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Heineken - lockdowns hit hard

Sophie Lund-Yates, Equity Analyst | 3 August 2020 | A A A
Heineken - lockdowns hit hard

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Heineken NV Eur1.60

Sell: 92.44 | Buy: 92.46 | Change -0.16 (-0.17%)
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In the first half of the year Heineken's underlying net revenue fell 16.4% to €9.2bn, while underlying operating profit dropped 52.5% to €827m. Once exceptional items, including a €548m write-down in the value of Heineken's assets because of the crisis, and the costs of previous acquisitions are included, the group made a €297m loss, compared with a €936m profit last year.

Although Heineken has seen a partial recovery, the situation remains "volatile and uncertain". The group will focus on controlling costs and capital spending, although input costs per hectolitre are expected to rise.

The shares fell 1.8% following the announcement.

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Our View

Heineken's sales slumped during lockdowns, although they are starting to pick up now restrictions are being relaxed. In the event of a sustained economic slowdown Heineken can expect to face further problems, and pressure could mount on its key bar and restaurant customers.

In the first half of the year a 16.4% fall in revenue has led to a 52.5% fall in underlying operating profit. This is known as "operational gearing" - which occurs when a small change in revenue causes a large change in profits.

Brewers are operationally geared because they have large fixed costs and must sell a certain number of pints just to cover these costs. Each extra pint they brew on top costs them very little and adds greatly to profits. Of course, the reverse is also true - when the number of pints sold falls, profits drain away quickly. This is what's happened to Heineken over the last few months.

Coronavirus has come at a time when Heineken was reporting slowing beer consumption in developed markets. A trend being driven by the twin challenges of lower consumption among younger people and ageing populations. But on the other hand, alcohol consumption had been growing in emerging markets.

These trends are accompanied by increased demand for more premium brands. That's somewhere Heineken has something of an advantage - boasting a stable of brands that includes Amstel and Moretti - as well as the obvious one. The group's been able to deliver fairly healthy operating margins, rising from 13% in 2011 to 16.8% in 2019, although these are still some way behind its bigger rival, AB InBev.

Many will be looking to Heineken's new CEO, Dolf van den Brink who replaced the long standing Jean-Francois van Boxmeer in June, to hopefully deliver growth and further margin improvements. But we expect long term strategies will be on the backburner at least in the short term, as the group tackles the more pressing challenges of COVID-19.

That means financial resilience is the first order of the day.

Heineken's responded to the disruption with a raft of cost saving measures, which will be key to helping it weather the storm. While finding these savings are important for all businesses, they're particularly important for companies with high operational gearing.

We should note net debt is currently 3.5 times cash profits, which is far higher than either we or management would like. Part of the problem is that cash profits have fallen heavily, but net debt has also risen substantially. Heineken has enough cash on hand for the time being, but unless profits rebound quickly the group will need to put a lot of effort into bringing debt down. Management may decide to raise extra capital to do this, as the burden may otherwise curtail its options.

If the world can avoid a second wave of coronavirus infections and/or a sustained recession the worst may be behind Heineken. The group should recover alongside the economy thanks to the strength of its brands, though the balance sheet may force some difficult decisions if conditions do deteriorate.

Heineken key facts

  • Current 12m forward P/E ratio: 23.9
  • 10 year average 12m forward P/E ratio: 17.7
  • Prospective yield: 1.8%

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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First half trading update

The fall in revenue was the result of a 13.4% fall in volumes and a 3.6% fall in prices. After a low point in April volumes started to recover through June as lockdowns began to be lifted. Net revenue fell hardest in the Europe and Africa, Middle East & Eastern Europe divisions, with net revenue down 20.8% to €4.1bn and 16.6% to €1.3bn respectively. The Americas and Asia Pacific regions performed slightly better, but net revenue still fell by 12.2% and 10.4%.

Underlying operating profit was lower in every region, and 84% of the decline can be attributed to Europe, Mexico and South Africa.

Europe was the worst hit region, and underlying operating profit fell 87.0% to €82m. Management attributed this to the group's "vertical integration" in Europe, where Heineken owns pubs, breweries and everything in between. This means fixed costs are higher and were a drag on profits when revenue was falling. This effect was amplified by the region's usual reliance on sales in bars and restaurants which were closed during the lockdowns.

Heineken's operations were suspended in Mexico during April and May, but reopened in June. The sale, distribution and production of alcohol was banned in South Africa from mid-March to the end of May, and was re-imposed in July after a temporary reprieve in June.

Net debt has risen from €15.3bn the end of 2019 to €16.7bn due to negative free operating cash flow and dividend payments. Net debt is currently 3.5 times cash profits, up from 2.6 times at the end of 2019 and well ahead of management's 2.5 times target. Free operating cash flow for the half year was negative €809m, compared with a €578m inflow last year.

Find out more about Heineken shares including how to invest

Update: A previous version of this article indicated that Heineken listed in 2014. This is not correct. The article has now been updated to reflect this.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.