ubs/investmentresearch This report has been prepared by UBS Securities Asia Limited. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 47. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Global Research 1 December 2017 Initiation of Coverage UBS Evidence Lab: China Beer Sector First year of volume recovery in 2017; what's next? We are positive on the China beer sector Beer consumption volume has turned positive for national breweries in 2017, and this is reflected in the latest UBS Evidence Lab survey. Despite premiumisation and industry consolidation, the China beer profit pool's (beer companies' aggregate EBIT) growth has been slow since 2010. We believe Chinese breweries' profitability has reached an inflection point, because of their supply discipline since 2014, an overall demand recovery in the mass-market consumer segment in 2017, and cost savings. We forecast a 28% CAGR for the China beer profit pool over 2017-20, driven by accelerating premiumisation and asset rationalisation by Chinese breweries; we think this has been overlooked by investors. and UBS Evidence Lab survey results provide evidence for our bullish stance The UBS Evidence Lab survey of 1,680 regular beer consumers in tier-1 to tier-4 cities in China and data science analysis showed increased spending in both volumes and value in the past year, driven by more varieties of product offerings and higher incomes. We attribute Anheuser-Busch InBev's (ABI) leading position in the premium segment to its high penetration in on-premises channels in tier 1 and 2 cities. However, perceptions of quality, high brand awareness and wide channel coverage, along with improved execution in marketing and branding and a shift to off-premises consumption might provide Tsingtao Beer and China Resources Beer (CRB) Snow upgrading opportunities. National Chinese breweries' factory closures can yield profitability upside Due to low volume growth expectations and capacity utilisation rates, breweries began to close excess capacity in 2015. We expect factory closures to accelerate from 2018, as SOE parent companies demand higher asset returns. In collaboration with the UBS Quant team, we worked out 36% EBITDA improvement in total for the top four national breweries from the closure of 20-30% of their factories. Stock implications: Buy CRB; upgrade TB to Buy; Neutral on Yanjing Brewery Of the three Chinese breweries, our most preferred stock is CRB. We initiate coverage of CRB with a Buy rating, given its market share gains, mix upgrades and biggest earnings upside from potential factory closures. We upgrade Tsingtao Brewery to Buy, due to our positive industry growth outlook, its strong brand awareness and channel coverage as shown in the survey, and valuations. We initiate coverage of Beijing Yanjing Brewery with a Neutral rating, given its market share and brand difficulties. Ratings, price targets and estimates Reuters Share Rating Price target 2017E EPS 2018E EPS 2019E EPS Company code price New Old New Old New Old New Old New Old China Resources Beer 0291.HK HK$21.45 Buy N/A HK$28.47 N/A Rmb0.52 N/A Rmb0.66 N/A Rmb0.92 N/A Tsingtao Brewery 0168.HK HK$31.70 Buy Sell HK$45.37 HK$21.41 Rmb1.04 Rmb0.89 Rmb1.38 Rmb0.88 Rmb1.75 Rmb0.97 Beijing Yanjing Brewery 000729.SZ Rmb5.94 Neutral N/A Rmb6.41 N/A Rmb0.09 N/A Rmb0.12 N/A Rmb0.19 N/A Note: Above data as at 30 November 2017. Source: Reuters, UBS estimates Equities China Distillers & Brewers Christine Peng, CFA Analyst christine-y.pengubs +852-2971 7571 Shanle Wu, PhD Analyst shanle.wuubs +852-2971 7513 Nik Oliver Analyst nik.oliverubs +44-20-7568 4982 Brad Chen Analyst S1460516060001 brad-a.chenubssecurities +86-213-866 8985 Initiation of Coverage: UBS Evidence Lab: China Beer Sector 1 December 2017 2 Contents OUR THESIS IN PICTURES . 4 PIVOTAL QUESTIONS . 6 Q: Will there be industry-wide price hikes in the next 1 to 2 years? . 6 Q: Will there be upgrading opportunities for domestic Chinese brands in the next 1-2 years? . 16 Q: Will the three Chinese breweries' factory closures accelerate over the next 1-2 years? . 29 WHAT'S PRICED IN? . 41 *UBS Evidence Lab provides our research analysts with rigorous primary research. The team conducts representative surveys of key sector decision-makers, mines the Internet, systematically collects observable data, and pulls information from other innovative sources. They apply a variety of advanced analytic techniques to derive insights from the data collected. This valuable resource supplies UBS analysts with differentiated information to support their forecasts and recommendationsin turn enhancing our ability to serve the needs of our clients. For this study, UBS Evidence Lab conducted an online survey of 1,680 18- to 54-year old Chinese consumers who drink beer (at home / outside the home) at least once every four to six months. Against these criteria, the target group was randomly identified from a sample broadly representative of the general online population in terms of age, gender and income, and weighted to reflect the population distribution across the North/ Northeast, Central, East, South and Southwest regions and across city tiers 1 to 4. Conducted from 23 October to 7 November 2017, conclusions based on the overall sample have a potential sampling error of +/-1.92% at a 90% confidence level. Christine Peng, CFA Analyst christine-y.pengubs +852-2971 7571 Shanle Wu, PhD Analyst shanle.wuubs +852-2971 7513 Nik Oliver Analyst nik.oliverubs +44-20-7568 4982 Brad Chen Analyst S1460516060001 brad-a.chenubssecurities +86-213-866 8985 Initiation of Coverage: UBS Evidence Lab: China Beer Sector 1 December 2017 3 China Beer Sector P2 UBS Research THESIS MAP a guide to our thinking and what's where in this report OUR THESIS IN PICTURES MOST FAVOURED LEAST FAVOURED China Resources Beer, Tsingtao Brewery Yanjing Brewery PIVOTAL QUESTIONS Q: Will there be industry-wide price hikes over the next 1 to 2 years? Yes, given supply discipline and rising cost pressures against the backdrop of a demand recovery and ongoing premiumisation trends. We believe Chinese breweries' profitability has reached an inflection point due to supply discipline since 2014 and an overall mass-market consumer demand recovery in 2017. more Q: Will there be upgrading opportunities for Chinese brands in the next 1-2 years? Yes, given an accelerating premiumisation trend and consumers' increased spending on beer consumption both in volume and value. ABI's leading position in the premium segment can be attributed to its high penetration in on-premises channels in tier 1 and 2 cities. However, their high brand awareness, quality perception and wide channel coverage with consumers can provide Tsingtao Beer and CRB Snow upgrading opportunities with improved execution in marketing and branding, helped by a potential shift towards off-premises beer consumption. more Q: Will the three Chinese breweries' factory closures accelerate over the next 1-2 years? Yes. National Chinese breweries' excess capacity shutdown began in 2015 due to low volume growth expectations and utilisation rates. We believe factory closures will likely accelerate from 2018, as SOE parent companies demand higher asset returns. We collaborated with the UBS Quant team to work out 36% EBITDA improvements in total for the top four national breweries by closing down 20-30% of factories. more UBS VIEW We turn positive on the China beer sector in view of the demand recovery, accelerating premiumisation and, most importantly, the supply discipline of mass-market national breweries since 2014. We forecast a 28% CAGR for the Chinese beer profit pool over 2018-20, compared with 6% in 2010-17E, driven by accelerating premiumisation and asset rationalisation, which we think has been overlooked by investors. Of the three national Chinese breweries our most preferred stock is CRB, which we rate a Buy because of its market share gain, mix upgrades and biggest earnings upside from potential factory closures. TB is a Buy, due to our solid industry growth outlook, its strong brand awareness and channel coverage, as shown in the UBS Evidence Lab survey, and valuations. We rate Yanjing Brewery Neutral as it struggles with market share and brand upgrades. EVIDENCE Our view is well supported by: 1) the UBS Evidence Lab survey results, which showed consumers' increased spending on beer both in volume and value; 2) our beer profit pool regression analysis which suggests the China beer profit pool is depressed relative to its GDP; 3) UBS Evidence Lab survey results showed high brand awareness and availability of both on-premises and off-premises channels; and 4) the UBS proprietary brewery supply chain optimisation model, which uses factory level data of the top four breweries' around 270 factories to estimate the EBITDA improvement potential of each. WHAT'S PRICED IN? Three national Chinese breweries all showed almost lowest investor weighting among peers and their valuations are below historical average levels. This suggests investors have not factored in profitability improvements for the mass-market Chinese breweries. more China beer market Source: Company data, UBS estimates 0%10%20%30%2010-17ECAGR2018-20ECAGR2010-17ECAGR2018-20ECAGR2010-17ECAGR2018-20ECAGRVolume growth Revenue growth EBIT growth0%20%40%60%80%2010 2017E 2020ECR5 market shares (by volume) Initiation of Coverage: UBS Evidence Lab: China Beer Sector 1 December 2017 4 China Beer Sector UBS Research P3 OUR THESIS IN PICTURES return We forecast ABI, CRB, and Tsingtao to have the highest incremental EBIT gains in 2017-20 We expect the combined capacity growth ratio for CRB, Tsingtao, and Yanjing to decline from 12% in 2013 to 0% in 2017 and -1% in 2020, while we estimate the China beer market's EBIT margin could rise from 6% in 2016 to 12% in 2020 A demand recoveryof the regular beer consumers, 38% of survey respondents indicated their current monthly spending on beer is higher than it was 12 months ago, while 9% are spending less ABI's leading position in the premium segment can be attributed to its high penetration in on-premises channels in tier 1 & 2 cities and the southern region; Tsingtao and Snow have higher coverage overall than Budweiser 02,0004,0006,0008,00010,00012,00014,00016,00018,00020,00022,00020102011201220132014201520162017E2018E2019E2020EChina beer market profit pool breakdown Others Yanjing Carlsberg Tsingtao CRB ABIRmb m -5%0%5%10%15%2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020ECRB, Tsingtao, and Yanjing's combined capacity growth ratio and China beer market EBIT margin (Capex - depreciation) / revenue China beer market EBIT margin0%20%40%60%80%100%Tier 1Tier 2Tier 3Tier 4LowMediumHigh18-2930-3940-54Total Tier Monthly HousholdIncomeAgeRegular consumer monthly spend on beer vs. 12 months ago More Unchanged Less0%5%10%15%20%25%30%35%CentralEastNorthSouthSouthwestTier 1Tier 2Tier 3Tier 4Total Region TierBrands consumed most often outside the home top 7 brands Tsingtao Snow Budweiser Harbin Yanjing Heineken Carlsberg Initiation of Coverage: UBS Evidence Lab: China Beer Sector 1 December 2017 5 China Beer Sector UBS Research P3 OUR THESIS IN PICTURES return Tsingtao and Snow lead all major brands in at-home consumption, attributable to their high penetration in the central, east, north, southwest regions, as well as low-tier cities In collaboration with the UBS Quant team, we worked out 36% EBITDA improvement in total for the top four national breweries from the closure of 20-30% of their factories CRB and Tsingtao's current investor weightings relative to MSCI China are 0.32% and 0.10%, respectively, down from their peaks of 0.40% and 0.41%, and in line with and below their respective historical averages CRB is trading at 0.3 standard deviation below its 12-month forward EV/EBITDA average since 2015; Tsingtao is trading at 1.2 standard deviation below its 12-month forward EV/EBITDA average since 2008; Yanjing is trading at 0.8 standard deviation below its 12-month forward EV/EBITDA average since 2010 Sources: Company data, Bloomberg, UBS Evidence Lab, UBS estimates 0%5%10%15%20%25%30%35%40%CentralEastNorthSouthSouthwestTier 1Tier 2Tier 3Tier 4Total Region TierBrands consumed most often at home top 7 brands Tsingtao Snow Budweiser Harbin Yanjing Blue Ribbon Laoshan0%20%40%60%80%-5001,0001,5002,0002,5003,000CRB Tsingtao Yanjing ABIRmb m EBITDA benefits from supply chain optimisation EBITDA Improvement % of original EBITDA (RHS)0.00%0.05%0.10%0.15%0.20%0.25%0.30%0.35%0.40%0.45%08/0708/0808/0908/1008/1108/1208/1308/1408/1508/1608/17CRB and Tsingtao investor weighting (relative to MSCI China) Tsingtao investor weighting (relative to MSCI China)CRB investor weighting (relative to MSCI China)Tsingtao AverageCRB Averageaverage = 0.24 average = 0.32 02468101214161820222401/0807/0801/0907/0901/1007/1001/1107/1101/1207/1201/1307/1301/1407/1401/1507/1501/1607/1601/1707/1712-month forward EV/EBITDA CRB Tsingtao Yanjing Initiation of Coverage: UBS Evidence Lab: China Beer Sector 1 December 2017 6 China Beer Sector UBS Research Sector Q1 PIVOTAL QUESTIONS return Q: Will there be industry-wide price hikes in the next 1 to 2 years? UBS VIEW Yes, given supply discipline and rising cost pressure against the backdrop of a demand recovery and the ongoing premiumisation trend. We believe Chinese breweries' profitability has reached an inflection point, because of their supply discipline since 2014 and the overall demand recovery in the mass-market consumer segment in 2017. EVIDENCE (1) Three Chinese national breweries having been cutting capex since 2014, matching volume growth in beer consumption (2) Their pricing trends have been lagging the industry average and retail prices since 2011 (3) Their expense ratios began falling in H117 amid higher cost pressure (4) UBS Evidence Lab survey results showed increased consumer spending both in volume and value. WHAT'S PRICED IN? Investors are underestimating profitability improvements at the three Chinese national breweries. Mass-market breweries 2011-13 overexpansion in capacity depressed pricing; signs of supply discipl