BUD Investment Summary

SCG recently acquired a minority interest in AB InBev and presented the idea to MOI Global, a group of investment managers. In the future, I will share the presentation in order to show the investment thought process. In the meantime, below is a summary of my thoughts. NOTE – This is not investment advice, all information should be confirmed, much of this is opinion, and AB InBev carries substantial risk.

Volume and Price Trends

Large beer companies’ biggest brands in developed markets are losing volume. Therefore, they’ve driven growth (if any) by increasing prices. In the U.S., growth in the beer category is attributable to craft and imports. While AB InBev has an impressive import portfolio, it needs a brand that resonates with Hispanic consumers (the company owns the rights to Corona and Modelo globally but had to sell the U.S. brand rights because of antitrust concerns).

People often say 3G doesn’t know how to drive organic growth. Is that true?

Yes, that data is stale. But, that chart doesn’t suggest 3G can’t grow organically. Instead, it says the biggest brands within AB InBev’s U.S. portfolio are losing share. But so are the categories those brands compete in. Stella, Michelob, and Rolling Rock are all growing nicely. Moreover, Corona and Modelo, which benefit from 3G’s international marketing are also growing nicely. I’d argue the trends against AB InBev’s larger brands are so strong that volume losses aren’t really management’s fault.

The beer industry responded to the volume trends above by increasing prices:

How far can they push price? That’s to be determined. In the meantime it’s important to look at how coordinated the price increases are. The beer industry benefits from a consolidated market with rational competitors. Craft is taking share and may put a ceiling on future price increases, but the image above shows an extremely desirable competitive industry dynamic. See http://ec.europa.eu/competition/mergers/cases/decisions/m7881_3286_3.pdf and https://www.justice.gov/atr/case/us-v-anheuser-busch-inbev-sanv-and-sabmiller-plc for interesting discussions about the industry.

Global Consolidation

AB InBev primarily competes in consolidated end markets. Moreover, the company has dominant market share in many end markets:

“Market share is often conflated with a competitive advantage, which it’s not…Generally speaking you will have much better economics when you have a relative scale advantage.” Pat Dorsey to Patrick OShaughnessy on the Invest Like the Best podcast, 2/20/2018 @ 30:25-31:34. The chart above is strong evidence of AB InBev’s relative scale advantage. That scale advantage, combined with consolidated end markets is highly desirable and results in eye popping gross and EBIT margins.

Leverage

The biggest risk in this investment is the leverage. While the headline leverage number is very high, it’s important to note that the leverage was incurred to make transformative acquisitions. It’s reasonable to criticize 3G for paying too much for SAB Miller. That said, the acquisition combined the number 1 and 2 players in the market, solidified AB InBev’s relative scale advantage, and gave AB Inbev exposure to growing end markets. Carlos Brito, AB InBev’s CEO, discussed the strategic importance of SAB Miller’s India assets saying:

The Groupo Modelo transaction was also strategically important. Groupo Modelo’s strategy involved gaining market share by keeping price constant. That strategy hurt Big Beer’s ability to raise prices without losing volume. When AB InBev acquired Groupo Modelo the U.S. beer market became more rational and the company acquired fantastic global beer brands. See https://www.justice.gov/atr/case/us-v-anheuser-busch-inbev-sanv-and-grupo-modelo-sab-de-cv for details.

Finally, 3G structured AB InBev’s debt incredibly efficiently. The debt has a weighted average cost below 4.5%, no covenants, and an incredible maturity profile. Recently, they improved the maturity profile even more but did have to issue slightly higher cost debt. See https://www.sec.gov/Archives/edgar/data/310569/000119312519007051/d691727d424b5.htm for prospectus.

Conclusion

There’s a lot of risk in this investment. People have said there’s no Alpha and AB InBev just offers Beta risk. That is a reasonable argument. But, it’s reasonable Beta risk to take because the company has such a strong competitive position and frequently sells a drug to a diversified consumer base.

The market doesn’t like management right now. But, the market is fickle. At these equity prices the investment can work without heroic assumptions. Below is a back of the envelope model.

In my view, the projected return is reasonable and the model is conservative. While I’d prefer returns far higher than 9%, this entity is an extremely strong competitor with a great management team competing in a consolidated, rational industry. Morever, the entity isn’t likely subject to technological disruption. 9% is reasonable given those facts.

Bears will disagree. That’s what makes markets.

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