Is This Bud for You?
Anheuser-Busch/InBev started trading in America today. Should investors take a sip, or is the new firm at risk of making the "Schlitz Mistake"?
One-time Tortoise Portfolio holding Anheuser-Busch was acquired in a cash deal by Belgian firm InBev last autumn, despite the credit crisis. Up until today, InBev did not trade in the United States, but the company just launched an American depository receipt trading under the ticker "AHBIY." Should we be interested? In a recent issue of StockInvestor, I interviewed Ann Gilpin, who has covered consumer products firms for Morningstar for the past three years.
Ann, care to give a quick history of A-B InBev?
InBev was formed in 2004 when Belgium-based Interbrew bought a majority stake in Brazilian-based AmBev (ABV). AmBev was run by a group of investment bankers who were acutely focused on cost-cutting, and even though Interbrew bought a majority stake in AmBev, the Brazilian management team at AmBev was quick to overtake and run InBev. By cutting company cars and other perquisites, the management team has made great strides in improving profitability at both AmBev and InBev.
In 2008, InBev launched a hostile bid for U.S.-based Anheuser-Busch, which controls about 50% of the U.S. beer market (the most profitable in the world). As some StockInvestor subscribers remember, A-B rejected the initial offer, but A-B eventually relented for a higher price, and A-B InBev was formed.
Do you think A-B InBev has a wide economic moat?
A-B InBev has the widest moat in the entire beer industry. It is the largest brewer in the world, controlling about 25% of global volume, and dominates many attractive markets, such as the U.S., Canada, Mexico, and Brazil. As such, it can outsell, outmarket, and out-spend any brewer on the face of the planet. In addition, A-B InBev owns four of the top 10 selling beers in the world. This scale and the popularity of its brands allow the firm to generate robust cash flows well above that of its competitors.
There have been many changes at Anheuser-Busch since the merger was consummated. Care to expand?
The A-B acquisition was a megadeal that cost InBev $52 billion. Since it was financed almost entirely with debt, InBev is eager to get out the machetes to reduce costs at A-B in order to reduce its financial leverage, especially since management bonuses are tied to debt/EBITDA ratios for the next five years.
There have been a number of dramatic changes at the firm, all aimed at cutting costs. Executive suites have been demolished in favor of open seating. Salaries have been rebased to 80%-100% of the market rate for a comparable job. The company jets and helicopters are for sale, with managers now flying coach class on Southwest (LUV). Marketing and advertising costs are getting slashed. In addition, A-B InBev has notified several suppliers that it will take up to 120 days to pay its bills, instead of the usual 30 days, despite existing contracts in certain cases. It is also reducing its purchase of a special kind of German hop used to make Budweiser.
What are the risks surrounding these changes?
The InBev management team is using its old playbook in A-B's territory. But with changes so dramatic, we think it is creating a culture clash and rocking the boat with key personnel. Since the acquisition, several senior employees have left, including many advertising and marketing executives with 20-plus years of experience in the industry. Today, the marketing department is run by younger and less-experienced lieutenants.
We are also concerned about the reduction of advertising and marketing spending, as well as the potential alteration of the recipe of Budweiser. The beer industry is highly competitive, and consumer tastes are shifting away from mass domestic beer and toward crafts and imports as well as spirits and wines. Now seems like an inopportune time to reduce advertising and marketing.
The history of Schlitz is a cautionary tale. What happened there?
Schlitz was once a sizable competitor in the U.S. brewing industry. It was neck-and-neck with Anheuser-Busch for market share in the 1950s and was the largest brewer in the U.S. from 1950 to 1952 and from 1955 to 1956. Its Schlitz brand was second only to Budweiser in 1950-76.
In the 1970s, several changes with marketing and formulation, like the ones we see at A-B InBev unfolding at the moment, eventually led to Schlitz's ultimate downfall. In late 1976, the company's chairman died and an accountant and a geologist rose to power. They immediately cut costs by changing the formulation of its Primo and Schlitz products, firing the most experienced marketing executives, and reducing advertising spending.
The results of these changes were profound. The company's market share fell by 50% from 1976 to 1981, Schlitz-branded products lost 91% of their market value from 1974 to 1982, and the company was forced to sell itself to Stroh in 1982 for $335.6 million. The downfall of Schlitz is infamous in the industry and is referred to as "The Schlitz Mistake." We are not at this point projecting history to repeat, but the similarities are certainly something to consider.
Do you think we should be interested in A-B InBev at the moment?
Right now, I wouldn't touch A-B InBev with a 10- foot pole. It is entirely too leveraged, and the stock price today does not compensate for the amount of risk in an investment in the shares, in my opinion.
Our fair value estimate is EUR 28 per share, which translates to $40 per ADR. But based on our scenario analysis, we think the ADRs could be worth anywhere from $17 per share to $61. A-B InBev is a highly profitable, wide-moat company that generates copious amounts of cash, but with the ADRs trading around $38 per share, I don't think A-B InBev is cheap enough to provide an adequate margin of safety, given the near-term risks.
You cover a lot of interesting companies. If not A-B InBev, what is your favorite opportunity today?
I like Diageo (DEO) and, if the shares dipped back below our Consider Buying price again, Molson Coors (TAP).
Molson Coors is a smaller-sized brewer operating in mature markets (Canada, the U.K., and the U.S.) and only has a narrow economic moat, but I like the firm's bottom-line story, which, in my opinion, carries far less risk than the one at A-B InBev. Nearly a year ago, Molson Coors and SABMiller formed a joint venture and combined their U.S. operations, which has about 30% market share. The JV will generate about $210 million in annual savings to Molson Coors--no small peanuts considering Molson Coors' stand-alone annual operating profit was $791 million prior to the JV. The savings to Molson Coors are pretty straightforward. For example, the JV will eliminate 45 million road miles from its distribution simply by taking advantage of the combined brewers' better geographical footprint. Meaning, it will now ship Coors Light to Florida from a brewery in the Southeast instead of from Colorado.
The benefits from this JV have already stood out in Molson Coors' results. In its first-quarter results, reported operating income grew 50%, as savings from the MillerCoors JV more than offset tough head winds from a 20% depreciation in the Canadian dollar and a 28% depreciation in the British pound versus the U.S. dollar. For better or worse, the shares rallied on the news, and the stock is currently rated 4 stars. With our fair value estimate at $59, we would gladly pound the table on this one if it dipped back into 5-star territory.
I like Diageo because it is trading at an attractive valuation and is the best positioned to benefit from long-term consumer trends toward spirits and higher-quality products. Diageo has the best portfolio in the spirits industry, owning eight of the world's top 20 brands and controlling about 25% global share. Also, the company has an entrenched global distribution network that is better developed than its competitors', giving it a wide economic moat. Like A-B InBev, Diageo is a highly profitable cash machine, but unlike A-B InBev, Diageo is cheap (roughly 12 times earnings, 3% dividend yield), trading at a nice discount to our $80 fair value estimate. This is a stock that I think makes a great long-term holding, and I enthusiastically recommend you keep it in the Tortoise Portfolio.
A recommendation I will gladly follow! Thanks, Ann.
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Paul Larson has a position in the following securities mentioned above: TAP. Find out about Morningstar’s editorial policies.