Example of a case report-2 - Financial Statement Analysis: Heineken 2013- Tutorial group 1 Team 2 - Studeersnel (2024)

Financial

Statement

Analysis:

Heineken

2013-

Tutorial group 1 Team 2

Ron Groote Wolthaar S

Stefan Janssen S

Colin Rijkers S

Durk de Vries S

Course: Financial Statement Analysis

Case: Heineken (2013-2014)

Submission date: June 1, 2016

Introduction

Heineken is a global beer brewer established in 1864. It is owned for just over 50% by Heineken

Holding NV, 12,5 % by FEMSA and the remaining 37,5 % by public shareholders. Heineken has six

business priorities in which it aims to excel. Currently, Heineken is the leader in the premium

quality beer segment as well as the cider segment. Furthermore, Heineken aims to keep

innovating, improve production efficiency and sustainability, and be commercially assertive. As at

31 January 2014, Heineken owns over 250 different brands in over 70 countries worldwide.

In this financial statement analysis, we will first conduct a strategy-, industry- and accounting

analysis. After that, financial statement analysis is conducted. Furthermore, we will forecast

Heinekens condensed income statement, balance sheet and free cash flow for the period

2015-2017, and we will estimate the value of its equity based on abnormal earnings. Finally, we will

give our recommendations about investing in Heineken and critically evaluate Heineken’s

creditworthiness.

Question 1: Qualitative analysis

Strategy analysis

Heineken follows a global oriented strategy with sales in 178 countries, operations in 70 countries,

and 85,000 employees worldwide at the end of 2013. Given the size of the company and the

volume of its production, the company can benefit from economies of scale. Furthermore, the vast

variety of products the company produces may lead to economies of scope. Both the former and

the latter induce cost advantages.

Heineken aims at producing affordable innovative high-quality beverages and strives for a large

product portfolio. The wide range of products, bottles, casings, and packages contributes to the

innovative component in their differentiating strategy. Another differentiating component can be

identified when looking at the way Heineken builds its brand. The company relies heavily on

advertising to communicate new innovations to the public. In general, they try to make advertising

unique and arousing to reach their end-customers.

The company claims to be efficient with innovative information systems installed in their operating

facilities. Also, Heineken aims at reducing non-product-related spending and increasing working

capital efficiency. Furthermore, Heineken invests in personal development programs focussing at

strengthening their intellectual assets which contributes to overall efficiency.

With respect to sustainability, the company has clear goals. Their “Brewing a Better World” is a

long term approach for creating shared, sustainable value for the business and the stakeholders. In

this program, the company focusses on different aspects such as responsible drinking, promoting

health and safety, and protecting water resources.

Heineken’s main customers are wholesalers, supermarkets, cafes, and other third parties. Delivery

to (international) customers is likely to be flexible given the global spread of brewing facilities.

Heineken also owns a distribution network which increases the control over delivery to clients.

Potential risks arise from several sources. First, there is increasing regulation with respect to the

consumption of alcohol. As can be seen in Europe, the legal drinking age as well as taxes on

alcoholic beverages increase. If this is a global trend, some of the customer base may disappear.

Second, Heineken recognizes volatility in the availability of raw materials, commodities, energy and

water. Therefore, the company has to make sure they can survive periods of low availability by

hedging against this risk.

All in all, Heineken has developed a strong brand and has clear future goals. The innovative and

often well diversified products create a position in the global market which is stable. For Heineken

to maintain this competitive position, it must continue developing new products and offering high

quality beverages supported by a strong marketing program. Furthermore, the company has to be

aware of global legal developments and societal trends altering the future demand of their

products.

Industry analysis

The brewing industry is a global business with several large brewing companies and a large

number of small, local brewers all across the world. With many companies, and some brewers

already brewing for centuries, the brewing industry is no longer a fast growing industry.

Furthermore, with large acquisitions between brewing companies, the rivalry amongst brewing

companies is relatively high. In most countries, there are many alcoholic beverages available.

Consequently, with low switching costs between beer brands, the market power brewers have is

relatively low. Also, this is an indication that brewers cannot set prices themselves. Heineken is

using differentiation techniques to capture a larger market share by owning multiple beer- and cider

brands. The high degree of differentiation in combination with the low switching costs makes the

brewing industry very price competitive.

Heineken is brewing beer and other beverages for over 150 years, and has developed a solid

brand. The brand reputation of the older brewing companies and the high price-competitive market

make it hard for new entrants to capture market share. In other words, for Heineken the threat of

new (comparable) entrants is low.

Heineken is primarily known for its beer brand. Although there are several alternatives to beer,

there are little alternatives comparable to beer. The unique structure of beer with a comparable

percentage of alcohol is hard to find. Furthermore, the difference between premium quality beer

and lower quality beer is clear. This makes the threat of substitute products relatively low, however,

small brewers might offer specialities which can be a substitute.

The analysis of bargaining power can be split into the bargaining power of buyers and suppliers.

Customers, have relatively low bargaining power as there are many customers and the number of

suppliers is significantly smaller. Furthermore, each customer only buys a small part of the total

supply. Only some large wholesale stores might be able to influence the prices a little, but in

general the customers have little power to affect prices.

Heineken has relatively high bargaining power compared to customers, as the number of

customers is so high that they cannot influence prices. Similarly, Heineken, being a large company,

can influence the costs of the materials used in production. Suppliers of input materials can be fully

dependent on a large company like Heineken.

Concluding, the brewing industry is an established industry which does not grow very fast

anymore, but has a high degree of rivalry between existing firms. The threat of new comparable

firms is small since existing firms already established their names in the market. Moreover, the

threat of substitute products is relatively low as there are little alternatives to premium quality beer.

Finally, large brewers have relatively high bargaining power compared to customers and suppliers.

2. Financial statement analysis

To facilitate the understanding of the financial analysis, two key tables are provided. The balance

sheet (table 1) and the income statement (table 2).

EQUITY & LIABILITIES

Total current liabilites ¬8 ¬8.

• ASSETS Table 1. Balance sheet Heineken (2013 & 2014)
• PPE ¬8 ¬8.
• Intangible assets ¬16 ¬15.
• Investments in Associates and JVs ¬2 ¬1.
• Other investments and receivables ¬ 737 ¬
• Advances to customers ¬ 254 ¬
• Deferred tax assets ¬ 661 ¬
• Total non-current assets ¬28 ¬27.
• Inventories ¬1 ¬1.
• Other investments ¬ 13 ¬
• Trade and receivables ¬2 ¬2.
• Prepayments and accrued income ¬ 317 ¬
• Income tax receivables ¬ 23 ¬
• Cash and Equivalents ¬ 668 ¬1.
• Assets classified as held for sale ¬ 688 ¬
• Total current assets ¬6 ¬5.
• Total assets ¬34 ¬33.
• Share capital ¬ 922 ¬ Equity
• Share premium ¬2 ¬2.
• Reserves -¬ 427 - ¬
• Retained earnings ¬9 ¬8.
• Equity attributable to equity holders of the company ¬12 ¬11.
• Non-controlling interests ¬1 ¬
• Total Equity ¬13 ¬12.
• Loans and borrowings ¬9 ¬9. Liabilities
• Tax liabilites ¬ 3 ¬
• Employee benefits ¬1 ¬1.
• Provisions ¬ 398 ¬
• Deferred tax liabilities ¬1 ¬1.
• Total non-current liabilites ¬12 ¬12.
• Bank overdrafts ¬ 595 ¬
• Loans and borrowings ¬1 ¬2.
• Trade and other payables ¬5 ¬5.
• tax liabilities ¬ 390 ¬
• Provisions ¬ 165 ¬
• Liabilities classified as held for sale ¬ 178 ¬
• Total current liabilites ¬8 ¬8.
• Total Liabilites ¬21 ¬20.
• Total equity and liabilities ¬34 ¬33.
• Table 2. Income statement Heineken (2013 & 2014)
• Sales ¬19 ¬19.
• Costs of materials, consumables and services -¬12 -¬12.
• Personnel expense (nature) -¬3 -¬3.
• Depreciation and amortization (nature) -¬1 -¬1.
• Other income ¬ 93 ¬
  • Operating Profit ¬2 ¬2.
• Share of profit of associates and joint ventures (NET) ¬ 148 ¬
• Net interest expense (income) -¬ 409 - ¬
• Other netfinance income/(expense) -¬ 79 - ¬
• Profit before taxes ¬2 ¬2.
• Tax expense -¬ 732 - ¬
• Net profit ¬1 ¬1.
• Table 3. Additional financial information
• Sales ¬19 ¬19.
• Net profit ¬1 ¬1.
• Net interest expense after tax ¬ 286 ¬ Effective tax rate 30% 24%
• Net investment (loss) profit after tax ¬ 104 ¬
  • Net operating profit after tax ¬1 ¬1.
• Excess cash and equivalents @ 5% of sales -¬ 282 ¬
• Minority equity investment (Ass. & JVs) ¬2 ¬1.
• **Net Operating Working capital ¬ 102 - ¬**
• Net Non-current operating assets ¬23 ¬22.
• Investment assets ¬1 ¬2.
• Business assets ¬25 ¬24.
• Debt ¬11 ¬12.
• Group Equity ¬13 ¬12.
• Capital ¬25 ¬24.

When comparing Heineken’s profitability to the market and one of its prime competitors in table 6,

it is clear that ROA and ROE are above the industry average but below that of AB Inbev. The return

on sales however, is far below the industry average and that of AB Inbev. This might indicate that

Heineken, on average, asks lower prices for its products to increase sales. All in all, it seems that

Heineken is outperforming the industry, but has at least one more profitable prime competitor.

B.) Evaluate the efficiency of the operating management by applying common-size analysis

over the period 2013-2014.

Analyzing Heineken’s efficiency leads to positive conclusions. Firstly, Heineken has increased the

net operating profit before tax, suggesting operations in 2014 were more efficient compared to

2013. Focussing on the line items shows that all components of the operating expenses decreased

relative to sales, which indicates a positive efficiency change.

Also, the additional efficiency measures indicate increased efficiency. Overall, the increased

efficiency is in line with Heineken’s goal to increase efficiency and consequently the operating

profit margin as stated in the annual reports of 2013 and 2014. Heineken’s ability to meet the

stated goals is a good signal to investors.

Table 6. Profitability Competitor analysis (2014) Heineken Brewery Industry AB Inbev

ROS 8% 34% 31%ROA 4% 2% 7%ROE 12% 9% 17%

Table 7. Common-sized income statement and profitabilityratios 2014 2013 Difference

Sales 100% 100%Net operating expense -86% -87% 1%Other income/expense 0% 1% -0%Net operating profit before tax (EBIT) 14% 13% 1%Investment income 0% 0% 0%Net interest expense -2% -2% 0%Tax expense -3% -2% -1%Net profit 9% 8% 0% Operating expense line items as a percent of salesPersonel expense -15% -16% 0%Cost of materials -62% -63% 0%

Depreciation and amortization (nature) -¬1 -¬1.

Other operating income/expense 0% 1% -0% Additional efficiency measuresNOPAT margin 9% 9% 0%Net income margin 8% 8% 0%

C.) Evaluate the investment management of the company between the years 2013-2014 by

using ratio analysis.

Analysis of the investment assets indicates that Heineken has improved the investment asset

management. Although they have decreased the amount of investment assets relative to total

business assets, they have increased the return on investment assets. This might be caused by

disposals of poor performing investments.

When investigating the efficiency of investment management (table 9), several changes are worth

mentioning. Firstly, there is a dramatic raise in net operating working capital turnover. This change

is mainly driven by the decline in overall cash reserves leading to a decline in excess cash.

D.) Evaluate the financial management of the company between the years 2013-2014 by

using ratio analysis.

Heineken’s current and quick ratio are below one, suggesting that Heineken is not performing well

with regard to liquidity. However, taking into account Heineken’s organized cycle and working

capital management, which they mention as a primary focus point, the company probably has

found a way to meet all its obligatory payments. Also, when comparing Heineken to the industry, its

seemingly weak liquidity is not abnormal. The cash ratio has decreased, which is a consequence

of 2014’s negative cash flow.

Table 8. Investment asset management 2014 2013 DifferenceInvestment-to-business assets ratio 0 0 -0.Net return on investment assets (after tax) 5% 4% 0%Investment income to sales 0% 0% 0%

Table 9. Efficiency analysis of Investment management Working capital management 2014 2013 Difference

Net Operating Working capital ¬ 102 - ¬

Trade receivables turnover 7 7 -0.Inventories turnover 7 8 -0.Trades payables turnover 2 2 -0.Days' receivables 51 45 5.Days' inventories 48 44 4.Days' payables 165 151 13.

Net Non-current operating assets ¬23 ¬22.

Non-current asset trunover 0 0 0.PPE turnover 2 2 -0.

Table 10. Liquidity analysis 2014 2013

Brewery Industry averageCurrent ratio 0 0 0.Quick ratio 0 0 0.Cash ratio 0 0.*Industry data retrieved may 20, 2016, from reuters

3. Forecast of the condensed income statement, balance sheet and free

cash flow.

Assumptions.

Several assumptions are employed in forecasting Heineken’s financials. An overview is provided in

table 13.

Two of the assumed ratios are not constant and require additional explanation which will be

provided in the following paragraphs. The constant assumptions are assumptions for which we

were not able to find expected changes, or for which Heineken states that it will be constant in

(A) Sales growth

Several factors influence the potential growth of Heineken’s sales in the subsequent years. The

factors positively and negatively affecting the sales growth are listed below in table 14.

We expect the sales growth to be higher than in 2014 given the opportunities in developing

markets and Heineken’s innovative strategy. However, in the long-term Heineken will probably

encounter more market saturation and less possibilities for innovations as the beverage innovation

portfolio is not infinite. Additionally, regulations restricting alcohol consumption might decrease the

total demand.

The initial sales growth factor is estimated by calculating the mean sales growth over the past 5

years. We expect that sales growth will first be around this rate and will decrease gradually, due to

Table 13. Forecasting Assumptions 2015 2016 2017(A) Sales growth 5% 5% 4%(B) NOPAT margin 10% 9% 9%Average working capital to sales ratio (2013-2014) -7% -7% -7%Average net non-current operating assets to sales ratio (2013-2014) 120% 120% 120%Average investment assets to sales ratio (2013-2014) 10% 10% 10%Return on investment assets (after tax) 5% 5% 5%After-tax interest expense 1% 1% 1%Average debt to capital ratio 46% 46% 46%Tax rate 30% 30% 20%

Table 14. Sales growth factors

Factors increasing sales growth Factors decreasing sales growth.

New innovations CompetitionIncreasing demand in developing countries Regulative changes (age-restrictions, taxes on alcohol) Limited innovation portfolio (variety of “beer-like” beverages is not infinite)

the long-term pressures described. Since we can not be sure about the number of successful

innovations left and the pace of implementation of restrictive regulations, we estimate a gradual

decrease of sales growth of 0% per year. Beyond the terminal year, 2017, sales growth will be

set at an annual rate of 0%.

(B) NOPAT margin.

The estimation of NOPAT and additional explanation are provided in table 15 and paragraph below.

Table 15. NOPAT Estimation

Describedchange by Heineken

annual factorchange

annualweightedchange

After tax (30%)weighted impact onNOPAT

Materialize in year:

General cost management*

continued costmanagement toincrease operatingprofit margin

-3% -0% 0% 2015 and onwards

Materials, consumables,and services

Input prices

slight decreaseexpected in 2015(also expected in2014)

-1% -0% 0% only 2015

Commercial & selling expenses

slight increase (according to target, alsoreported for 2014)

1% 0% -0% 2015 and onwards

Other Disposal EMPAQUE** only in 2015 0% 0% -0% only 2015 2014R 2015E 2016E 2017ENOPAT 9% 10% 10% 10%Annual change 0% 0% 0%Target/continuedchanges*** Value 2014 Value 2013

% change2013-

Weight to total operating expenses 2014Total operating expense ¬16 100%Materials, consumables,and services ¬12 ¬12 -1% 73%General cost management ¬2 ¬2 -3% 13%Input prices ¬6 ¬6 -1% 39%Commercial spending ¬3 ¬3 1% 21%

• Heineken states they will increase the operation profit margin by general cost management. Actualsavings are not provided. Given that tight cost management is also reported in 2013, the relative savings onoperating expenses (excluding input and commercial & selling expenses) is used as an estimate. (note 13,annual report 2014)

** The disposal EMPAQUE is expected to have a negative impact on the operating profit margin in 2015 of25 basis points. (annual report 2014)***target/continued changes are changes in operating expenses also reported in the annual report of 2013.In absence of known changes, the relative change between 2013 and 2014 is used to estimate the futurechanges of this component.

4. Valuation of Heineken

Assumptions.

For the valuation, the forecast in the previous section is used. Additional assumptions are given in

table 17. Table 18 is the actual valuation.

Valuation.

For the valuation process, only the cost of equity is used.

Table 17. Additional valuationNumber of shares (dec. 31, 2014) 576 mlnGrowth rate beyond terminal year 0%Cost of equity 5% Beta 0.Risk-free rate 0%Market return 6%Cost of debt 3%WACC 4%

*Beta: retrieved from infinancials/fe-en/01189EN/Heineken-NV/Beta*Risk-free rate & market return: retrieved from market-risk-premia/nl.html

Table 18. Valuation Heineken (mln) 2015 2016 2017 Terminal value Year 1 2 3Beginning BV Equity 2015 ¬13 ¬13 ¬14.Earnings ¬2 ¬2 ¬2.Capital charge ¬ 750 ¬ 744 ¬ 783Abnormal Earnings ¬1 ¬1 ¬1.PV factor 0 0 0 16.PV of abnormal earnings ¬1 ¬1 ¬1 ¬25.

Cumulative PV of abnormal earnings ¬28.Beginning BV Equity 2015 ¬13.— Minority interest beginning 2015 ¬1.Total equity value begin 2015 ¬41.Equity value per share ¬71,

Table 19. Sensitivity analysis Cost of equity4% 5% 5% 6% 6%Sales growth beyond terminal year 0% 84 76 67 62 57. 0% 88 78 69 64 58. 0% 91 81 71 66 60. 0% 96 84 73 67 61. 1% 100 87 76 69 63.

5. Advice to investors

Chapter 9 explains the principle of equity security analysis. In this analysis, the intrinsic value of a

firm’s equity is being analyzed to determine whether or not an investor should invest in that

particular company. Heineken is one of the largest beer brewers in the world and has a stable

position in the market. The beer-brewing industry has surpassed its growth phase, and to well-

known brands like Heineken, the threat of new entrants is relatively low. However, there is still a

high level of rivalry between existing beer-brewing companies. Given Heineken’s aim to become

the world’s largest high quality brewer, there is still an opportunity for Heineken to grow even

further. Moreover, when looking at Heinekens year-end stock prices over the last couple of years,

we see that since 2008, the year-end stock price almost quadrupled. This is an indication that

Heineken is still growing fast.

The year-end price for a share of Heineken in 2014 was ¬58. By applying the abnormal

earnings method based on 2014’s annual report, we estimate that the equity value of Heineken is

¬71. Therefore, according to our estimations, the shares of Heineken are undervalued at this

moment in time. Given this undervaluation, the historic movements in Heinekens share prices and

its aim to grow even further in the future, we would recommend an investor to make an investment

in Heineken.

6. Evaluation of Heineken’s creditworthiness

As indicated in the liquidity and solvability analysis of question 2, the liquidity ratios tend to be quite

low for Heineken at first sight. However, compared to industry averages, we see that lower liquidity

ratios tend to be normal for brewers, due to efficient working capital management (i. low days’

receivable, high days’ payable and low cash on hand).

Table 20. Liquidity analysis 2014 2013

Brewery Industry averageCurrent ratio 0 0 0.Quick ratio 0 0 0.

Cash ratio 0 0.*Industry data retrieved may 20, 2016, from reuters

Table 21. Solvency analysis 2014 2013

BreweryIndustry average

Liabilities-to-equity ratio 1 1.

Net debt-to-equity ratio 0 0.

Net debt-to-capital ratio 0 0.

Interest coverage (earnings-based) 6 4 3.