Looking for Further Upside in Heineken

| About: Heineken N.V. (HINKF)

Stock price: €30.4 ($44.8)
Conclusion: Looking for further upside. We confirm our valuation range of €35-40 ($52-59) per share in light of Q3 trading update.

Q3 trading update: sales down 3.9% to €4bn, almost flat like for like (-0.4%), adjusted EBIT up double digit. Guidance 2009 raised from high single digit organic net profit growth to low double digit growth.

Q3 confirms our investment thesis:

  • Value strategy to offset lower volume. Volume continued to be under pressure (-4.7% like for like) in Europe, Americas and Asia, while Africa is slowing down. However, the positive price and mix effect (+2.6%) almost fully compensated for the decline. The Heineken (OTCQX:HINKF) brand in the premium segment (down 2.7%) outperformed the rest of the portfolio. Volume in Eastern Europe were also impacted by the SKU rationalization in Russia. According to management, the adjusted underlying decline should be in the mid single digit range instead of 9.4% reported for Eastern Europe in Q3 and -12% for the 12 months.
  • Management confirmed that it will continue to work on margin restoration next year, implying further price increases in 2010.
  • Cost cutting is on track. Heineken announced new projects: 4 brewery closures (2 Russia, Finland and UK) and 3 malting plant closures in Romania, in addition to the 3 breweries closed in Spain, France and Czech Republic. Russia is more profitable despite lower volumes thanks to the positive impact of SKU rationalization and optimized sales forces. According to the CFO, the trend in input costs has improved. Marketing spending for the year should decrease in line with the trend observed in H1, helped by lower media rates.
  • Positive swing on the hedging front for 2010. Hedging should turn positive as 70% of the dollar is covered at 1.35 versus 1.43 in 2009.
  • Balance sheet is under control thanks to good cash generation. Management confirmed that Heineken will end the year with a net debt lower than 3.1x EBITDA. We are looking for 2.9x by the end of 2009 and 2.4x by the end of 2010.

Acquisition risk?
Heineken reiterated that they would be interested in a number 1 or a number 2 position in future markets and also would look at the potential of the Heineken premium brand in these markets, in addition to available cost synergies.
We believe that FEMSA Cerveza (valued between $7-$9bn) meets Heineken acquisition criteria but not at any price.. Heineken’s CFO added that “their hands are full managing the new perimeter” and that they are also “willing to get the debt down”. In addition, Heineken faces covenant of 3.5x net debt/EBITDA which limit its room for maneuver. As a result, we think that SAB Miller is more likely to pay up to $9bn and buy FEMSA.

Valuation looks moderate at 13xP/E and 7.9xEV/EBITDA vs 14x and 9.5x average based on 2010 estimates. FCF yield (8.9%) looks attractive. DCF points to €40 per share. As a result, we confirm our €35-40 valuation range per share.

Author's Disclosure: Long Heineken at time of writing.

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