Although China is the largest market in the world for beer, total volumes in the market have been shrinking since 2014 due to increased consumer preference for wine and other alcoholic alternatives.

The premium beer category in the country, however, has increased by at an impressive pace of around double digits annually – mainly on the back of the number of relatively well-off, and increasingly discerning, Chinese.

Collection of alcoholic beverages

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But there's more growth ahead. Many analysts believe the super premium & premium segment will grow at a CAGR of 16% up to 2023 while the affordable premium segment will grow at an 8-12% CAGR.

The rapid expansion in the premium beer segment is one reason why Hong Kong-listed China Resources Beer Holdings Co Ltd (SEHK:291), known as CR Beer and owner of the ubiquitous Snow Beer in China, carried out a strategic transaction with brewing giant Heineken N.V. (OTC:HEINY) in mid-2018. But can the Chinese brewer capture the attractive premium market?

Why a strategic transaction?

Back in 2017, CR Beer had the largest market share of all beer producers in China, at 26.8%. Most of CR Beer's beers, such as Snow, are for mass consumption yet are low margin products. So even though the company shifts impressive volumes, it doesn't actually make that much money. In recent years though, CR Beer management has gone out to capture more of the lucrative premium market demand via M&A.

In 2018, CR Beer's parent company – China Resources – and Heineken entered into a strategic transaction, in which Heineken bought a 40% stake in China Resources Beer for HK$24.4 billion (US$3.1 billion).

In addition to the cash, CR Beer received a license to use Heineken's premium brand in China while Heineken would also combine its China operations with the local beer maker. In 2017, Heineken's operations in China amounted to an insignificant 0.5% of the total China market by volume.

The combination of the two has potential. Heineken has an unquestioned premium lineup of beers. CR Beer also has a market-leading position and a great nationwide distribution network to help distribute Heineken beers.

Success depends on execution

Although the premium beer sector in China is growing and CR Beer has a great nationwide distribution network to distribute premium Heineken beers, the combination of the two isn't guaranteed to work out unless there's exceptional execution. Due to the lack of execution, Japan's Asahi Group Holdings (OTC:TSGTF) had to give up on a similar effort with a different Chinese beer producer.

That was in 2009, when Asahi took a 19.9% stake in China's Tsingtao Brewery Co Ltd (OTC:TSGTF) for US$666 million – with a similar aim of capturing premium brand growth. However, it later had to sell it as it didn't pan out as originally envisioned. But perhaps that deal was ahead of its time given the more recent popularity of premium beers in China.

Given CR Beer's current stock price, shareholders will need to witness top-notch execution in the future to justify the valuations. Presently, CR Beer's shares trade at a price-to-earnings (PE) ratio of 108, while its FY 2018 earnings per share (EPS) shrank 17% year-on-year to RMB 0.30. Since hitting a 52-week low in early January 2019, the stock is now up by 51% since then.

Even though it's in a mature sector, CR Beer doesn't pay much of a dividend, yielding just 0.4%. That means investors will be looking for growth from this company on the back of the compelling domestic consumption story in China.

Foolish last thought

So, can it capture the premium segment? CR Beer certainly has scale and distribution on its side. Yet it doesn't have much experience with premium beers and Heineken hasn't really succeeded in capturing enough of the market. In the premium market, CR Beer will still need to compete with determined giants that include Carlsberg and AB InBev.

Again, the success of CR Beer will depend on how well management executes in what is an intensely competitive space. Investors should be closely monitoring the company's premium brand market share and growth rates in quarterly earnings to see whether they're making any real progress.

A version of article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.