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Heineken - the recovery begins

Nicholas Hyett, Equity Analyst | 28 October 2020 | A A A
Heineken - the recovery begins

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Heineken NV Eur1.60

Sell: 91.60 | Buy: 92.60 | Change -0.04 (-0.04%)
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Organic beer volumes fell 1.9% during Heineken's third quarter, and 8.1% during the first nine months of the year. The flagship Heineken brand grew sales 7.1% during the quarter, and sales are up 1.0% for the year so far.

Heineken's reported net profit for the first nine months fell from €1.7bn to €396m as cost savings partially offset volume declines, costs related to the pandemic and the impairment of some assets.

The shares fell 1.1% following the announcement.

View the latest Heineken share price and how to deal

Our View

Heineken's sales slumped during lockdowns, although they've picked now restrictions have been relaxed. The rising second wave of coronavirus infections is likely to set progress back, but Heineken's global presence means the policies of any one region matter less than the overall trend.

In the first half of the year a 16.4% fall in revenue 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 those 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. Something Heineken knows only too well after the last couple of months.

Coronavirus has come at a time when Heineken was already 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. Encouragingly, the premium portfolio has done well over the last quarter, indicating that customers aren't trading down too much amid tough economic conditions. The group's historically 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.

Heineken's responded to the recent 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 was 3.5 times cash profits at the half year, and we doubt that's improved much in the most recent quarter. This level of debt 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.

We had hoped that the worst was behind Heineken, and that's probably still true despite the challenges of a second wave. 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

  • 12 month forward Price/Earnings ratio: 24.0
  • 10 year average 12 month forward Price/Earnings ratio: 18.0
  • Prospective dividend yield (next 12 months): 1.8%

All ratios are sourced from Refinitiv. 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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Third quarter trading update

In Europe organic beer volumes fell 2.4%, driven by a 20% fall in on-trade sales from pubs and restaurants. However, off-trade sales volumes from shops grew by high single digits, which was ahead of the market in most regions - especially for premium products. Third party volumes fell 16.1% as wholesale operations were negatively impacted by outlet closures.

Organic beer volumes in the Americas grew 2.5%, driven by the premium portfolio. However, some countries introduced strict restrictions, such as Mexico where dry laws caused volumes to fall by mid-single digits. In the USA volumes grew by low-teens as distributors restocked inventories and the on-trade started to recover.

Africa, Middle East & Eastern Europe saw volumes fall 2.5%, marking a quarter-on-quarter improvement in all key markets. The premium portfolio fell overall, as a five week ban on the sale of alcoholic drinks was imposed in South Africa.

In Asia Pacific organic volumes fell 12.3%, as recurring lockdowns and a lack of tourism weighed on local consumer confidence, especially in Vietnam. While some regions saw declines of as much as 80% (Bali), growth was strong in South Korea (thirties) and China ("strong double-digits").

Heineken has announced a strategic review to define its recovery strategy after the pandemic, and intends to reduce staff costs at its head and regional offices by around 20%.

Furthermore, Heineken has also bought several cider brands (including Strongbow) in Australia, is entering the Peruvian beer market and is exploring the Hard Seltzer category.

Due to ongoing uncertainty Heineken is not giving detailed guidance, but expects further volatility and restrictions during the second wave of infections. Additionally, several currencies have depreciated against the Euro, such as the Mexican Peso and Brazilian Real.

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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 Refinitiv. 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.