Description

BUD is a predictable double in 6 years for a 12+% IRR.  BUD is a good way to play the recovery of emerging markets.  It is recession-resistant. It has great management. It has a wide moat.  And the quarter’s results and dividend cut are, in the long term, not as bad as it seems towards intrinsic value. BUD shares have been drifting lower for more than two years, and are now trading back around where they were at the start of 2012. When sentiment in emerging markets comes back, and after management executes on cost-cutting, debt paydown, and efficiencies and growth, the stock can go back past above $133, which is the all time high price achieved in 2016, to $150 a share by 2024. (Note: I had to rewrite this idea and reformat the idea)

Statistics

Shares Outstanding 1,970 million

Total Net Debt is 109 Billion

Enterprise value is 263 Billion

TTM EBITDA is 22 Billion

TTM Sales is 55 Billion

Target Sales in 6 years at 3.5% growth is $68B

Target EBITDA in 6 years is $25B

ROIC 12.4%

Gross Margin 63%

Emerging Markets Have A Terrible Year, But Will Bounce Back

With less than 6 weeks left to close 2018, emerging markets have had one of its most terrible years. From late January to early September, the MSCI Emerging Market Index fell 20%, according to Bespoke Investment Group.
In fact, that stretch through nearly three quarters of the year is the MSCI Emerging Market’s third-longest bear market on record, according to an analysis by Bespoke Investment Group. Tariffs on China aren’t the only reason – or even the main reason – emerging markets are lagging. Their problems have to do with the combination of a strong U.S. dollar and rising interest rates. Many other nations’ stock markets are suffering as badly, or worse. India is down 10%, South Africa 25%. Argentina has dropped 23% and Brazil 17%.  I refer to Virtualodin’s Mwrite-up on TUR for a great write-up on what is going on with emerging markets. What is true of Turkey, is also true of Argentina, Indonesia and many other countries.

The U.S. isn’t immune to tarriffs.  Since tariffs are essentially a tax on U.S. consumers, there is a good chance they will eventually reverberate and hit the U.S. economy too. The research firm FactSet stress tested the impact on U.S. stocks. It found that, if tariffs stay the same as they stand today, the S&P 500 would eventually fall by 10%. In a more radical scenario, where trade tensions heighten further, the S&P would drop 20%. That hasn’t happened yet, but it’s well within the range of possibilities, if the tariff battle continues to unfold.
This too shall pass and emerging markets will be in favor again.

However, I am not a big fan of buying emerging market funds or emerging market etfs.  There is a lot of management fees and costs, management turnover, active investing risk. This article, https://www.marketwatch.com/story/4-reasons-why-big-name-strategists-are-wrong-about-investing-in-emerging-markets-2018-09-05, highlights many of the reasons to be wary of investing in emerging market funds.

BUD Is Recession-Resistant

I prefer to buy dominant telco providers in an emerging market country (e.g. TKC in Turkey) or recession-resistant consumer staples that are dominant in emerging markets.  Alex981 wrote about BUD back in 2011. At that time, alex981 wrote , “Doing so takes advantage of the market's over-enthusiasm for emerging markets, and under-enthusiasm for consumer staples companies in developed markets.”  Now I say, buying BUD takes advantage of the market's under-enthusiasm for consumer staples in emerging markets.

For 2019, BUD is my best consumer staples play for emerging markets.  In 2015, emerging markets represent 66 percent of BUD’s business compared to 34 percent in developed markets.  In 2017, this ratio is now 78-22 in favor of emerging markets. It does not matter whether one is in the U.S. , U.K, China, Argentina, Turkey or Zaire, beer is beer and the adage that people drink more beer during bad times is true in every country.  During good times, a person can drink 1 glass of beer. During recession, a person drinks 2 glasses of beer. During times of depression, a person drinks 3 glasses of beer. I prefer betting on management that will not be turned over within the next several years.  I also prefer management with a strong track record. For example, it has tripled Budweiser’s volume in China (an emerging market, if you will) in less than three years and has doubled its share in the United Kingdom (a developed market).

Strong Management

3G is known as one of the best operators and best capital allocators in the world. They use zero based budgeting (where all expenses have to be justified again at the beginning of each fiscal year) and have a strong discipline of controlling costs and achieving best cash conversion cycles.   BUD's compensation policy of mostly variable incentives based on highly quantitative goals, with very high but achievable targets, instills the responsibility for the company's performance and the creation of shareholder value into each of its managers. It is said that BUD is able to stretch its paying cycle 20% ahead of 2nd place Heineken. Management’s aim is to cut costs by $2.5 billion every year. Management has also said it is committed to getting its ratio of net debt to Ebitda down to two times (from the current 4.9 times) and that its goal is for dividends to grow in line with the business after the dividend cut.

Wide Moat

I believe AB InBev has a wide economic moat through a material cost advantage over its peers, its brands, its work culture, and its management. In 2017, BUD sold almost 3 times as much beer as its second competitor, Heineken.  In fact, it sold 612 million hectolitres of beverages, versus Heineken with 218 million hectolitres. AB InBev's purchasing power advantage is significant. For example, the firm buys 8% of the U.S. rice crop every year, according to the Rice Almanac.

BUD generates meaningful cost economies from its size and its local concentration in many countries. BUD holds a dominant market share of 70% in Brazil, the third-largest beer market in the world by volume, and owns around 50% of the U.S. market, the world's second largest.

The achievement of scale in local markets increases manufacturing efficiency, brings operational leverage to the firm's high-fixed-cost base, and reduces the average cost of production, which results in BUD’s highest profitability outside of China among beer manufacturers.

BUD generated almost $35 in EBITDA per hectolitre in 2017, much higher than the $26 per hectolitre generated by second-place Heineken, and it owns industry-leading operating margins in the low 30s. Driving BUD's profitability is its majority stake in Ambev, the Latin American brewer that generates a near 50% EBIT margin in beer in Brazil!

As aonther illustration of its wide moat, BUD owns five of the world's largest beer brands by volume, either directly or through equity ownership in the brand operator. Its entire list of brands can be seen here. https://en.wikipedia.org/wiki/Anheuser-Busch_InBev#Brands

AB InBev's competitive advantages have allowed the firm to generate excess returns on invested capital for several years. ROIC, including goodwill, has remained in the low-double-digit (i.e. 12%) range over the past five years, even throughout the Great Recession and the large acquisitions made since then. I believe its cost advantage will sustain this level of returns for at least the next two decades.

I got a lot of flak for saying BUD has a great moat.  The most common argument is the rise of craft brands. Some VIC’ers argue that two guys can get together, form a craft brand, sell the brand to BUD, and start again.  This is a very U.S. centric point of view of BUD’s business. Ask two guys in Nigeria if they can form a craft brand and put a dent on BUD’s business in Nigeria. And, to repeat, 72% of BUD’s business is in the emerging markets, not developed markets.   Furthermore, BUD, unlike sugary soda, does not have generic competitors and does not have to fight the anti-sugar trend.

Also, a research report among millenials by JP Morgan does not show that BUD’s brands are faring better among millennials than the perception.  The research included an interesting point on millennial drinkers: they drink Budweiser and Bud Light at rates that are about five points above the category average for domestic regular and light beers, respectively. And millenials are much fonder of Shock Top and Goose Island, ABI’s craft brands, which they consume at rates 17 points and 14 points above the category averages, respectively.

Third Quarter Results

On the day of the of 3rd quarter results and dividend cut, the stock was down 10%. Income funds and retail investors sell shares on dividend cut news. However, private market value buyers, who look at Enterprise Value to Cash flow multiples, should prefer it if the cash flow goes toward paying dividends or toward reducing the Enterprise Value. The stock’s negative reaction was exacerbated by the fact that the results came during a bad week for the stock market, where every piece of news, good or bad, had a worse reaction than in an ordinary market sentiment.

The company cut dividend from 3.60 Euros a share to 1.80 Euros a share.   The dividend cuts will go toward paying down debt. With 2 billion shares outstanding, this means BUD can pay down debt by an extra $4B, or about 20% of EBITDA, per year.  

During Q3, BUD's profit fell to $956M from $2.06B a year ago as weaker emerging market currencies factored in. Total beer volumes were up 0.2% during the quarter. EBITDA grew by 7.5% and the company's gross margin rate widened 116 bps to 40.3%.

BUD’s results fell slightly behind analysts’ estimates.  Its results are complicated by various nonoperating items. After adjusting for acquisitions and divestitures, currency changes, and extraordinary items, total organic revenue in the third quarter was up 4.2% to $13.3 billion, while EPS fell to $1.16 from $1.19. Premium brand revenues rose 7.7%. Total beer volumes grew 0.2%, and volumes of AB InBev’s brands rose 0.5%. The company continues to execute on promised cost cuts.  The stronger dollar was a big factor and took its toll because currencies in many of its country markets were weaker. Good results in Europe(+5%), Mexico, and Africa were offset by weaker results in Brazil and Argentina. Brazilian volumes fell over 3%. U.S. revenues rose 1.5%. Still, the third-quarter organic revenue growth of 4.5% is above average for large-cap consumer staples companies in the present environment. The price/mix growth driver of 4.2% means that strong pricing should shelter AB InBev from rising commodity inflation better than some other large-cap consumer staples businesses.

My point is that while the dividend cut caused the selling by dividend investors, value investors should see the fundamentals and ignore the effects of the dividend cut.  Given that the organic sales growth of 4.2% was achieved, the 3rd quarter results were not as bad. It looks to me that the stock price is now a good entry point. It seems like investor fatigue with this stock has reached many value investors, including some in the VIC community.

Valuation

I estimate that management will achieve their targeted cost savings of $2.5 billion this year. I further estimate they will save $0.5MM annually for the next 6 years. I also estimate that because of cost savings and efficiencies, they will achieve operating margins in the 37% range after 6 years. I forecast sales to grow at 3.5% per year for the next 6 years to $68B. I estimate the dividend cuts will help quicken the paydown of debt so that in 6 years debt will be down to $75B while EBITDA will be up to $25B (3 times Debt to EBITDA).  I put a value of 15 times EBITDA and come up to a market price of $150 per share. Stock is currently trading at 12 times EV to EBITDA. D&A is not very meaningful in this mature beer business.

Catalyst

Paydown of Debt

Continued execution, cost efficiencies

Rebound in Emerging Market Sentiment