Qingdao Beer: Continuous Upgrading to High-End Market

Summary of Qingdao Beer's 1st half 2022 performance conference call

Key points of 1st half performance

1. Overall sales situation: Market sales in January and February were good, with some decline in March and April, but sales recovered in May. In July, sales growth exceeded the decline in March and April, and sales increased year-on-year at the end of July.

2. Sales of various products: 1) Total sales volume was 4.72 million kiloliters, with a slight decline. 2) The main brand, Qingdao Beer, sold 2.6 million kiloliters, an increase of 2.8% year-on-year. 3) The sales volume of medium-to-high-end products was 1.6 million kiloliters, an increase of 6.6% year-on-year. Among them, the classic variety accounted for the majority, with a retail price of 10 yuan in Qingdao, and an increase of over 8%. As a dark horse, the sales growth of Bai Pi (White Beer) was far higher than double digits. Cans performed well, growing by 10%. Pure products and small bottles saw a slight decline. The sales volume of 1903 fluctuated slightly.

3. Cost trends: 1) The cost in the first half of the year increased significantly but was within the budget control. 2) The cost in the second half of the year is expected to decrease. The price of aluminum material has dropped from 20,000 yuan/ton to 17,000-18,000 yuan/ton, and the international barley price has fallen from over 500 US dollars to 450-460 US dollars. The price of packaging materials has also fallen slightly.

4. Marketing expenses: Marketing expenses in the first half of the year decreased year-on-year, while marketing expenses in the second half of the year were slightly higher than in the first half of the year. The year-on-year change for the whole year is basically the same.

5. Sales expectations: In recent months, sales have been growing at double-digit rates, and with the effective control of the pandemic in the second half of the year, it is expected that sales will continue to grow rapidly.

6. Goals for the raw material business: Expand production capacity before next year's peak season to meet consumer demand.

**7. Measures for cost saving and revenue growth: 1) Revenue growth: Improve product structure and adjust pricing system; normalize the structure according to regions and products; increase promotion in sports, music, and experiential marketing. 2) Cost-saving measures: update, transform, expand, or relocate old factories; strengthen the accurate investment of sales expenses.

8. Measures to increase product profitability: 1) Continuously introduce new products. 2) Structural adjustment. 3) Improve the effective cost ratio.

9. Progress in the "One Vertical and Two Horizontals" development strategy: The "One Vertical" coastal economic belt has basically stabilized, while the "Two Horizontals" development along the Yellow River and the middle reaches of the Yangtze River is relatively good. In the past two years, the revenue and sales growth rates have been relatively fast. The development along the Yangtze River is relatively difficult, but it has been improved by developing medium-to-high-end products.

10. "1+N" product matrix and N strategy: 1) Improve the image and increase the price range of ultra-high-end products such as "One Saga Legend," "Century Journey," and "Amber Lager." 2) Sell fresh products through a nationwide sales network.

11. Consumption trend: Consumption upgrading is a major trend. The medium-range wine of the company saw fast growth in the first half of the year. The company is promoting the replacement of product structures and upgrading of the low-end products. Management Remarks

I will briefly analyze the company's operating performance in the first half of the year. After overcoming the impact of the epidemic on the consumer market, we achieved a reversal in sales in the first half of the year. In February this year, our market sales achieved a good start, and the performance in the past two months has been relatively impressive. However, starting from March, our core base market in Qingdao encountered a pandemic, and some regions in Shanghai and Northeast China also experienced the epidemic, and these regions are all traditional advantageous markets of Tsingtao Beer. In March and April, our sales decreased to varying degrees, but the company's management team rose to the challenge and held a marketing mobilization conference for all employees and sales staff after the May holiday, calling on everyone to use the peak season and seize market opportunities to strive for recovery from the sales losses in March and April. We have used various promotion methods, including community marketing, club marketing, live streaming, product marketing, e-commerce, etc., to achieve the recovery and growth of market sales. Although our sales in the first half of the year decreased slightly, they were basically flat and far better than the industry (down by two points). Starting from May, our market sales have already achieved recovery, and by July, we have not only retrieved the market sales that declined in March and April but also remained flat with July last year. Moreover, by the end of July, we have achieved a year-on-year increase in sales.

In addition, we also faced the problem of rising costs, especially the increase in packaging materials. The company made efforts to adjust the structure and price system, making both revenue and profit reach historical highs, mainly due to a series of effective work on cost savings and efficiency improvement.

In terms of cost savings, 1) the company accelerated the upgrade of product structure and adjustment of price system. Although the sales of 4.72 million hectoliters decreased slightly, the main brand of Tsingtao achieved 2.6 million hectoliters, a year-on-year increase of 2.8%, and the middle-to-high-end products of Tsingtao beer above the classic level completed 1.6 million hectoliters, a year-on-year increase of 6.6%, which had a more obvious effect on the improvement of the average price due to its large base number and mid-to-high-end price level. 2) The company made some normalized product price adjustments by region and product. 3) The company strengthened the precision investment of sales expenses and promoted the market in conjunction with the "One Belt and Two Roads" strategy, increasing the promotion efforts in sports marketing, music marketing, and experience marketing. 1903 Bar and Tsingtao Time Coast Craft Beer Garden brought consumers a new high in the experience of craft beer.

In terms of savings, the company carried out a series of updates, transformations, expansions or relocations of some subordinate production plants, and made great progress in the digitalization and intelligence of our subordinate factories, which continuously reduced our energy consumption, and the cost was effectively controlled due to economies of scale. In terms of market, we also strengthened the precision investment of sales expenses. In the context of the pandemic spreading in multiple places, we controlled some offline promotion activities and increased some online market promotion, which further improved the effectiveness of expenses. Looking at the market environment for the first half of the year, the market is still in the high season for sales and our sales are still growing rapidly. The company will seize the favorable opportunities of Mid-Autumn Festival and National Day. Moreover, some areas in the south are experiencing high temperatures and drought, and the sales of our beer in many regions have reached new highs.

Questions and answers with Dolphin Analyst:

Q: The ton price in the second quarter increased by 7%, can you break it down? For mid to high-end products 1.66 million liters, the growth rate is 6%. What is the growth rate and proportion of several major products?

A: Reasons for the increase: 1) gradual improvement. 2) Adjustments made to some pricing systems last year. We did not make a very detailed calculation of the breakdown, but structural improvement is the main factor and adjustments to the pricing system are relatively less. Since last year, the range of products we adjust in price has been greater than before.

Q: From the upgrade of growth rates in non-immediate drinking channels and the marketing of sinking markets, what is the judgment about the high-end trend as a whole? Will there be any adjustments to the corresponding product and regional strategies?

A: The growth of mid to high-end products mainly comes from classic products such as canned beer, "Hong Ren Dang Tou", "Century Journey", and wheat beer, and the growth rate of these products is faster than that of ordinary beer, which also drives the increase in average price.

Q: What are the goals and plans for new products launched in the second quarter such as fresh wort and early wheat beer in the future?

A: For the future prospects of these fresh beer products, the company still places them in a very high strategic position, with these fresh products accounting for 100 million RMB of the total revenue. On the one hand, we are developing high-end bottled products such as "Legend of the Century" and "Century Journey"; on the other hand, we are also working hard to develop fresh wort and pure fresh beer. Moreover, we use the 250-plus 1903 bars as promotion centers for fresh products. When it forms a certain network in the future, we can reach some surrounding consumers. We believe that there is still good room for growth for fresh products in the future.

Q: The current cost of packaging materials has fallen slightly, what is the cost trend in the second half of the year and even next year? How much will the cost increase for the whole year?

A: The cost has increased significantly in the first half of the year but is basically under control within our budget. In the second half of the year, the cost will decline, especially for international bulk materials, especially aluminum, which used to be as high as 20,000 USD/ton, but now it has dropped slightly to 17,000-18,000 USD/ton and is really headed down. The cost of packaging materials will follow the same trend in the next six months or even next year.

The international barley price has dropped slightly by more than 500 USD compared to the peak of this year, and is currently at around 450-460. The decline in speed was relatively fast before, but now it has slowed down slightly. Since we purchase barley in bulk, we may purchase a batch at the beginning of the year, which can be used until October or November, and the impact on costs is not too sensitive. But overall, the increase in costs in the second half of the year may be slower than that in the first half of the year, as the cost has been rising since July of last year.

Q: What is the trend of the expense ratio in the second half of the year? How to judge profitability?

A: The marketing expenses invested in the whole market in the first half of the year have decreased slightly, mainly due to the impact of the epidemic this year. Many terminals closed in March and April, and even May in Shanghai, so investment in these terminals was delayed. 2) We have always been focusing on market fee management in recent years. Since May, our sales performance has been good. The growth rate of expenses in the second half of the year may be slightly higher than that in the first half of the year, but it is basically the same year-on-year.

Q: In August, the hot and dry weather was conducive to beer consumption. Was the growth rate of beer consumption faster in August than in July? What are the expectations for the direction of cost investment and sales in September and October when the weather turns cool and enters the consumption off-season?

A: Since July, sales have maintained rapid growth. After the epidemic, there has been a resurgence or revenge consumption in the consumer market, and catering and tourism have recovered quickly. In addition, the objective environment of drought, less rain and high temperature in the south has indeed increased the consumption of beer. Sales have been growing rapidly at almost double digits in recent months. We will disclose the specific situation in the third quarter report, it is not convenient to provide a detailed introduction now. The peak season has not yet ended. In September, we will continue to increase the intensity of market promotion and promotion activities during the Mid-Autumn Festival and National Day, striving to maintain sustained and rapid growth in sales.

In the second half of the year, the epidemic has been effectively controlled and our sales have also been growing rapidly, so the investment in the market will definitely be larger. We will also do some sports marketing promotion during the World Cup this year. Market investment will definitely increase in the second half of the year.

Q: When can the barley purchased at the beginning of the year be used? Considering next year, will a certain amount of barley be locked in at the end of this year? Or only buy a part at the end of this year and then lock it next year? What are the purchasing strategies and important time points for barley?

A: Barley in North America and Western Europe is harvested at the end of the year. Basically, we will purchase the imported barley we need for the whole year at the end of the year and the beginning of the year. Therefore, the price fluctuation in the middle has little effect on us. We have also begun to pay attention to the purchasing situation of barley in major producing areas abroad. We used to mainly purchase in Australia, and now this part of the purchase has stopped due to some well-known reasons. However, if their government changes and policies are loosened in the future, there may be other changes. At present, our purchases are mainly France and Canada barley, and the proportion of purchases from eastern Ukraine and Russia is very small. This year, we are also continuing to expand the amount of barley purchased in South American countries such as Argentina, striving to achieve diversification of our raw materials and be able to resist the risks of market fluctuations in individual regions. It is still difficult to predict price changes before the time of barley purchase.

The prices of packaging materials such as glass bottles and cans are evaluated once a quarter for contract adjustments. Now the prices of packaging materials have fallen slightly.

Q: Will a new round of equity incentives be launched later? If so, what is the schedule for the new round?

A: Our first incentives were unlocked in July, and the current situation has been very effective. The coverage is also relatively wide, covering most of the company's mid-to-high-level management. With everyone's joint efforts, our performance and stock price have also reached new heights. The success of the first incentive has set a good example for us to set up the second and third incentives, and has also strengthened our confidence in continuing to use capital market tools for long-term incentives. In terms of time, since we are still in the assessment period this year, theoretically the assessment period will end next year, and we can have follow-up discussions with the controlling shareholders and relevant government departments. It is difficult to predict the specific time, but the company will definitely continue to use capital market tools for long-term incentives.

Q: What is the performance of the main single product in the first half of the year and whether it meets expectations? What is the strategy for future single products?

A: Overall sales of mid-range and above products grew by 6.6% in the first half of the year, which is a considerable increase. Among the major single products, the classic products grew by more than 8%, which is higher than 6.6%. The white beer, as a dark horse, grew at a rate much higher than double digits and has blossomed all over the country. In the future, we will continue to cultivate major single products as the main force and direction for future profitability and growth.

Q: Due to the impact of the epidemic, cost input was relatively cautious in the first half of the year. What is the situation of cost investment in the third quarter (whether the cost reduced in the first half of the year will be added to the third quarter or whether the investment will be relatively cautious)?

A: We will not invest the reduced cost in the third quarter that was cut in the first half of the year. The cost in Shandong has indeed decreased compared to last year, but it is not caused by artificial factors, but rather the adjustment of strategic plans for different market opportunities. Due to the improvement of the epidemic situation in various regions in the third quarter and the loose control, the investment in restaurants and contract stores may increase. However, the cost investment in each quarter has historical conventions and budget management. If there are market opportunities, the investment will certainly be increased. But each plan is constantly changing in the implementation process, and temporary adjustments are also very normal. The cost growth rate in the third quarter may be slightly higher than the first half of the year, but it is not significantly different from the overall situation in previous years.

Q: What is the company's plan for closing factories to improve efficiency?

A: Prior to the outbreak of the epidemic in 2020, the company mentioned a preliminary plan to close down 10 factories in 5 years. After that, we have gradually closed and adjusted some factories, excluding the 2-3 factories that have already been closed from the 10 mentioned. As a state-owned enterprise, we actively responded to the government's "six stabilizations and six guarantees" policy and did not take any large-scale actions. However, there are still small adjustments internally, and we closed two factories in Zaozhuang last year and built a new factory, and this internal integration is ongoing. Considering future development, there is currently no new plan for whether the established factories will be closed. In July and August of this year, there has been a shortage of production capacity in some regions, so the issue now is to ensure the operation of the plants.

Yesterday, the board of directors approved the expansion of the Qingdao factory and some individual factories in the northwest to increase production capacity. Whether the existing smaller factories will be relocated or expanded in the future will be decided according to the market situation. We will communicate this with the capital market and investors at that time. We are also optimizing production capacity and developing new products now. Whiskey and soda water businesses are now being done in our beer factories using surplus factories. Whether to open an independent factory in the future will depend on the situation at that time as the product business develops. Q: If there is no plant closure plan this year, can you briefly introduce the situation of reducing losses in the fourth quarter?

A: This is difficult to predict because the fourth quarter is typically the slowest season of the year. As sales decline, the capacity utilization rate of many of our subsidiaries will also decrease significantly. However, fixed costs and expenses cannot be reduced, which will lead to seasonal losses. Last year, due to the disruption of the pandemic, there were fluctuations in certain regions. This year, we will continue to expand our market, but with the current sporadic outbreaks of the pandemic, it is impossible to predict whether the impact will be greater or lesser than last year.

Q: 1) The growth rate of high-end product sales in the first half of the year is about 7%. What is the distribution of each price range? 2) What are the expansion plans for non-beer businesses? 3) What is the strategic plan for the future positioning, price range construction and continuous upgrading of the Tsingtao Brewery brand?

A: As for the composition of price ranges for high-end beer, we have introduced it before. The main part of the beer that grew by 6.6% to 1.6 million yuan is our classic series. Our retail price is around 10 yuan in Qingdao. The development of canned beer is good, with a growth rate of 10%. Larger categories such as wheat beer are growing relatively fast. For products like pure draft beer and small bottles, which were more affected by the pandemic in our industry in the first half of the year, there was a slight decline. As for our soda water and whisky, whisky has entered the initial production stage. Since whisky requires three years of storage, many of the raw materials for whisky, including oak barrels, have been affected by the pandemic's disruptions, making it challenging to purchase items from abroad. Our whisky products may meet everyone approximately by next year. We are also producing soda water, but its growth rate is also affected by the pandemic, and significant expansion takes time. Tsingtao Brewery brand will no longer be a regional brand, but as our second brand in terms of cultivation, the company still has many regional brands, including the Silver Wheat variety in Shandong Province, which is not small and has tens of thousands of tons. Its unit price is slightly lower than that of Tsingtao Brewery. We will gradually replace many of our regional brands with Tsingtao Brewery. This will take some time and depend on the market.

Q: What is your opinion on the improvement space of the net profit margin of our Tsingtao beer in the mid-term perspective, such as increasing it to 15% in 2025?

A: The core of improving the return on net assets still depends on the company's profitability. The company has been implementing a high-quality development strategy in recent years. The main measures to improve profitability on the product side include 1) continuously launching new products, as a new revenue growth point, 2) structural adjustment, which requires higher investment and internal management indicators for mid-to-high-end products, 3) improving the cost-effectiveness ratio, and continuously refining channel management. There has also been the launch of digital marketing. The return on net assets of the company has been steadily increasing in recent years, but the target of achieving a 15% net profit margin in 2025 may not be realized, and the key is steady improvement.

Q: Pure draft beer and canned beer series are our continuously enlarging single products. Has the marketing strategy for pure draft beer changed due to the pandemic?

A: In the future, we will focus on promoting our bottled beer and canned beer products as strategic products. The company has adjusted production capacity, and will continue to increase the canning rate. Last year's canning rate was 28%, and we have seen new improvements in the first half of this year. This has supported the increase of our mid-to-high-end product proportion and ton price. With the development of tourism and household channels, there will also be good prospects for canned beer in the future. We are also expanding our canned beer production capacity to meet market demand. In terms of marketing, in addition to promoting our products through nightclubs and bars, our own chain bar "1903" is popular among customers for our original and bottled beer products. This year, we also produced bottled original beer that can be purchased online, although production capacity is still quite limited. Regarding the marketing strategy for our bottled and original beers, we have changed our spokespersons to Xiao Zhan and Su Youpeng. Through their endorsements, we hope to expand our market coverage. In addition, there is the upcoming World Cup, and we plan to promote our products around this event, and we are also planning a series of activities to drive further growth.

Q: What is the strategic position of 1903 in the product mix?

A: 1903, which is included in our 1.6 million mid-to-high-end products, has experienced some fluctuations in the first half of this year, similar to our bottled beer. Although small and large-bottled 1903 has been affected by the epidemic, this is a relatively short-term issue. In the long run, we will position 1903 and August as mid-range products and promote them to the market. Southern markets have a higher acceptance of 1903, and the development of this part of the beer is also promising.

Q: The company's regional development is not very balanced, so what are the different development strategies and expectations for the three categories of regions over the next 3-5 years?

A: Our main market strategy is "one vertical and two horizontal". The "vertical" refers to the coastal economic belt, which was our earliest market. Due to increased competition and the entry of foreign brands, there have been some fluctuations in sales volume in certain regions such as Guangdong and Fujian. However, we have actively taken measures, such as adjusting our sales team, product mix, and market strategies. Currently, the South China market has achieved basically stable sales. The "two horizontal" refers to areas around the Yellow and Yangtze Rivers. The development along the Yellow River has been relatively good, with revenue and sales growth rates remaining rather fast in markets such as North China, Northeast China, and Northwest China during the past two years. Some small breweries have seen their production capacity rise which has brought about good performance for the companies. Along the Yangtze River, this is a relatively difficult area for us to develop, and we have closed some small factories in the past. Through strengthening mid-to-high-end product production, we have seen some improvements. Looking at the whole year, our proportion of losses is decreasing, and profitability is increasing. We are confident that we will achieve further growth in some of the more challenging markets through further adjustments to production capacity and product mix.

Q: What is the company's future promotion and management objectives for the original beer product?

A: Original beer is positioned as a high-end product, but its main problem is that its shelf life is only seven days. We can only cover areas above the county level, as we need to maintain a cold temperature along the cold chain. There are some difficulties in logistics and distribution, so it may not be able to cover the whole country. Most importantly, the progress of production technology will determine whether we can make advances in these areas. Furthermore, our original beer production capacity is not enough, but we are currently expanding and expect to increase capacity before the peak season next year to meet consumer demand. Q: The company emphasizes high-end positioning a lot. What is the strategy for the "N" in the 1+N product matrix?

A: Firstly, in the past two years, we have produced some ultra-high-end wines, such as 'Legend of the First Dynasty', 'Journey of a Hundred Years' and 'Amber Lager'. This has not only improved our brand image, but also raised the price range of our products. The current market response after the product launch is very positive. The first batch of 'Legend of the First Dynasty' and 'Journey of a Hundred Years' produced before the Spring Festival was sold out with 300-400 thousand bottles in the first four months, indicating a high demand despite the high pricing. 'Journey of a Hundred Years', priced between RMB 200-300, fills the market gap for wine, business events, atmospheres and banquets, and the market demand is very good.

Fresh products are also part of the 'N' component. Regardless of pure or original, fresh products belong to our production platform. Through e-commerce and circle fusion, we are developing a nationwide sales network for bars. Both of these products are profitable growth points in the future, with an average price higher than that of ordinary wines and a fast-growing market demand.

Q: Will the World Cup in the third quarter of this year significantly increase the consumption of off-season beer, or is it just an event marketing campaign?

A: In the past, the World Cup was held in the peak sales season of June, July and August. But this year, in the Middle East, it may be held in November, which is a better season in that region. Currently, on the one hand, the outbreak has uncertain impact on the overall market. In the past, many catering establishments, including nightclubs, would put the television in large venues for people to drink and watch the games together during the World Cup. Whether such offline activities will be as much as before is still uncertain. From our own perspective, sports marketing is an important market mechanism of ours. This year's Winter Olympics was also held in winter. We launched a Winter Olympics can, and increased brand promotion and marketing efforts through various channels such as the internet and television. Therefore, our sales in January and February have a certain connection with our effective market promotion through sports marketing.

As for how much impact the World Cup held in November this year will have on our sales, since we have not experienced it before, we have prepared and planned in all aspects, making good use of the opportunities for sports marketing and increasing market promotion to launch a series of products. As long as there is an opportunity in the market, we will seize it and drive our sales.

Q: Has the sales growth of ultra-high-end products reached the company's plan at the beginning of the year? Has the company's business-to-business (B2B) products received a good amount of sales due to the downgrade of consumer spending, or is there still not a clear distinction of consumer spending levels in the beer industry that leads to a consumption upgrade?

A: The consumption downgrade of beer has not yet occurred. Our high-end products grew by 6.6% in the first half of the year. Among them, the promotion of pure fresh beer was somewhat affected by bars and nightclubs. However, the sales of 'Legend of the First Dynasty', white beer and other products have continued to grow. From the fastest growing products, such as canned beer, the growth rate is still high. Due to different enterprise standards, we should position canned beer as mid-range beer internally, but its price is not necessarily lower than that of other brands of high-end beer, and the mid-range beer still has a fast growth rate in the first half of the year. We still cannot see the phenomenon of downgraded consumption from our point of view. In the past, people may have drunk cheaper beer, but due to the lockdown caused by the outbreak, they may consume canned beer or other types of beer at home instead, leading to an increase in growth rate. Regarding the changes in "low-end wine mainly pushed by product structure replacement and upgrades", such as upgrading from Laoshan to Tsingtao after transformation, we consciously make adjustments like for Shanshui and Yinmai, which are low-priced regional brands, we strive to adjust their prices to be comparable to Laoshan or other higher-priced situations.

Q: Assuming that the epidemic situation improves next year and everyone is not affected by the epidemic situation, what will the price increase per ton next year be compared to the 7% increase this year?

A: Prediction is difficult. Currently, the company has many beers and a wide sales area, and it is very difficult to predict any changes in the average price. From our perspective, "consumption upgrading is a major trend in the entire beer industry." As long as the trend of consumption upgrading is maintained, our brand advantages and quality advantages will continue to be exerted. We will strive to promote and sell more medium-high-end products for a sustained increase in average prices.

Q: What is the progress of the Dongsuo factory plan promoted by the company, and what improvements will it bring to the production and consumption ends?

A: In order to increase profits, we have successively carried out digital and skill improvements and transformations on the factories below. The only Dongta factory in the beer industry is now Qingdao Beer Factory, which was originally the birthplace of Duanzhou Road. Yesterday's board of directors approved the continuing transformation of warehouse storage, logistics, and feeding routes in factory one, further improving the level of intelligent transformation of factory one. After the transformation is completed, Qingdao Brewery will become the benchmark of the industry, and its automation and other aspects will definitely be the best. Other factories have also made some improvements in the past two years through relocation and rebuilding. Currently, the largest production capacity is Qingpi Third Factory in the suburbs of Qingdao. The production capacity of Qingpi Third Factory has reached 1.2 million kiloliters. Customized canned products for individuals, units, birthdays, and celebrations can be produced according to design requirements within two weeks. These intelligent and digital improvements are being continuously promoted. This is the direction of our future development and is also worthy of expectation.

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