall Street's consensus view. Analysts are far more bullish, forecasting c.4-5% growth consistently. This looks reasonable based on what we can see. Europe is not a geography in decline, but a core foundation that is creeping up. There is no reason to suggest flat growth organically should occur.
Margin improvement is also forecast, which suggests Analysts believe Carlsberg can return to its pre-FY22 level. This is likely based on what pricing action has achieved so far, which is significant revenue growth and resilient volume.
Our outlook is for positive growth, but closer to the 3% level. Further, we are always hesitant with "margin mean reversion" as we have seen in many cases, this is far more difficult than expected to achieve. We would conservatively suggest no further slippage.
Valuation
Carlsberg is currently trading at 14x LTM EV/EBITDA, 12x NTM EV/EBITDA, and 21x NTM P/E. These metrics are all at a noticeable premium to Carlsberg's average trading multiples.
The arguments for a premium include:
- Asian growth driving value through better margins.
- Europe continues to remain robust.
- Pricing action has been a success.
- Improving shareholder distributions.
- Strong foothold in the premium segment and an expanding non-alcohol offering.
The bear arguments are:
- The Russian business is gone with a substantial loss. The Ukraine business is materially damaged.
- Margins have declined and there is no certainty over an improvement.
- FX risks continue to represent an issue with reported revenue v. organic revenue.
Overall, we would suggest a slight premium is warranted. Growth in Asia with pricing action trumps the Russian business loss and will support margins. However, we see little evidence beyond this to suggest upside.
Final thoughts
Carlsberg is a quality business, owning leading brands across the globe. Its market position should mean steady growth in Europe will continue and outperformance in Asia is likely. The big opportunities commercially are premium branding and non-alcoholic beverages. The former looks to be executed successfully, with continued development. The latter is less so, but it is too early to be concerned.
The only issue with the valuation is that it does not imply any quantifiable value today. This is a great business which is valued in the region of its fair value.
For further details see:
Carlsberg: Long-Term Winner With No Upside