Heineken – Volumes Remain Subdued, But The Valuation Has Become More Attractive

  • Volumes at Heineken continue to be affected by COVID-related restrictions, albeit the situation is steadily improving.
  • There are other bright spots below the surface, such as the strong performance in its premium portfolio.
  • Cost inflation is going to be a noticeable near-term issue, but in the long-run the firm continues to enjoy relatively good growth drivers.
  • The shares look priced for high single-digit annualized returns, which is reasonably attractive given the company’s defensive profile.

By Marc Dockray @ Seeking Alpha. I wasn’t exactly thrilled with Heineken’s (OTCQX:HEINY) (OTCQX:HINKF) valuation when I last covered it around ten months ago, mainly because the shares had crept back up to 22x pre-pandemic earnings even though COVID was going to be a drag for at least a fwasn’t exactly thrilled with Heineken’s (OTCQX:HEINY) (OTCQX:HINKF) valuation when I last covered it around ten months ago, mainly because the shares had crept back up to 22x pre-pandemic earnings even though COVID was going to be a drag for at least a few more quarters. While I was optimistic the company would achieve high single-digit long-term annualized earnings growth, a quiet period while earnings normalized and grew into the share price was definitely a possibility.

That call appears to have played out, though not for the reason given. The business is indeed still shaking off the effects of the pandemic – which everybody expected – but it’s the share price action that has been unpredictable, with the stock down heavily these past few weeks following the Russia/Ukraine global sell-off. As a result, the shares are currently off around 20% since last coverage, albeit they were actually up a little bit until as recently as mid-January.

With that, I think we are back into reasonably attractive territory as far as the valuation is concerned. Heineken isn’t my favorite international brewer right now – I think AB InBev (BUD) has a better all-round story on profitability, emerging market exposure and valuation – but that doesn’t mean there isn’t quite a lot to like here, and with its stock now under 20x FY22 EPS estimates I’m tentatively upgrading Heineken to ‘buy’ from ‘hold’.

COVID Continues To Be A Drag On Volumes

As expected, the lingering impact of public health restrictions on the global on-trade industry has continued to weigh on the company’s beer volumes, particularly in Europe, where on-trade beer volume was still off 30% versus pre-COVID levels. Beneath the headline numbers, however, there is actually quite a bit to like.

Starting with those, group-wide beer volume came in at just over 231mhl in 2021, up 4.6% on 2020 but still off immediate pre-pandemic levels of circa 240mhl. Full-year revenue growth was stronger, with 4.6% organic beer volume growth supplemented by eye-opening 8.3% growth in revenue per hectoliter.

That led to 12.3% year-on-year organic net sales growth, with operating profit up over 475% to €4.5bn, largely due to an accounting bump from its UBL holding, which it now has majority control of. On an underlying basis, operating profit was up over 40% year-over-year to €3.4bn, with margin up around 330bps to 15.6%, helped by fixed cost leverage as well as cost savings measures designed to offset higher costs, FX headwinds and the operating de-leveraging stemming from COVID.

While volume, revenue and profit remain below 2019 levels, it’s not all bad news here. The company put in what looks like a very strong performance in its premium segment – significant given that it is one of the main long-term growth drivers here. Full-year trademark Heineken brand volume was up in the high-teens area, while there was also good performance from Amstel, Birra Moretti and Edelweiss. That led to overall premium beer volume growing double-digits last year, comfortably outstripping the consolidated group rate.

Furthermore, remaining COVID restrictions should continue to wind down, albeit slower than might have been anticipated, and that will obviously be a near-term tailwind for revenue and profit.

Near-Term Outlook Still A Bit Mixed, But Longer-Term Is Positive

While COVID is now moving into the rear-view mirror amid the continuing global on-trade recovery, the near-term outlook is still a bit mixed. Management had already flagged input cost inflation as a significant headwind this year – somewhere in the mid-teens area in per-hectoliter terms, which it will look to offset somewhat with another round of higher pricing. That, in turn, might lead to softer near-term volume growth. The company does also have direct Russia exposure, albeit not as significant as European peer Carlsberg (OTCPK:CABGY), and surging energy prices obviously won’t help with cost inflation.

I am a bit more optimistic over the long-run. Sure, the global brewers aren’t exactly replete with growth opportunities – demographics and competition are big problems in certain developed markets, with consumers, especially in the 18-34 category, turning away from lager and toward wines and spirits. That said, there are still pockets of growth to go after, most obviously in emerging markets but also with premiumization.

In terms of the former, while I do prefer AB InBev’s emerging market footprint, especially its African exposure, Heineken is well placed in a number of Asian and African markets, and its emerging market footprint is better than peers Molson Coors (TAP) and Carlsberg. The recently announced acquisition of Distell and Namibia Breweries Limited also increases its presence in Africa – strengthening its position in South Africa and giving it control over the market leader in Namibia. It also gives it a platform in some East African markets like Kenya and Tanzania. Given the size of the prize that’s on offer – Africa is around half of global beer growth and still enjoys a demographic tailwind – I can only view that as a good thing.

The company is also quite well exposed to premium-end brands, which could give it a long-term bump from price/mix. Trademark Heineken brand volume is already up around 17% on pre-COVID levels – a rare recent bright spot for the firm – while I am also hoping that line extensions such as Heineken Silver can at least somewhat offset the trend away from beer in developed markets, particularly among the Millennial and Gen-Z groups.

Valuation Now More Reasonable If Not Spectacular

Heineken shares currently change hands for just over €79 each in Amsterdam trading, putting them at a circa 5.2% earnings yield based on 2022 EPS estimates.

While it might not look all that cheap, I do think the valuation is a lot more reasonable than it has been in recent times. Growth isn’t going to be gangbusters, save for the near-term as it catches back up to pre-COVID levels, but between its emerging market and premium-brand exposure I still think Heineken is good for mid-single-digit long-term annualized revenue growth. That, in turn, should power high single-digit annualized earnings growth as the company looks to rebuild near-term margins to the high-teens area, with further gains coming from fixed cost leverage thereafter.

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