China Resources Beer: Cost Control Has Reached the Limit, When Can We See the Turning Point of Gross Margin?

Hi everyone, I'm the Longqiao Dolphin. On March 24th, during the Hong Kong stock market midday break in Beijing time, China Resources Beer (0291.HK) released its full-year 2022 results. "From a marginal perspective in the second half of the year, revenue was slightly lower than market expectations (with a 500 million yuan gap, deviating by 3.3%), and core profit (gross profit - sales and management expenses) was lower than market expectations (with a 500 million yuan gap, a relatively large deviation)."

The main points are as follows:

"1. Sales volume maintained, difficult to increase average price: Although sales volume is relatively close to market expectations, the average price has only increased by 1.8% due to the inadequate price increase in the second half of the year, against the backdrop of continued structural optimization (premiumization rate increased from 18% to 20%), which is a little off the market's expected increase of 6.4%."

"In the past three periods of performance, the increase in average price has basically been in the range of 5-8%." Although the average price appeared to have increased by 5.2% for the entire year in 2021, the increase in the second half of the year was less than 2%, which effectively pulled the trend of price increases down by one notch.

1. Gross profit margin declined, limited buffering of sales expenses: At the same time that the average price did not rise enough, the improvement in sales expenses was also relatively limited, with the sales expense ratio down by only 0.3 percentage points in the second half of the year, basically not giving more buffering space to the fluctuation of the gross profit margin.

"3. Cost control has reached its limit, and it is difficult to make an excess contribution again:" Over the past few years, China Resources has been optimizing its production capacity while the optimization of management expenses has been very evident and has been keeping negative growth for a long time. However, after several years of adjustment, it now appears to have been squeezed to the limit, and there is little room for further excess contribution.

The overall view of Dolphin Jun: Overall, China Resources' performance in the second half of last year was very ordinary, but because the foundation was good in the first half of the year, the average score was pulled up slightly. There has indeed been no improvement in gross profit margin in the second half of the year, or there may have been some signs of improvement in the fourth quarter, but it has not yet been manifested after the merger. However, from the trend of cost, and the speed of premiumization, the trend of improvement in gross profit margin will be very obvious this year.

After years of improving quality and efficiency, it now appears to have reached a plateau, and it is difficult to save any more leftovers from management expenses. However, maintaining the current stability and balance is basically achievable.

From the company's current tone of continuous promotion of premiumization, the trend of increase in average price will not stop, and sometimes due to environmental factors, the degree of increase may be controlled. As long as the trend of price increases can continue, and the trend of premiumization does not decline, the company still has long-term value worth attention.

If you are interested in the financial report conference call and management communication, the Longqiao Dolphin will later share the summary of the conference call through the Longqiao app community platform or the investment and research group. Interested users are welcome to add the assistant's WeChat account "dolphinR123" to join the Longqiao Dolphin Investment and Research Group and get it first. Financial Report Analysis:

I. Lacklustre Performance in H2 2022, Hindering the Whole Year

The full-year revenue was RMB 35.3 billion, with a growth rate of 5.6%, which is acceptable. The net profit attributable to the parent company was RMB 4.3 billion, a year-on-year decrease of 5.3%. This is mainly due to the benefit of land sales of around RMB 1.7 billion in 2021, which boosted the base. Excluding various other income and financial expenses that include this factor, the core profit (gross profit - sales expenses - management expenses) rate has actually improved (from 8.0% to 9.9%).

However, the improvement in core profits mainly came from H1 2022, mainly driven by noticeable expense improvements while the gross profit margin was constant. Looking only at H2, the situation is not very good. This is not only because of cost fluctuations, which led to a decline in the gross profit margin (a common phenomenon in the industry, not just for China Resources Beer), but also because the degree of convergence of the expense rate was lower than expected and, as a result, the core profit margin for H2 2022 had a gap with expectations and the same period last year.

China Resources Beer has been reviewing production capacity and reducing costs over the past few years, and the improvement in expense ratios has been very obvious. Therefore, the market has an inertial mindset that this improvement can be sustained. However, based on H2 performance, this improvement has clearly reached a plateau.

Thus, in an environment where the gross profit margin is declining, the lack of expense ratio improvement to provide a buffer zone directly caused the decline in profit margin.

II. Sales Volume is Still Good, But the Average Price Has Not Kept Up

From the perspective of quantity and price, the main contradiction that caused the significant difference in performance between the first and second half of last year was price.

In terms of sales volume, the second half of the year was relatively close to market expectations, reaching 4.8 million liters, with a small increase in the single digits. Furthermore, the product structure is continuously optimized, with the proportion of high-end products increasing from 18% to 20%.

China Resources Beer has indeed put a lot of effort into high-end products. In 2022, the company's sales of Heineken continued to grow by double digits. At the same time, the group continued to promote the construction of a diversified brand portfolio last year, launching several new products. In addition to ultra-high-end beer, several new flavors of fruit and milk beer with relatively high market acceptance were also launched.

Although this improvement is reflected in the change in average price, it was relatively weak in the second half of last year. Unlike the previous three financial reporting periods, the growth rate of average price slowed down significantly. Previously, it was at least in the mid to high single digits, but in the second half of last year, the growth rate of average price was only 2%. This is also the main reason why the performance in the second half of the year was lower than market expectations, where the market expected the average price in the second half of the year to be at 3100, but actually it was only 2970 (in yuan/kiloliter).

In fact, whether from the perspective of cost increases to stabilize gross profit margins or from the perspective of structural improvements and increasing average prices, a good degree of improvement in average price in the second half of last year is needed. The performance of CR's average price is similar to that of Tsingtao Beer, which released its financial report yesterday, but Tsingtao Beer's results in the third quarter were good, while it was off-target in the fourth quarter because of its more detailed breakdowns. CR can only be seen as a good performer in the first half of the year, but lagged behind in the second half of the year.

The impact of the lower-than-expected improvement in the average price is quite severe and will directly affect the gross profit margin, which we will analyze later.

From the perspective of the industry pattern for the whole year, CR's market share continues to increase. Although the increase is relatively small (from 31.0% to 31.1% for the whole year), considering that CR has the largest market share and a wider coverage, it is not easy for CR Beer to have any improvement due to the logistics problems caused by epidemic prevention management last year. The performance of the industry was also not good last year, with a production increase of only 1% for the whole year.

As the Dolphin has repeatedly mentioned before, the main focus of the beer industry in the future is the improvement of the average price (through price increases and structural improvements), and the driving force on the volume will be very small. Therefore, in this period of performance (focusing on the second half of last year), the degree of improvement in the average price was relatively limited, making CR's overall performance in the second half of the year very bland.

Of course, in the Dolphin's point of view on yesterday's review of Tsingtao Beer's financial report ("Saving Money is Also an Attitude"), there is still industry space for leading companies in the short and long term. In the short term, there will be a small surge in volume in the first and second quarters of this year (although there will be some pressure in the third quarter due to the base number issue). In the medium and long term, the improvement of the average price has not been broken (although CR's performance in the second half of the year seems weak), and its main support still comes from the rise in per capita income.

III. Is the turning point for gross profit margin here?

As we mentioned earlier, the average price increase for CR Beer in the second half of the year is quite limited, and in an environment of rising costs, the gross profit margin may become quite dangerous. As we detailed in our overview of the beer industry previously, the decline in packaging material costs (beginning in mid-2020 and early 2021) has already provided some relief to cost pressures, but from an accounting perspective, this relief will only begin to be reflected in the fourth quarter of last year.

Previously, the Dolphin was hoping for a turning point in gross profit margin, and some clues were seen in Q4 results for Tsingtao Beer yesterday. However, due to the consolidation and statistical reporting between the third and fourth quarters, it is not yet clear for CR this time, and it will need to be confirmed in the first half of this year. The more problematic thing is that barley prices have risen sharply in recent years. Although they account for a relatively low proportion of the cost structure (less than 15%), the increase is fierce, which may greatly offset the contribution from the decline in packaging material costs.

From the perspective of the second half of the year, gross profit margin is still expected to decline by 1.8 percentage points, leading to a 2% drop in gross profit even while revenue maintains single-digit growth.

Looking at the cost per ton, there has been a significant increase since the second half of 2021, and there is still no sign of easing in the second half of last year. Theoretically, there should have been some signs of easing in the fourth quarter, but it cannot be found temporarily due to consolidation disclosure.

The more negative situation is that the cost pressure in the second half of last year was basically borne by the manufacturers themselves, and was not transmitted to the factory end. To put it bluntly, because the price increase in the second half of the year was not enough, it has already hurt the enterprise's gross profit margin. The Dolphin's guess is that although there will be some improvement in the fourth quarter, it will have a limited impact on the overall situation because of its small proportion, and the drag will mostly come from the third quarter.

Confirmation on whether the turning point for gross profit margin has really arrived also needs to be made in the first half of this year. However, based on the previous communication from the company, improvement in gross profit margin is highly likely, but the statement was made in comparison to last year, and no conclusion was given regarding the unit cost decrease.

In the long-term review, although price hikes were also implemented last year, cost increases were fast and did not fully translate to the end, so companies could only bear part of the cost.

From a production perspective, CR Beer has been optimizing its production capacity in recent years, and the results have been quite obvious. However, now that we're in the later stages of optimization, the company's excess contribution is gradually not as good as before.

4. Improvement in expenses has entered a plateau

Along with the gradual optimization of production capacity, the improvement in the company's expense ratio, particularly in terms of management expenses, has also reached a plateau.

Compared with the significant improvement in management expense ratio in previous years, it seems to have reached a bottleneck in the second half of last year. Therefore, profit basically reflects changes in gross profit margin, and there is no more room for expense improvement to buffer. This has caused gross profit margin to fall by 1.8 percentage points, and only limited improvement in management and sales expenses, resulting in a 1% decline in core profit margin.

In the financial statements, the unexpectedly high contribution of other income in the second half of last year made the pre-tax profit margin appear stable, but this achievement is not very meaningful.

Chronicles of CR Beer by Dolphin:

Earnings Season

August 17, 2022, earnings call "Continuing High-End Development, Striving to Be the Best"

August 17, 2022, earnings review "CR Beer: A Brave 'Loner' Soaring Even Higher"

March 25, 2022, earnings call summary "CR Beer Performance Call: High-End Development Trend Remains, Short-Term Costs Under Pressure" On March 24th, 2022, Financial Report Review: "Huawei's determination to go upscale remains unchanged under the epidemic".

On March 22nd, 2021, Financial Report Review: "Is CR Beer Going Downhill? Too Short-Sighted".

Risk Disclosure and Statement of this article: Dolphin Research Disclaimers and General Disclosures.