Customers sit behind crates featuring branding for Heineken NV’s Heineken and Tiger beers at an outdoor restaurant. (Photgrapher: Maika Elan/Bloomberg)

Cheap Chinese Beer Won’t Refresh Heineken

(Bloomberg Opinion) -- Heineken NV could hardly be blamed for having a bit of an inferiority complex about Anheuser-Busch InBev SA.

After all, it’s only a couple of decades and half-a-dozen major takeovers ago that the Dutch brewer was the larger of the two companies in production terms.

Cheap Chinese Beer Won’t Refresh Heineken

Nowadays, AB InBev sells nearly three out of 10 liters of beer consumed globally. Heineken may account for another 8 percent of the global market, but it remains a distant competitor to its rival across the border in Belgium.

Friday’s $3.1 billion deal to buy into China Resources Beer Holdings Co. – maker of Snow, the biggest beer in the world’s largest beer market – looks like a smart way of addressing that issue. Snow was one of the brands that AB InBev threw off to get through its takeover of SABMiller Plc. Adding even the equity-accounted 20 percent slice of China Resources’ 118 million kiloliters of annual production from the deal to Heineken’s 218 million kiloliters would go some way toward making up the gap with AB InBev.

The problem is, that’s the wrong lesson to draw from this battle. For all its globe-straddling heft, the strength of AB InBev isn’t about size – it’s about its margins. Increasing Heineken’s exposure to China’s low-margin beer market is more likely to set it back a step than push it forward on that quest.

Cheap Chinese Beer Won’t Refresh Heineken

The global beer industry can largely be divided into three groups. At one extreme, you have AB InBev and its majority-owned Brazilian unit Ambev SA, which have used their dominant market shares in key regions, operational and supply-chain excellence, and vast buying power to knock out consistent operating margins in the region of 30 percent for a decade.

At the other end are Chinese brewers, whose cutthroat competition has kept margins at an equally consistent 5 percent or so. The rest of the industry lies between these two points with margins that range from high single-digits to the mid-teens.

To be sure, the point of the deal will be to change that dynamic. China Resources already has an outstanding distribution network to get beer to the country’s consumers. By licensing Heineken’s fancy foreign brews, it stands a decent chance of squeezing better profits from that fixed-cost base than those it currently gets for lower-margin brands like Snow.

Cheap Chinese Beer Won’t Refresh Heineken

The country is forecast to get the biggest slice of premium beer volume growth over the coming five years thanks to its burgeoning middle class, according to China Resources. Trailing 12-month operating margins are already hovering around 7 percent or so, about double their levels four or five years ago.

Still, if you want to go premium, the best way to do it is to, you know, go premium. Taking a stake in a more commoditized market and hoping that you’ll be able to flip it to a better state can backfire, as Heineken has been seeing in Brazil where it bought the second-biggest brewer from Kirin Holdings Co. last year.

“We weren’t expecting these products to accelerate so fast in the first year,” Chief Financial Officer Laurence Debroux told Bloomberg on Monday – sounding almost apologetic – after double-digit volume growth in the lower-margin Brazilian unit weighed on first-half profit, prompting a slump in the stock.

Cheap Chinese Beer Won’t Refresh Heineken

That’s particularly the case because there’s nothing inevitable about how a country’s drinking habits will advance. The success of baijiu-maker Kweichow Moutai Co., which has turned itself from the drink of choice for toasts at official banquets into an aspirational product for China’s middle class, shows that beer isn’t the only game in town.

Beer as a share of total alcohol consumption in China will fall from almost 30 percent in 2015 to less than 25 percent in 2022, according to Euromonitor Passport data.  That suggests one possible path ahead is the sort of stagnation that’s been seen in wealthy markets like Europe, North America and Japan, where consumers have switched to wine and spirits or simply given up on alcohol altogether.

Perhaps Heineken can bring some unique genius to the China market that eluded Asahi Group Holdings Ltd., which recently quit its 18 percent stake in Tsingtao Brewery Co. at a rotgut price after eight years. If not, it risks ending up with a hell of a hangover.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

©2018 Bloomberg L.P.