Heineken N.V. Offers Above-Average Growth And Margin Self-Help, But A Lot Of That Is In The Share Price Now
Summary
- Heineken is coming out of pandemic-driven volume pressures with a bold plan to cut significant costs, reinvest in marketing and digital initiatives, and maintain an above-peer growth rate.
- Bullish analysts are expecting better margin leverage from the self-help program but that may be premature/optimistic given Heineken's more spread out volume/market share profile.
- Revenue growth should remain a source of upside, with Heineken one of the leaders in premiumization and category innovation, including alcohol-free beers.
- With the shares up 20% in about six months, I see today's price as more "fair" than "undervalued", and this is a name I'd look to add on pullbacks.
Operating conditions have remained challenging for brewers, particularly brewers like Heineken N.V. (OTCQX:HEINY) with above-average exposure to on-premises channels (basically, beer consumed outside the home), as pandemic lockdowns have seriously hurt business in Western Europe and some Latin American countries. The good news, such as it is, is that the first quarter will likely be the last really poor one ahead of recovery for the rest of 2021.
Navigating the pandemic isn’t Heineken’s only challenge. The company is really the last of the major brewers (depending upon your definition of “major”) to launch a large-scale restructuring program, and management is targeting significant expense reductions, but only expecting to get back to around pre-pandemic margins in 2023. While bulls see this as a conservative guide, that may not be the case given Heineken’s model.
These shares have done okay since my last write-up, mostly tracking with the S&P 500 and other brewers like Anheuser-Busch InBev (BUD), Carlsberg (OTCPK:CABGY), Diageo (DEO), while Constellation (STZ) has outperformed and Molson Coors (TAP) has significantly outperformed (much to my own surprise). At this point, I would say Heineken is an okay hold, with some positive leverage to premiumization, volume growth, and self-improvement, but with some fundamental challenges as well.
One More Ugly Quarter
When Heineken reports first quarter volume figures later this month, the results are likely to make for mostly unimpressive, if not ugly, reading.
With around 40% of sales coming from on-premises consumption and less than 30% of EU on-premises locations open through most of the quarter, it’s hard to see how the EU results won’t be ugly. I likewise don’t expect great things from Brazil or Mexico – Brazil due to reduced on-premises activity and Mexico due to a combination of the pandemic, more intense price competition from ABI, and FEMSA’s (FMX) OXXO stores including more ABI brands.
There will likely be a few bright spots. Nigeria and South Africa will probably be stronger, and I wouldn’t be surprised if Vietnam surprises to the good. Unfortunately, on balance, it is likely to be a still-challenging quarter.
The good news is that this is likely the last really bad quarter. There are still concerns about COVID-19 infection rates in Europe, but I expect improving vaccination rates to lead to more reopenings as the second quarter and remainder of 2021 roll on. Likewise for the rest of Heineken’s major markets.
How Far Can Self-Help Go?
With fourth quarter/full-year earnings, Heineken also announced its “EverGreen” cost reduction and productivity program. In contrast to notoriously cost-conscious ABI, Heineken is one of the last major brewers to make a big push on margins, though such a move was widely expected as a major post-pandemic initiative.
In simple terms, Heineken is targeting a 10% reduction in costs base (around EUR 2B), including a 10% global workforce reduction and lower related costs (travel, infrastructure, et al). Offsetting these cuts, Heineken still views itself as a growth company and will be reinvesting in higher marketing spend and digital/IT, including investments in back-office systems, analytics, and consumer interaction.
All told, management believes these moves will lead to an operating margin on par with pre-pandemic levels (around 17%), but with a growth rate above the average for the alcoholic beverage space.
Bullish sell-side analysts seem to think that Heineken may be sandbagging the guidance and that the actual margin leverage will prove to be higher, particularly if brand-building can drive stronger price/cost leverage and volumes.
That’s a plausible bullish scenario, but there are some challenges to consider. Brewing isn’t really a global business, it’s a local business. Manufacturing and distribution is handled locally and brands tend to be local (as does marketing). That means that brewers with large share and efficient operations (boosted by scale advantages) tend to do better on margins, and that includes ABI and Diageo, which is why Diageo can generate pretty good margins on comparatively modest volumes.
That’s not good for Heineken, though, as Heineken has over 50% share in Nigeria (about 5% of volume), around 40% share in Mexico (17% of volume), over one-third share in Vietnam (around 8% of volume) and 20% share in Mexico (12% of volume). After that, it’s a collection of higher shares in smaller markets (Cambodia, Cameroon, Austria, the Netherlands), and lower shares in larger markets (4% in the U.S., <10% in South Africa, almost nothing in China, et al).
To be clear, I’m not saying that Heineken is a bad business. I’m just saying that the company doesn’t have the have scale advantages in large markets to really excel on margins, at least not in the near term.
Growth Is Still A Relevant Factor
An important “but” is Heineken’s leverage to growth opportunities. Heineken management likes to talk of the company as a growth company, and that’s not entirely unfair. In a segment that has seen significant volume weakness in mainstream brands, Heineken has done quite well in premium and super-premium categories and has been a leader in premiumization.
The flagship Heineken brand in particular remains strong, with growth opportunities. Heineken has managed to take share from ABI in Brazil (arguably its strongest market), and new concepts like 0.0% ABV beer seem to be catching on relatively quickly.
On top of that, Heineken is well-leveraged to some growing markets. Nigeria may be a smaller market in terms of volumes today, and affordability is a limiting issue, but that’s a fast-growing country. Likewise with Cambodia and Vietnam, and while the company’s position in China isn’t all that large, it has a decent share of the growing premium category, and markets like Indonesia could surprise over time.
The Outlook
I believe Heineken can and will continue to grow value share in the global beer market over time, and I’m looking for long-term revenue growth in the mid-single-digits, helped by the aforementioned trends of premiumization, product innovation, and market growth in certain emerging markets.
Margin leverage is where I’m a little less confident. I do believe management will execute on its cost-reduction targets, but I think the bullish analysts who expect more near-term margin leverage upside may be disappointed. Longer term, yes, I think price/cost will be positive, but I think it will be a tougher achievement over three to five years.
I still believe Heineken can get its FCF margins into the mid-teens, and that’s still a pretty bullish, if not aggressive, assumption given the company’s historical performance. Assuming they can do it, FCF growth should be in the low double-digits.
The Bottom Line
With the 20% move in the shares, I don’t see Heineken shares having quite the same value as before. I think it’s a decent enough hold, and I can see a path to outperforming both sell-side expectations my own estimates (mine are generally higher), but I’m not as confident on further rerating potential, so I’d likely hold what I owned and wait for a dip/pullback to add.
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Analyst’s Disclosure: I am/we are long FMX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (7)
www.theheinekencompany.com/...
I also really like the fact that the Heineken family still has a significant economic interest in the company in addition to running it. Some publicly traded family run businesses (BF.A, EL, ROL etc) make some terrific long term stocks and have made plenty of shareholders wealthy over a lifetime.