Description

I recommend purchase of Heineken Holdings, the holding company for the Heineken beer company.  It is selling at 18.9x current year earnings estimates and should be able to grow volumes organically at 2%+ per annum, revenues at 4-5% per annum in Euros and improve margins slightly.  In the current environment, I think that it is a very low price for such a high quality business.

Holding company

Heineken holdings is the holding company for Heineken NV, it is the only asset owned by the Heineken holdings.  The number of shares of Heineken NV owned by Heineken holdings is equal to the number of shares of Heineken holdings that are outstanding.  So effectively, 1 share of holdings = 1 share of NV.

Operating business – Heineken NV

The company is the second largest brewer in the world, behind Ab Inbev.  Some of the company’s beer and cider brands include Heineken, Amstel, Desperados, Sol, Tiger, Moretti, Strongbow.  

Industry structure and competitors

Most markets in which the company operates are oligopolies, with very rational competition and attractive margins.  Barriers to entry outside the United States tend to be very high, these are primarily distribution and brand recognition, as well as economies of scale.  Competitors include Ab Inbev, Carlsberg, Kirin, and a few others. 

Operating performance

In recent years, the company has been growing volumes organically at 2%+ per annum.  In the five-year period ended 12/31/2018, annual volumes grew by 2.8% organically, annual revenues by 4.5%, and annual operating income by 8% per annum.   For 2019, consensus forecasts 2.9% organic volume growth, 5.1% organic revenue growth and 3.9% organic operating income growth.  For 2020 and 2021, consensus forecasts are for 2.7% and 2.8% organic volume growth respectively, 4.7% and 4.7% organic revenue growth, 5.7% and 6.0% organic operating income growth, and EPS of E 4.69 and E 5.06 respectively. 

56% of operating income comes from developing countries.  Mexico and Vietnam each account for more than 10% of operating income.  Based on my understanding of Heineken’s November 6^th 2019 presentation, the company seems to feel comfortable forecasting 2% annual organic volume growth for the foreseeable future. 

The company has not performed well in the US beer market and its efforts in China have not led to profits, with the company selling its business to a local player for stock and agreeing to a distribution agreement. 

Th company has significant opportunities for growth: the two most important ones are

a)   the impact of merging its Chinese business.  As a result of the merger, Heineken should get national distribution for its brands and that should lead to very significant volume and profit growth.

b)    continued market share gains in Brazil & end of the distribution agreement there in 2022.  The company’s Brazilian business which was drastically expanded with purchase of Kirin’s Brazilian business three years ago has drastically lower margins than company as a whole and is hurt by having the former Kirin’s business tied to Coca Cola’s distribution system.  The contract ends in two years.  Assuming the company can continue to grow volumes in Brazil and get margins up to company’s average would provide a significant boost to profitability. 

Capital allocation

I think that the company has allocated capital well.  It has historically grown through acquisitions and the company seems to be a shrewd and disciplined acquiror.  For instance, the company passed on the first time the Schinkariol beer business in Brazil that was bought by Kirin was sold for $3.9bn and bought it from Kirin for $0.7bn.  It’s acquisition of Asia Pacific Breweries has been a homerun.  The company also pays a decent dividend which I estimate to be roughly 2% based on E 88.5 stock price and my forecast for E 1.77 dividend to be paid in 2020.    

Management quality

I do not have special insight into management, they seem fine, and the company has certainly grown faster than its competitors. They also do not seem to make major unforced errors. 

Family control

The company is controlled by the Heineken family and another local family.  This has both pluses and minuses.  The plusses are that the business has a long-term orientation and is willing to take short-term pain for long-term value creation.  The downside is that it lacks the discipline of the take-over market, costs seem to be a bit high, and in the world of virtually zero interest rates, a case could be made for higher debt levels with extra debt used for share buy-backs.  Debt to EBIT is estimated to be equal to 3.5x on 12/31/2019. 

Risks:

There is a new very tough policy by the Vietnamese government against drunk driving.  It has supposedly led to a 25% decline in beer consumption so far in 2020.  If it lasts, and consumers do not switch to drinking at home or using taxis, then one could easily see a tremendous drop in Vietnam’s profitability.  I personally doubt that a 25% decline in consumption will last.  If one assumes a 10% volume decline and 20% operating income drop, then that would reduce company’s net income by 2%.

The end of exclusivity in Mexico at Oxxo stores.  As part of its acquisition of Femsa, Heineken was guaranteed exclusivity in Oxxo stores.  This exclusivity is ending.  The impact is hard to predict but I doubt that Heineken’s sales are going to fall sharply in Mexico because of this.

Coronavirus in Asia will lead to lower tourism in 2020 and probably less going out and will probably impact beer sales in 2020, but I doubt that this will persist post 2020. 

Conclusion: given the level of real interest rates, the rates of return available on Class A real estate world-wide, it seems that a high quality, low-leveraged business that can grow at inflation +2% per annum is drastically undervalued at a P/E of 19. 

Catalyst

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