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Heineken - Cost inflation dents profits

Nicholas Hyett | 29 July 2019 | A A A
Heineken - Cost inflation dents profits

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Heineken NV Eur1.60

Sell: 91.60 | Buy: 92.60 | Change -0.04 (-0.04%)
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Organic net revenue rose 5.6% in the first half of the year to EUR11.4bn. However, higher raw material costs and increased investment in e-commerce and technology meant operating profits came in behind market expectations, rising just 0.3% to EUR1.8bn.

Heineken announced an interim dividend of EUR0.64. This is in line with the group's policy of paying an interim dividend that's equivalent to 40% of the previous year's total dividend.

The shares fell 5.4% in early trading.

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Our View

Given Heineken sold 234m hectolitres of beer last year, reports of slowing alcohol consumption in the developed world might reasonably concern investors. It's a trend being driven by the twin challenges of lower consumption among younger people and ageing populations.

So far the company's been able to weather the storm better than you might expect.

Lower alcohol consumption in Europe and the US is being accompanied by increased demand for more premium brands. That's somewhere Heineken has something of an advantage - with a stable of brands that includes Amstel and Moretti - as well as the obvious one. The group's been able to deliver fairly healthy profit margins, rising from 13% in 2011 to 17.2% in 2018.

Management's also invested heavily in emerging markets, including recent moves to bolster its position in China and Latin America. These markets (particularly Brazil) may be lower margin than more established regions, but they have attractive growth potential.

Unfortunately it feels like the recipe that's been so successful in recent years is losing its sparkle.

Lower volume growth in areas like Western Europe has seen competition heat up, putting pressure on pricing even among Heineken's more premium brands. Lower margin developing countries are keeping volumes moving forwards, but are also less profitable. The whole mix isn't being helped by inflation in the price of raw materials.

As a result margins are expected to slip backwards from here, and growth expectations have been cut.

In the long run we think Heineken's got what it takes to balance the equation and keep growing profits. However, the challenges in developed markets are real and might see growth stall in the short term. Given the shares currently trade on a PE ratio of 22, some 29% above the 10 year average, the shares could be volatile in the years ahead.

Still, progress should be enough to keep the dividend bubbling up from the 1.8% yield on offer over the next year- remember though there are no guarantees.

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Half Year Results

Beer volume rose 3.1%, to 116.1 million hectolitres (mhl). The Heineken brand saw volumes rise 6.9%, while Tiger and Amstel drove high single digit growth in the international brand portfolio. Cider volumes rose 2.1%, with low & no-alcohol beer volumes up 9.5% driven by Heineken 0.0. The Craft & Variety business saw volumes grow by low-single digits.

On a regional basis, Heineken continues to struggle in its more mature developed markets. Operating profits fell in the group's two largest regions Americas and Europe, down 1.7% and 5.7% respectively, with volumes struggling in the US and Western Europe. By comparison, Asia Pacific saw revenues rise 11% and profits rise 16.3%, and Africa, Middle East & Eastern Europe saw revenues rise 10% and profits rise 1.9%.

Organic operating expenses rose 6.6%. Input costs were up 8.5%, or 5.6% on a per hectolitre basis, largely due to increases in the price of packaging materials. Marketing and sales expenses also rose 5.5%, and now represent 11.7% of net revenue (2018: 11.6%). The group also increased investment in digital initiatives such as direct-to-consumer websites and business-to-business platforms.

The group finished the half with net debt of EUR16bn, compared to EUR12.1bn at the end of the last financial year. That reflects an increase in working capital as well as the acquisition of Chinese group CR Beer. The group finished the half with a net debt to EBITDA ratio of 2.9 times.

Heineken expects volatility to continue for the rest of the year, with the group expecting to deliver 'superior' top-line growth through price and volume increases. Input and logistic costs are expected to rise by mid-single digits.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.