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Financial Mail - Investors Monthly - - Contents - Stafford Thomas

High hopes were rid­ing on AB InBev when it listed on the JSE amid great fan­fare in Oc­to­ber 2016. Th­ese have, how­ever, proved to be very mis­placed.

From an open­ing trade of R1,938, the share price of the world’s largest brewer has slid by more than a third. In its reporting cur­rency, US dol­lars, it has fallen by just on a quar­ter since hit­ting a record high in July 2016.

AB InBev’s share price has been buf­feted by strong head­winds driven by ris­ing US bond yields and a less than in­spir­ing earn­ings per­for­mance.

In com­mon with other con­sumer sta­ples com­pa­nies, an­a­lysts use dis­counted cash flow (DCF) as a key fac­tor to value AB InBev. In a DCF model, fu­ture ex­pected cash flows are dis­counted to ob­tain an es­ti­mated present value.

DCF models are based on free cash flow, which is the net taxed amount avail­able after all cap­i­tal ex­pen­di­ture.

The 10-year US trea­sury bond yield pro­vides the bench­mark at which fu­ture free cash flows are dis­counted. A ris­ing bond yield will drive up dis­count rates and, in the process, lead to a lower es­ti­mated present value of a com­pany.

This is a head­wind AB InBev has faced since the US 10-year bond yield hit a record low of 1.35% in July 2016 and be­gan a rise that has taken it to its cur­rent level of about 3%.

From a profit per­spec­tive, AB InBev has got nowhere in the past three years. Re­flect­ing this, nor­malised EPS of US$4.04 in its year to De­cem­ber 2017 were still 26% lower than the best-ever $5.43 of 2014 and on par with nor­malised EPS in 2011, de­spite rev­enue hav­ing climbed from $39bn to $56.4bn in those six years.

Also weigh­ing on the firm’s share price is mar­ket con­cern that it will cut its div­i­dend, which has been un­changed at $3.60 for the past three years.

“AB InBev has stated that it won’t cut its div­i­dend but there is still con­cern re­lated to its high gear­ing level,” says Claude van Cuyck of Denker Cap­i­tal.

AB InBev geared up heav­ily to fund its $103bn ac­qui­si­tion of SABMiller in Oc­to­ber 2016. Debt on its bal­ance sheet soared from $43.5bn in 2015 to $116.4bn at the end of 2017.

This left the com­pany with net debt of 132% of its eq­uity and an an­nual in­ter­est bill of $6.3bn, which ate up 35% of op­er­at­ing profit in 2017. AB InBev says its op­ti­mal level of net debt is twice earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion (Ebitda). Net debt at the end of 2017 was at 4.8 times Ebitda.

A lower div­i­dend pay­ment must thus be tempt­ing, par­tic­u­larly for CEO Car­los Brito. He has fo­cused heav­ily on scalin­gup AB InBev through an ag­gres­sive, debt-funded ac­qui­si­tion strat­egy that started with InBev’s ac­qui­si­tion of An­heuserBusch for $52bn in 2008.

Brito is not sat­is­fied with the group’s scale and has set his sights on in­creas­ing an­nual rev­enue to $100bn by 2022 at the lat­est. It’s a tall order, and get­ting there will re­quire an­other mega-ac­qui­si­tion — some­thing that would only seem vi­able on a bal­ance sheet with a far lower level of gear­ing.

The profit growth needed to pay down debt faster is also elu­sive. The first quar­ter of AB InBev’s cur­rent fi­nan­cial year brought no joy for share­hold­ers, who were pre­sented with a 1.4% fall in nor­malised EPS.

Rev­enue grew by 4.7%, with AB InBev’s three global brands — Bud­weiser, Stella Ar­tois and Corona — reg­is­ter­ing 7.9% growth glob­ally and 12.2% out­side their home mar­kets. The three brands ac­counted for 19.1% of group rev­enue in 2017; the bal­ance came from more than 500 re­gional beer brands.

AB InBev’s big­gest chal­lenge in the first quar­ter re­mained the North Amer­i­can mar­ket, where its beer vol­ume dropped 4.1%, from falls of 3.3% in 2017, 1.6% in 2016 and 2015, 1.4% in 2014 and 2.7% in 2013.

The North Amer­i­can mar­ket, dom­i­nated by the US, is AB InBev’s big­gest; in 2017 it ac­counted for 28% of the com­pany’s nor­malised Ebitda.

In the US AB InBev is fac­ing de­clin­ing vol­ume and mar­ket share in a con­tract­ing main­stream beer in­dus­try. In 2017, for ex­am­ple, the US Brew­ers’ As­so­ci­a­tion re­ported a 1.2% vol­ume de­cline, while AB InBev ex­pe­ri­enced a 3% fall.

Strong growth in the US craft beer seg­ment is adding to the pres­sure. In 2017, craft beer re­tail sales rose 8% to $26bn, ac­count­ing for 23% of the $111.4bn US beer mar­ket.

The $162.5bn mar­ket-cap AB InBev is far from cheap, trad­ing on a his­toric p:e of 23.8 and, ac­cord­ing to a Morn­ingstar con­sen­sus fore­cast, an op­ti­mistic for­ward p:e of 19.2.

Be­yond AB InBev’s pos­si­ble at­trac­tion as a rand hedge, it is a share one should con­tinue to treat with cau­tion.

The first quar­ter of AB InBev’s cur­rent fi­nan­cial year brought no joy for share­hold­ers

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