Carlsberg: Olympics And Euros Angle May Disappoint (OTCMKTS:CABJF)

Carlsberg (OTCPK:CABJF) might be an interesting prospect going into the coming quarter since it will contain the Euros, which is something that retailers, for example, call out. In Q3, there will be the benefits of the Olympics – another major sporting event for Carlsberg markets. The relative success of the English Euros team, which went deep into the tournament, should mean a fair bit of Carlsberg consumption, with the UK being more than 10% of the company’s market. Performance has been fair so far as well as of the previous earnings, although new figures are incoming, and they’ve also announced an acquisition of Britvic (OTCQX:BTVCF) which should bolster their non-alcoholic portfolio.

We do have concerns, though, on competitors disappointing with soft guidance, which also have relevant UK markets and have until now been subject to similar trends. This spells trouble for Carlsberg as it approaches the earnings date on August 14th. We are also not convinced by the relative and absolute valuations, which do not provide big margins of safety. We have concerns.

Previous Earnings

The previous earnings highlight growth in less mature markets, such as Serbia, Ukraine and to a lesser extent Poland. Premium beer growth was also supported by again more emerging markets in Asia, including Vietnam and China. Volume growth was strong in these less mature markets, including also Laos and India. The non-alcoholic portfolios performed comparatively better in the mature markets, consistent with the general pressure of people being more health conscious in those markets.

Overall, increases in revenue per liter were driving around two-thirds of the organic sales growth, with the remaining being from volume.

The outlook as of last earnings was 1-5% of operating profit growth, which is quite a lot of variance. Homing in at the lower end of that range would probably be a significant disappointment. With many of the breweries in the same boat as Carlsberg, volumes strong in less mature markets, but considerable pressure in mature markets, we are concerned around margins as marketing and sales dollars begin to be spent on chasing many of the same customers in similar premiumization strategies in less mature markets.

Possible Disappointments

In the previous earnings, there are already mentions of things that might cause some disappointments in the upcoming quarter. One thing is the push for the premium brands, particularly in the growing markets, which will require more marketing and distribution expenses. While in principle a good idea, the press on growth may cause some disappointment in terms of operating profit, which was one of many elements that caused Heineken (OTCQX:HEINY) to disappoint markets on the announcement of its earnings. A lot of businesses are doing this, including Ambev (ABEV) which we covered as it tries to capitalize on its Corona brand and trading down from spirits in its Latin markets. Competing for the same attention will lower ROI on marketing dollars and increase competition in distribution.

Around 10% of Heineken’s global beer volumes are in the UK, which means UK exposure for Carlsberg is comparable to Heineken, where the UK is going to be the most affected by the Euros factor. If Heineken was able to disappoint in its earnings on organic growth despite tailwinds that might have otherwise been ignored by markets, since the Euros is a biannual occurrence, we’d be concerned about the same for Carlsberg.

Final Remarks

Carlsberg took a dive upon announcing the initial offer, which then had to be bid up, for Britvic. Britvic has some great brands, including rights to sell 7Up, Gatorade, Lipton Ice Tea in major markets. This will bolster Carlsberg’s non-alcoholic portfolio in key European markets, which is going to help weather what has become secular pressure in those geographies for traditional brewed products. The strategic rationale is there, particularly as growth in non-alcoholic at Carlsberg could have been better in the last results.

They’re paying about a 12x EV/EBITDA multiple, and the forward PE for Britvic, which is trading close to the announced acquisition price, is around 20x.

Based on SA spreads, that’s about an average multiple in terms of PE and a little bit premium in terms of EV/EBITDA. At any rate, we think it’s an expected and relatively uncontroversial M&A price that shouldn’t destroy much value in overpayment.

On an implied acquisition approach, however, markets would disagree with that assessment, since Carlsberg lost around 10% of its value around the acquisition announcement initially. There isn’t much reason to expect dis-synergies in this acquisition. With Britvic’s consideration being around 28% of Carlsberg’s market cap in total, it’s a little strange to imagine that almost half the value of Britvic is an overpayment. It would imply that it was already very overvalued before the acquisition announcement, which it wasn’t really. Even if you assume Britvic was 20% overvalued in the acquisition, the consideration would only be overpaid by 743 million GBP, or 6.6 billion DKK, which is only 5.6% of Carlsberg’s market cap. On that basis, there might be reason to buy the dip.

However, looking at Carlsberg’s multiples – while somewhat discounted to peers, it’s not a massive steal. Also removing outliers, Carlsberg ends up looking less impressive and offering narrower margins of safety.

We don’t see a relative case. At 15x and 14x TTM and forward PE respectively, earnings yields are only around 7%, and not far ahead of risk-free rates. There are plenty of safer picks with higher yields in international markets, so there’s not much of an absolute case either.

Then, with peers causing disappointments, we’d be concerned about Carlsberg’s ability to impress in the coming call. With equity researchers being extremely focused and dependent on comps in all their forecasting and valuations, we think things are leaning towards being troublesome. Although, it does trade a bit cheaper than Heineken. Still a pass.

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