Beer industry production Volume in fourth-quarter 2016 was slightly better than our expectations, with 1% year-on-year decline compared with the year-ago period. The Chinese beer market seemed to gradually recover from the unfavorable weather in the first half, as the growth rate improved to a 4.4% year-on-year decline from an 8.4% year-on-year decline. Tsingtao, China’s second-largest beer maker, has struggled competing against China Resources Beer Holdings (291 HK)'s Snow Beer and other overseas brewers, as demonstrated by its 6.6% decline in Sales Volume versus a 5.2% decline of industry in aggregate for the first three quarters. Owing to its conservative sales strategies and product positioning, we expect Tsingtao to further underperform its peers and anticipate its sales volume to fall 2% year over year in the fourth quarter. We forecast its revenue and net profit to decrease 5% and 9% year over year in 2016, respectively. However, we maintain our narrow moat and stable trend ratings for the firm and our fair value estimates remain at HKD 27.50 per H-share and CNY 23.00 per A-share.

We view the shares of Tsingtao as overvalued. We forecast medium-term organic beer industry volumes to be flat, hindered by a significant headwind from the drinking-age population and only moderate per capita consumption growth. However, we anticipate inflationary-like pricing of 2% and a positive mix effect of 1% to lead to 3% medium term industry value growth, as China is in the growth phase of premiumization. While we expect Tsingtao’s brand intangible assets will enable upgraded product mix and further pricing gains, we are concerned the firm will continue to face additional downward pressure from intensifying competition, weak consumer sentiment, and a sluggish Chinese economy. Overall, we forecast Tsingtao's revenue to grow at an average annual rate of just 1.2% through 2020, considerably lower than the growth we project for the industry and global brewers operating in the region.

Analysts: Allen Cheng and Jessica Yi

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