AMM Dividend Letter Issue 7: Return of the King of Beers
This is from the AMM Dividend Letter released May 3, 2014. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.
In a recent interview with 60 minutes about his new book “Flash Boys”, Michael Lewis declared the stock market “rigged” (see the clip here: http://www.cbsnews.com/videos/is-the-us-stock-market-rigged/). Flash Boys is about the world of High Frequency Trading (HFT), and the “edge” that some traders have been able to achieve by using very fast computers to “see” market data ahead of their competitors. While this is disconcerting for short-term traders and speculators, we don’t think these concerns are relevant to long-term investors.
Carl Richard in the New York Times sums up this view rather succinctly:
“Now, if you’re a trader who spends every day making trades for a living, you’ll be interested in the conversation about whether there’s a system in place for front-running your trades that costs you a bit each time you buy or sell. And if you’re a concerned citizen, you’ll care whether people are breaking the law. But as an investor, high-frequency trading doesn’t matter because you’re focused on the boring work of buying good things and owning them for a long time.”
First and foremost our goal is to invest (i.e. take an ownership position) in high-quality businesses. We describe high quality as the ability to invest incremental capital at a high rate of return on the shareholder’s equity. Unlike traders/speculators who seek to buy a stock and then flip it for a profit a short time later, we seek to become long term shareholders in a business that can provide us an attractive return over time.
If the stock market is “rigged”, perhaps it is in favor of the investor that has the patience to own high-quality businesses and who ignores the day-to-day, week-to-week, and month-to-month fluctuations of the stock market. Wealth will compound at a surprising rate for the patient investor who lets high-quality businesses generate high rates of return on capital over many years.
Interestingly, this approach seems to be the exception and not the rule to investing today. A casual glance at the “Investment” section of the local Barnes & Noble shows a heavy weighting toward books on trading, charting and generally trying to game the market. A much smaller section is dedicated to actual investment analysis.
Price is What You Pay, Value is What You Get
The second pillar of our process is to pay a fair price for our investment. Traditional financial theory defines the value of any assets as the sum of all future cash flows discounted back to present day at an appropriate discount rate. This creates a present day or intrinsic value, the price we are willing to pay today for future returns. Buying below present value generates higher returns while paying too much leads to lower returns. If we pay significantly above fair value for an asset it may even lead to negative returns over time, even for a high quality company. Ideally we seek to invest at prices below our conservative estimate of intrinsic value to provide both a margin of safety and the opportunity for higher long-term returns.
Ultimately we want to buy businesses that provide a good or service that consumers will want well into the future. Estimating future cash flows for these types of companies is much easier than for companies with new or untested products. It becomes even easier if the company makes a product consumed by mankind since the dawn of civilization. We can safely assume this product will be desired well into the future.
Anheuser-Busch InBev (BUD) is a perfect example.
Dividend Stock in Focus
Anheuser-Busch InBev (BUD): $106.28*
*price as of the close May 2, 2014
The 2008 merger between Anheuser-Busch and InterBrew resulted in Anheuser-Busch InBev (BUD) which is now the largest brewer of a 12,000 year old consumer staple.
The first humans out of Africa were nomadic hunter-gatherers. When they stepped foot into the Fertile Crescent their nomadic lifestyle ceased as they now had access to an abundant source of cereal grains, a new food source that humans could store and provide an unexciting but reliable meal when needed. Families took root, built permanent settlements, and banded together with other families. The building blocks of modern civilization were set.
All harvested grain was stored together in one easily defended central location; however the vessels used to store the grain were not water tight. When water mixed with the grains, especially barley, the mixture turned into a sweet tasting gruel. Left alone for a few days the gruel underwent a further transformation becoming slightly fizzy and pleasantly intoxicating. Mankind had discovered beer!
The first beer had low alcohol content but was rich in suspended yeast, a strong source of vitamins and protein. The higher levels of B vitamins helped compensate for the decline in meat consumption as man began to farm more and hunt less. The first beers weren’t filtered requiring the use of straws to drink. Also, the beer was stored and served in containers too large for personal consumption. Sharing a beer was an offer of sustenance and friendship. 12,000 years later sharing a drink is still a universal symbol of friendship.
Beer consumption has survived the rise and fall of many governments and civilizations, and we see no reason why it will not continue to survive and grow as long as mankind exists. As the global leader of a timeless consumer staple, Anheuser-Busch InBev (BUD) is in an enviable position.
Shares for Anheuser-Busch InBev (BUD) started trading in the U.S. in 2009. Since then management has grown the dividend at an annual rate of 38.7%.
The chart is a little misleading. After buying Anheuser-Busch, the new mega-brewer slashed its dividend to pay off its new debt as fast as possible. The management team has proven themselves to be skilled deal makers, willing to cut dividends and sell assets if the net positive is a stronger and more valuable business. There is always a chance management cuts the dividend again if they can scoop up another global brewer, like SABMiller Plc. We would expect the dividend to come back once the deal is complete and the balance sheet restored.
Catalysts for Dividend Growth and Price Appreciation
Anheuser-Busch InBev’s management team is adept at acquiring other larger brewers, cutting costs, and creating value for its shareholders. This goes back to the merger between Brazil’s two largest breweries, Brahma and Antarctica, to create Ambev. Then Interbrew, at the time Europe’s leading brewer, merged with Ambev to form InBev. Then InBev bought Anheuser-Busch to form Anheuser-Busch InBev.
To complete the Anheuser-Busch transaction, InBev had to sell assets, including South Korea’s largest brewer, Oriental Brewery. The sale of Oriental Brewery included a buyback clause. Earlier this year, Anheuser-Busch InBev exercised this right and bought Oriental Brewery back from KKR.
Anheuser-Busch InBev also purchased the rest of Grupo Modelo that it did not own. Management targeted $1 Billion in cost savings from the deal. The cost savings are expected to be delivered ahead of schedule in 2015.
Craft Beer Boom! (Then Bust)
Craft beer currently represents 10.2% of the domestic beer market. Bart Watson, an economist with the Brewers Association, thinks it could reach 15% in the near future. In Oregon, craft beer accounts for 47% of all beer consumed. While trends never move in an orderly fashion (there are typically booms and busts along the way), right now we are amid a craft beer boom.
According to the Denver Post, Colorado added 56 new permitted breweries in 2013 pushing the state’s total to 217, double that of 2012. Across the nation 1,528 new breweries opened in 2013. That’s on top of the existing 2,043 craft brewers.
The craft beer market is still dominated by a handful of breweries like Boston Beer Co. (SAM), Sierra Nevada Brewing Co., New Belgium Brewing Co., and Deschutes Brewery. The remaining craft brewers are fighting for tap and shelf space in a crowded market. It is only going to get tougher. For the breweries that are under capitalized the fight will be brutal.
Anheuser-Busch InBev has the capital, the scale, and the distribution network to help any established craft brewer ramp up and survive the coming fight. In 2011 Anheuser-Busch InBev purchased Chicago’s Goose Island for $40 million. Anheuser-Busch InBev started a national roll out strategy and Goose Island’s sales increased significantly. In 2013 alone Goose Island’s volume increased “more than 70%”. The chart below compares Goose Island’s sales volume growth to its closest competitors as of October 2013. Shock Top is an Anheuser-Busch InBev beer too.
In February Anheuser-Busch InBev bought Blue Point Brewery. Blue Point is a 15 year old company and produces about 60,000 barrels a year. Their flagship beer is the Toasted Lager, a 2006 World beer Cup Gold Medal Winner. The company needs capital to compete and expand on a national scale. We expect Anheuser-Busch InBev to do for Blue Point what they did for Goose Island.
The craft beer boom has also played a part in lagging U.S. sale sales volumes for Anheuser-Busch InBev. Buying and investing in craft brewers can offset U.S. Volume declines. Craft beer is also premium priced beer which combined with management’s ability to increase distribution and cut costs is a recipe for higher profits.
China is still one of the fastest growing beer markets in the world and is Anheuser-Busch InBev’s fastest growing market. For 2013 the company’s beer volume sales grew 8.9% with only a 14.1% market share. The Chinese beer market is fragmented and the bulk of the beer consumption growth has come from low-end beers. This is a strong opportunity for Anheuser-Busch InBev. The company’s high-end brands can gain market share through organic growth, acquisitions, and partnerships.
The merger of Anheuser-Busch with InterBrew left the new company with a highly leveraged balance sheet. Except for the small dividend it paid out, all excess cash flow was used to deleverage the balance sheet (i.e. pay down debt). The ultimate target was a Net Debt to EBITDA ratio of 2x. Anheuser-Busch InBev reached this target and is now returning excess cash to shareholders. On top of the year-end dividend, Anheuser-Busch InBev paid out its first interim dividend since the merger last year. Management wants the dividend yield to be in-line with its consumer staples peers. The goal is a dividend yield of 3-4%.
Management also stated that cash will be returned to shareholders through share buybacks too.
Another Mega Deal
Anheuser-Busch InBev wants more exposure to the faster growing emerging markets of Africa. Its largest competitor SABMiller Plc has solid exposure to these markets, and that company’s CEO has gone on record that an Anheuser-Busch InBev buyout of SABMiller is a workable deal. He then declined to say if any discussions between the two companies have taken place. According to Bloomberg, an acquisition of SABMiller would add over $7 billion in revenue from Africa and $4 billion in Asia. Bloomberg also estimates a combined Anheuser-Busch InBev and SABMiller to have over 50% of the “global beer profit pool”. A combined company is a large opportunity for Anheuser-Busch InBev’s management to generate a lot of value through scale and cost cutting.
“A great business at a fair price is superior to a fair business at a great price.” – Charlie Munger
Anheuser-Busch InBev is a great business. The company is the leading global brewer and brews 7 of the world’s top beer brands: Bud Light, Budweiser, Corona, Skol, Stella Artois, Brahma, and Beck’s. Anheuser-Busch InBev also has a large, if not the largest, market share position in many key markets including Brazil (69%), Argentina (77%), Canada (41%), U.S. (48%), Belgium (57%), and Ukraine (36%). The company sports industry leading margins too. Our discounted cash flow model puts Anheuser-Busch InBev’s fair value at $106 per ADR. When the stock dipped below $100 we started buying as we viewed this as an opportunity to buy a great business at a fair price.
For more on beer and the early development of human civilization, plus how 5 other major drinks help shape civilization read.
A History of the World in 6 Glasses
From colonial days to the craft beer boom, the history of beer in the United States.
Ambitious Brew: The Story of American Beer
Flash Boys: A Wall Street Revolt by Michael Lewis
The behind the scenes story of the how the Brazilians were able to wrestle Anheuser-Busch away from the Busch family.
Dethroning the King: The Hostile Takeover of Anheuser-Busch, an American Icon
Why Carlos Brito, the CEO of Anheuser-Busch InBev, is one of the most effective CEOs…. Frugality (Joe Kusnan’s Blog)
Dividend growth investing provides inflation protection (AMM Dividend Letter)
The stock market has been “rigged” since day one (The Reformed Broker)
The next big thing in craft brewing Introducing Samuel Adams Heli-Yum
Apple (AAPL) hits one of its catalysts (AMM Dividend Letter)
No matter how full life gets there is always room for a couple beers with a friend (Balanced Action)
All past letters are archived here.