The problem with AB InBev and beer is, well, Americans
It may be the no 1 brewer in the world, but that doesn't help when tastes in its biggest market are changing
In his testimony to the US Senate, new US constitutional court judge Brett Kavanaugh said: “I drank beer with my friends. Almost everyone did. Sometimes I had too many beers. Sometimes others did. I liked beer. I still like beer.”
The subject of beer came up repeatedly. Kavanaugh challenged senators, asking them whether they loved beer too. The interaction was an odd moment in a highly charged environment, but it says a lot about the character – and the changing character – of beer in the US. And that, all of a sudden, is an issue for South African shareholders.
Almost two years ago now, South African shareholders of SABMiller voted to sell the company to the global giant AB InBev. After the dust settled, it’s becoming clearer that from the perspective of SA shareholders, the takeover was a not a great result (if you took the shares). And that is very surprising, at least to me.
It’s surprising because the takeover results in one of the most asymmetric major industries on the planet. AB InBev is now four and a half times larger than its nearest rival beer maker, Heineken. Surely a company that much bigger would have a huge competitive edge over its rivals?
Turns out, not so much. AB InBev's share price is down now about 20% over the past two years. Almost all the other non-US beer companies are flat or up. Japanese beer maker Asahi, to whom AB InBev had to sell many of its key Eastern European brands including Pilsner Urquell is up 25%. Constellation Brands, to whom AB InBev had to sell some of its Mexican brands, is up 25%. The chief beneficiaries of the deal were, it turns out, the company’s competitors.
From the perspective of US shareholders, the takeover is probably still good news despite the share price decline, because it gave shareholders more exposure to emerging markets. And that is because AB InBev’s big problem is the US, which still constitutes about a third of its profits.
US shareholders get the benefit of the cost savings, which are according to the company running now way ahead of the estimates, and are around $3.5bn. But offsetting that is a huge debt pile accumulated by the company as a consequence of the buyout.
Financial analysts and rating agencies are blasé about these numbers, but to me they are a concern. Beer companies generate an enormous amount of cash; turnover is fast, consumption is high, margins are excellent. I guess for this reason, most analysts aren’t perturbed by AB InBev's $100bn-plus debt pile.
The company still has a A- debt rating from the ratings agencies, better as it happens than Heineken and Molson Coors. To me, this is crazy; AB InBev has a debt of two-thirds its market cap, Heineken has a debt of one-third its market cap. How can that not make a difference?
The debt pile has other problems for AB InBev. First, it’s just not coming down with any real meaning. When InBev took over Anheuser Busch in 2008, the company’s debt compared to earnings jumped as you would expect. Debt to earnings was 1.7 before the merger, and it jumped to 7.8 after the merger. Within two years it was back down 3.2.
With the SABMiller takeover, it once again jumped, this time to 6.8. It then went up, then it came back a bit, and it’s now about 5.4, according to S&P Capital IQ analysis. The second problem is related; at its current dividend yield, it is paying out around about 80% of its free cash flow and almost all its profit in dividends. It’s almost inevitable dividends will have to come down, which, ironically, shareholders might actually like.
In retrospect, I think this is a short version of what happened here. The Brazilian managers and owners of InBev, a set of really remarkable people, pulled off a stunning buyout of US beer maker Anheuser Busch. It turned out fabulously. So they decided, as one does, to do it again, but this time even bigger.
But repeating the magic has turned out to be much more difficult than they expected. One reason is that the second takeover put them into such a size advantage, compared to other players, that a whole bunch of brands and markets had to go out the window to make the deal happen.
And they got hit by a bit of bad luck too. US tastes are changing. Millennials hate these big brands, which they associate with their parents’ generation. They are excessive, thoughtless, frat-boy drinks. Hello Mr Kavanaugh.
As a result, third-quarter revenue in the US was down 5.7%, which some analysts say is the biggest quarter-on-quarter decline in the company’s recent history.
The company can and has responded to these issues. It is introducing its European brands like Michelob, which have a craft-beer kind of appeal. It can shift its marketing to focus on higher margin brands. And the structure of the company, being more weighted to faster growing markets, helps. It remains a solid company, and its problems are temporary.
But the answer to Kavanaugh’s question might well be, “Do you have any house red?”