PICK OF THE MONTH
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