Moody’s says it will not downgrade its ratings of Carlsberg and Heineken, despite the potential harm a massive French tax increase in January could pose to national beer sales.
On December 13, the French Constitutional Court (Conseil Constitutionnel) rubber-stamped government plans to raise beer excise duty by 160% from January 1, senior analyst at Moody’s Investor’s Service, Yasmina Serghini-Douvin, noted in a sector comment.
As of January 2013, the standard excise duty rate for beer in France will jump 160% to €7.2 ($9.56) per hectoliter/degree of alcohol of finished product (from €2.75 in 2012) for breweries with a yearly production exceeding 200,000 hectoliters.
“In an already depressed consumer environment, we expect that higher taxes on beer will dampen beer consumption in the country, which is a credit negative for European brewers,” Serghini-Douvin wrote.
“French market leader Heineken, with an estimated market share (in volume) of approximately 32.4% and Carlsberg Breweries, with 29.1%, are likely to bear the brunt of the proposed tax hike,” she added.
Operational weakness risk
But the analyst said that the French tax hike would not affect Moody’s ratings for the brewing giants – Heineken: Baa1, Carlsberg: Baa2 – because they continued to focus on generating cash flow and diversification.
Heineken’s recent acquisition of Asia Pacific Beverages (APB), in particular, would reduce its Western European net sales exposure from 45% to 41%, Serghini-Douvin observed
That said, she warned that Heineken’s credit metrics would deviate from targets set out for the Baa1 rating category: debt/EBITSA of below 3.0x and retained cash flow (RCF)/net debt in the low to mid-20s in percentage terms.
Similarly, Carlsberg’s credit metrics had deteriorated since 2011 driven by weak performance in Eastern Europe, the analyst said; the firm had RCF/net debt of 23.3% in 2011, while debt/EBITDA was 3.1x “above level deemed appropriate for its rating category”.
“The above metrics leave these companies in a somewhat more vulnerable position to cope with operational weakness,” Serghini-Douvin said, “driven by a challenging macroeconomic and fiscal climate across Europe and an uncertain input cost environment.
Retail price hikes of 15-20%
The analyst said that, as a result of the tax increase, Moody’s expected beer sold in supermarkets (the bulk of volumes sold in France) to see much steeper price rises than drinks sold via on-premise channels, because beer duty was based on volumes, not prices.
Moody’s expected Brewers to pass on the higher tax to consumers, Serghini-Douvin said, with Carlsberg and Heineken estimating price increases of 15% to 20%.
“Assuming that prices reflect the full extent of the tax increase, then this will hurt consumption, at least initially,” the analyst wrote.
The threat to beer volumes was compounded by French plans to raise standard VAT to 20% from 19.6% and its reduced rate (in restaurants, for instance) from 7% to 10%, she added.
Worse still, beer volumes in France had fallen in recent years, Moody’s noted, prompting Heineken to focus on its premium portfolio (including its eponymous brand) and push brands such as Desperados and Pelforth in the on trade.
Kronenbourg losing ground
The premium category gained share in recent years as a result, Moody’s said, while Carlsberg also reported market share improvements in 2011, particularly in the on-trade channel.
“However, the company has suffered from the steady decline in the mainstream category where its popular Kronenbourg brand has been losing ground. To boost market share and growth, Carlsberg announced restructuring efforts in the country.”
Beer taxes had risen across Europe in recent years as governments tried to curb national deficits, Moody’s said, with Holland’s recent hike, and measures planned in Italy and Finland.
“Overall, we believe that brewers most exposed to Europe will continue their cost-cutting efforts in order to preserve their margins in the region in 2013,” Serghini-Douvin wrote.
“However, we remain concerned that cost-cutting might not prove sufficient to mitigate weak demand in light of largely unfavorable trading conditions across most European countries, driven by austerity measures, higher taxes and still high unemployment rates.”