In the Spotlight - Carlsberg counts cost of Q3 surprise

Investors were taken by surprise this week when Carlsberg seemingly rode back on its previous assertion that the brewer did not expect "any material impact" from higher raw material costs.

Carlsberg's CEO, Jorgen Buhl Rasmussen, told investors in August that the firm did not expect "any material impact" from higher raw material costs. However, the Denmark-based brewer conceded this week that  it will be impacted.

"We are facing higher input costs than previously expected and this will require price increases across most of our markets," Rasmussen said.

The spectre of higher costs helped to drag down Carlsberg's share price by around 5% on Tuesday (9 November), despite the brewer reporting an increase in sales and profits for the third quarter of 2010.

"Carlsberg have benefited greatly from falling input costs through 2009 and 2010 YTD," Sanford Bernstein analyst Trevor Stirling said. "However, the price of malt has been strong since the end of July as a result of the grain shortages in Russia and estimates of reduced its estimates for corn yields and production in the USA."

He added that while Carlsberg is "fully hedged" in Western Europe through 2010, the firm is "running a much shorter hedge book" in Russia, where it operates the market leading brewer Baltika Breweries.

"Although we do not expect input cost pressures in 2011 to be nearly as bad as those in 2008, because Eastern Europe is unhedged, they will have to pay for the jump from trough to peak on malt which would require approx a 6% rise in selling price to recover," Stirling said.

In Eastern Europe, a region that accounts for around 31% of the brewer's revenue and more than half of its profitability, the market declined "slightly", the company said on Tuesday, adding that it is facing higher malt prices for "at least" the next nine months.

ING analyst Gerard Rijk told Reuters that performance at Carlsberg's Eastern European unit was "disappointing" when compared with rivals.

The brewer said that the Russian beer market grew by 2% in volume in the third quarter. However, its Baltika Brewery unit recorded a 39% market share, down from 40.1% share in the previous quarter. Price hikes unmatched by rivals and increased marketing by competitors caused the drop, Rasmussen told analysts on the earnings call.

Rival Anheuser-Busch InBev last week reported an 8% rise in Russian beer volumes.

Nonetheless, Carlsberg performed better in the region than Dutch peer Heineken, which said last month that it continued to feel the effects of the increased beer tax, thus reporting a 15% drop in volumes in Central and Eastern Europe.

In Northern and Western Europe, Carlsberg managed to increase its market share slightly to 15.5% from 15% three months earlier, despite the overall beer market in the region declining by around 2%.

The increased share was mainly driven by strong performances in the UK, Poland, South Eastern Europe and Norway.

Carlsberg, whose beer brands include Tuborg, Baltika and Kronenbourg, recorded net sales for the three months to the end of September of DKK17.7bn (US$3.3bn), an 8% increase on the same period of 2009. On a like-for-like basis, excluding disposals and currency, third quarter sales rose by 2%. This compares to a 4% drop in the first half of the year, when the effects of a beer tax hike in Russia weighed heavily on the group.

Consolidated net profits for the third quarter rose by 30% to DKK2.176bn, while operating profits rose by 18% to DKK9.15bn.

UBS analyst Jason Derise told the Wall Street Journal that Carlsberg's operating profit came in above expectations, but said that "some of the details in the report are troubling." Like other analysts, he also pointed to the narrowing market share in Russia and the rising input prices as key disappointments.

Stirling believes Carlsberg will need around a 12% increase in selling price to protect margins in Russia, around 5% above current inflation in the country.

In Western Europe, Stirling was more optimistic. "The impact of hedges means that Carlsberg does not face such proportionate severe headwinds in 2011," he said. "Combined, with higher average selling prices, we estimate that a 2%-3% price increase is required to protect margins."

Carlsberg maintained its guidance of a 40% in net profits for the full-year. It also tweaked its guidance on operating profits for the year, from DKK10bn to "more than" DKK10bn.