Anheuser-Busch InBev: Three Major Headwinds

by The Compound Investor

The last time I covered Anheuser-Busch InBev (BUD) it had just completed its $107B mega-acquisition of SABMiller. I commented that while it was a certainly “buy-and-hold forever” type stock, there were three headwinds worth bearing in mind. These were its future growth prospects, its current valuation and its debt. Although I’m not usually one to measure performance over a 12-month period, there might be something in the fact that the stock has hugely underperformed since the deal closed.

Let’s start with the growth issue. The short version is that it’s going to be extremely hard to come by going forward. That is hardly surprising when you consider the sheer size of the company, but the point stands nonetheless. I mean, it sells fifty billion bucks worth of beer each year. There just isn’t much of runway to work with in terms of tapping new markets or increasing per-capita consumption. In fact, only four consumer products companies in the world post higher annual revenue – Nestlé, Unilever, Procter & Gamble and PepsiCo.

Limitations

Historically, the big beer industry players have faced this low-growth outlook through consolidation. In the case of Anheuser-Busch, it made huge strides in pumping up profit margins by exploiting synergies and cutting costs. As a result of this strategy, profit per unit of beer sold went through the roof. For instance, Grupo Modelo profit margins doubled when it took over the Mexican brewer in 2013. Similarly, AB InBev saw North American EBIT increase from $3.77b to $5.71b after InBev merged with Anheuser-Busch in 2008. It achieved that within three years even though total volume sold fell from 140m hectoliters to 125m hectoliters.

Going forward, it’s going to be much more difficult for the company to move the needle in this respect. First of all, there just aren’t all that many big acquisitions left to be made. Also, the SABMiller deal perhaps shows the limitations of the cost reduction strategy since its profit margins were already very high to begin with. For Anheuser-Busch to add another 10-15% in profits via an acquisition, it would need to find a brewer already raking in over a billion dollars each year in net profit. Unsurprisingly there aren’t that many around, leading many to speculate that the company’s next deal will fall outside of the beer industry.

Debt

The second big headwind is its debt load. All of this big M&A activity has left the company sitting on a highly leveraged balance sheet. The total debt pile stood at around $120b at the end of 2016. Net out the $8.5b or so that Anheuser-Busch held in cash and equivalents, and we are talking net debt of circa $110b. That looks like an uncomfortably large number, even after factoring in estimated FY18 EBITDA of around $25b.

Management’s long-term target is to reduce that net debt ratio to something like 2x EBITDA. Once you strip out interest, taxes, capital expenditures and the dividend, you aren’t left with a whole lot of cash for debt reduction. Unless that target is a very long-term one, then don’t be surprised to see a dividend cut here.

Valuation

That bring us to the third and final headwind: its current valuation. You could forgive low growth out to perpetuity if the stock was going on sale. For instance, imagine it traded at 14x annual earnings in the current interest rate environment. In that case, you already lock in a 7% earnings yield. You can then start thinking about organic growth from purchasing power and volume growth. Since the beer industry is pretty stodgy, let’s say that figure sits somewhere between 1% and 2% per annum.

On top of that, you can throw in the high quality cashflow from its scale advantages and well-known brands like Budweiser, Corona and Stella Artois. That cashflow can enrich shareholders in other ways (paying off debt and reducing interest costs, repurchasing shares which increases the per-share amounts of future earnings and dividends, and so on).

If you tack all that on to the initial 7%, then you don’t actually need all that much else to hit the magical 10% annual returns mark. That was the great part about buying well-known consumer stocks over the years. Not only did they give you a good starting base, but growth was a lot more impressive than many folks could have imagined. The issue with Anheuser-Busch stock today is two fold. Firstly, you don’t get to start anywhere near 7%. Instead, you are currently on around 4%. Secondly, an outlook of “inflation plus a few points” is probably as good as it gets from here on out.

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