The Curious Case Of BUD

Could BUD be more than just the king of beers in 2014?

At present we find ourselves in the middle of a secular bull market - equity premiums have risen and multiples are expanding. Many prominent managers are saying that the market is overpriced and the growth in earnings is not keeping pace with valuations. Revenue is no longer beating expectations and gone are the days of 2010-2012 when companies were expanding margins, trading at ridiculously low PE ratios and holding tons of cash out of fear, all while beating earnings estimates. Some analysts have projected that the S&P may even reach a historic high of 2000 in 2014.

Bushwhacking through the jungle of such information, every once in a while, a savvy investor is offered a unique opportunity. An opportunity to conservatively more than double their money over the next decade from a relatively safe, boring, global company that has maintained a predictable track record of increasing shareholder value. That company is the European heavyweight Anheuser Busch Inbev SA, commonly known on the NYSE as BUD.

What is the thesis on BUD?

Let's for a second take away your quick traditional equity valuation for BUD. I can give you BUD's economic profit (derived by multiplying capital charge and NOPAT (net operating profit after tax) discount it for 10 years at an average mid-to-high single digit growth rate and cost of equity with the 10 year Treasury at 5% (you know, just to make it more interesting). Additionally, let's slow the company down to a low to mid-level growth rate thereafter, find its terminal value, discount that, add the invested capital today and come to a range of estimated firm value figures that is much higher than what the company is worth today.

However, let's instead look at some recent news.

In its last quarter, core profit at the company rose 13% to $5.2bn, net profit surged 47% to $2.52bn, revenue increased to $11.71bn from $10.29B and normalized EPS grew 32.7% to $1.46 when consensus was $1.31. The company is expanding margins drastically (the current operating margin of 58.6% is a 5-year high point) and consistently increasing revenues year over year. BUD generated a 3 year average annual EPS growth of 15.34%, and has unbelievable scale and marketing capabilities. This is all happening despite the company trading at just 12 times earnings when the industry average is 19.2 times. Although BUD generated a ratio of cash flow from operations/total sales of $8.9 billion (down from $10 billion the previous year), the 5 year comparison shows that the firm has been able to maintain certain stability in its free cash flow with 2012-2013 being very robust years.

A comparison with other great 'operators of capital' helps to really put things in perspective. Let's compare BUD with KO (Coca-Cola), a company with similar scale and operations that has been consistently creating shareholder value for over 110 years. BUD made 20% more operating income than KO last year, EBIT in its most recent quarter is half the size of KO's EBIT year-end and yet this company is trading at a market value that is cheaper than KO. This takes into account the recent problems KO is experiencing with flat global volumes, lower soft drink consumption in mature and emerging markets, and dietary changes of the North American consumer. BUD is a monster operator of capital: the company made more operating income last year than TD Bank, Canadian Imperial Bank of Commerce and the National Bank of Canada, jewels of the TSX and the Canadian economy - combined.

This is not to say that BUD doesn't have its own problems or any headwinds. Recent beer consumption in emerging markets (i.e. Russia, Brazil) has slowed and volumes and sales in North America are flat. Prices of soft commodities are rising which may squeeze margins, and most concerning, recent growth in fixed assets has been rising as rapidly as revenue growth (which makes for a larger future capital charge and increases the risk of lower ROA growth). Moreover, there is still a lot of uncertainty with regards to new excise taxes imposed by governments worldwide which could hamper demand.

However, I feel that the problems presented above provide the perfect buying opportunity as they are simply the catalyst behind BUD's depressed valuation. Volumes will slowly rise with population growth, the rising middle class in emerging markets and untapped potential in 'new' emerging markets (i.e. Africa, Indonesia etc.). Consumer spending in mature markets will increase (i.e. Europe and NA)), new products will be rolled out, costs will be passed on to the consumer and brand recognition and scale will expand through investment. New brands and companies will be acquired as evidenced by the recent acquisition of a South Korean brewer and American craft brewer Blue Point brewing. All of these factors will cause revenue to rise faster than the investments made in fixed assets today. Nevertheless, time and strong management execution are prerequisites.

At the end of the day, I am so confident in the vitality of this company that even if the headwinds outlined above come on strong I remain long BUD. Furthermore, a safety net is in place given the company's excellent track record of increasing shareholder value and its sound use of capital. I can't predict the future, but I think BUD presents an opportunity to buy a wonderful company at a great price.

Disclosure: Logos LP is long BUD.