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Raise a glass to AB InBev
… or should it be BAT?
Renier de Bruyn
May 17, 2018
AB InBev is the market leader in eight of the 10 countries with the biggest beer profit pools. It owns seven of the top 10 most valuable beer brands in the world. In 2016, AB InBev acquired SABMiller. The beer giant has a highly regarded and ambitious management team, and a good track record of embedding large acquisitions to add value to the group. However, its success has led to a very large company with high margins and high market shares in its operating markets. This makes future growth difficult to achieve, even for a competent management team.
The acquisition of SABMiller has shifted the group towards a higher contribution from emerging markets, which adds to volatility, but exposes it to improved potential volume growth. AB InBev has a high level of debt (US$104 billion net of cash), mostly denominated in hard currencies (US dollar, euro and pound) while profit has shifted towards emerging markets, exposing the group to currency volatility. Management will prioritise the reduction of debt levels over the next few years, at the expense of dividend growth.
After a disappointing 2016, AB InBev showed some improvement in 2017 in most of its markets. Management has also guided it towards further growth momentum in 2018 – although the first quarter should be softer given the timing of holiday events and weather conditions. Brazil recovered somewhat from a weak base while good progress was made towards achieving cost savings targets from SAB. Revenue growth also continued to benefit from shifting towards more premium beer brands and price increases in certain markets, but volumes remained flat, dragged lower by the business in the US.
The US remains constrained given the slow decline in Bud Light (from a high market- share base which is proving difficult to defend). AB InBev does have a few smaller brands in the US that are growing very well, but their base is still too small to offset Bud Light’s decline.
The company’s strategy of ‘premiumising’ its markets is continuing successfully through its global premium beer brands, Budweiser, Stella Artois and Corona. This remains an ongoing opportunity, especially in ex-SAB markets where this company lacked the premium brands to compete in that segment before the AB InBev acquisition.
Perhaps surprising is the extent to which AB InBev has started to adopt some of SAB’s strategies in its own traditional markets to improve operations there. This is another reason why the AB InBev group has been so successful with past acquisitions – its willingness to learn and adopt best practices.
AB InBev remains a well-managed, global company that can add a good balance to South African equity portfolios. Unfortunately, this does come at a price – the company is still trading at elevated valuation metrics relative to its own longer term history. Profits should continue to recover in the short term driven by SAB synergies, stronger emerging market currencies and financial deleveraging, but prospects for subsequent long-term growth are more constrained.
Global consumer staple companies have performed strongly for seven years as a result of low bond yields and demand for their predictable earnings streams in a low economic growth environment. The recent rise in US bond yields has reversed some of the gains, showing the sensitivity of these shares to rising interest rates.
Given the high emerging markets exposure – especially Latin America – and hard currency debt exposure, AB InBev offers less protection against rand weakness than one might expect. The rand has had a high correlation to the Brazilian real and Mexican peso – the two most important emerging market currencies in the AB InBev world. Still, the company offers diversification from country-specific risk for South Africa.
AB InBev has performed poorly since listing on the JSE in January 2016, losing 37% in rand terms. While the share is now trading in line with our fair value, we find better value in BAT, which on a two-year forward price-to-earnings ratio is trading 30% cheaper than AB InBev, versus a historical average of 15%.
Despite its recent pullback, BAT has been a phenomenal performer over the past two decades, even outperforming the likes of AB InBev. Anyone with the foreknowledge back then of the declining global cigarette demand, massive excise tax increases and advertising bans that would be introduced over the ensuing years, would likely have been surprised by the healthy returns BAT shareholders have received.
The most important reason for BAT’s strong performance has been the company’s ability to pass through price increases to consumers – both as a result of the addictive nature of the product and because advertising bans prevented new competitors from entering the market. This is an important distinction between the beer and tobacco industries – the ability to continuously increase prices to offset volume declines is much weaker for the beer brewers.
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