Analyst Note
(Last updated 19/01/10)
Global brewing giant SABMiller's third-quarter trading update confirms our thesis that top-line growth will likely be fuelled by increased demand in emerging markets despite lacklustre growth in mature markets. Our recently raised fair value estimate remains in place. On an organic basis, lager volumes were basically flat in the quarter as growth in emerging markets offset volume declines in Europe (down 2%), South Africa (down 4%), and the US (MillerCoors sales-to-retailers down 4%). Lager volumes were up 4% in Latin America, up 7% in Africa, and up 5% in Asia. Management did not provide any further details on profitability or sales in its trading update, and its outlook, not surprisingly, was rather mixed. The company stated that consumer demand was varied across markets with some regions experiencing a strong rebound in consumer demand while others were still weak. We expect this to be the case for the remainder of its fiscal year, which ends in March. We will provide a more in-depth analysis of the company's performance when it reports full-year results later this year.
Fair value estimate: 1,700p ¦ Fair value uncertainty: Medium ¦ Economic moat: Wide
Thesis
(Last update 13/01/10)
SABMiller is a highly profitable wide-moat brewer with massive global scale and valuable assets in key markets. Although it recently lost its number-one spot after the Anheuser-Busch InBev combination, we think the two giants can peacefully coexist in the world, and we expect SABMiller, with its much more flexible balance sheet, to step up on the acquisition front to continue building out its scale.
SABMiller controls roughly 15% of global volume and was once the largest brewer in the world, until 2008 when second-place InBev acquired third-place Anheuser-Busch to control about one fourth of global volume. Still, SABMiller retains considerable scale. Six of the firm's brands are among the top 50 in the world, and the firm has the number-one or number-two spot in more than 90% of the markets in which it competes, including China, India, the United States, and South Africa. Its economies of scale allow it to generate robust profitability, with operating margins steadily above 20% during the last several years.
Unlike many other brewers in the world, SABMiller has considerable exposure to emerging markets, with roughly 64% of its fiscal 2009 operating profits generated from Latin America, Asia, and Africa. Although emerging markets are less efficient and operationally riskier, we think this is a potentially huge opportunity for the firm, as per capita consumption in these markets lag those in developed markets. For example, the Chinese beer market is already 60% bigger than the US market, but per capita consumption is only one third of what Americans consume. SABMiller is well-positioned to benefit from this potential increase in consumption as it jointly owns the Chinese brand, Snow, which is the best-selling beer brand in the world.
SABMiller's bigger rival, A-B InBev, also has several market-leading positions across the world, and has effectively shut SABMiller out of the highly profitable Brazil and Canada beer markets, which it dominates. However, we think the two giants have established kingdoms with minimal overlap, allowing the two to coexist. SABMiller has already established its dominance on most of the African continent but has shied away from Brazil. Meanwhile, A-B InBev is pulling back on its interest in China's Tsingtao, but SABMiller has no presence in Canada.
One market where the two compete head-to-head is in the US, but in this market we think SABMiller has the upper hand. We believe there is a large downside risk to the cost-cutting at A-B InBev, which would be a direct benefit for SABMiller, and we foresee significant earnings growth through the MillerCoors joint venture (with Molson Coors). And with plenty of assets in emerging markets up for grabs and SABMiller's balance sheet in good health (compared with that of A-B InBev, which is shackled with debt), we wouldn't be surprised to see the firm make a few acquisitions to step up its global scale.
Valuation
We are raising our fair value estimate for SABMiller to 1,700p per share
from 1,550p to account for foreign
currency fluctuations since our last update. Our fair value estimate
for SABMiller implies forward fiscal-year price/earnings of 19 times,
price/cash flow from operations of 17 times, and enterprise value/EBITDA
of 10 times. Our fair value incorporates a spot exchange rate of $1.62
per £1 as of January 12, 2010 (SABMiller reports in US dollars but
trades in sterling on the London Stock Exchange). Our fair value
estimate will fluctuate as foreign currency rates change.
In fiscal 2010, we expect the top line to decline because of weakness in consumer spending and the transition of its US operations to a joint venture. We assume a long-term annual sales growth rate of 5%-6% (excluding acquisitions) driven primarily by growth in emerging markets such as Asia and Latin America. SABMiller's profitability should improve greatly during the next few years as cost savings in the United States from the MillerCoors joint venture are realised and nascent markets gain scale. Including joint-venture income, we expect SABMiller's earnings before interest, taxes, and amortisation (EBITA) to approach 33% of sales net of excise taxes by fiscal 2014. Although acquisitions are likely, we have not modelled any into our valuation because of the uncertainty of the timing and size.
If we were to assume a long-term sales growth rate of 7%-8% and EBITA profit including joint-venture income to reach 34% of sales net of excise taxes by fiscal 2014, our fair value estimate would rise to 2,146p per share. Conversely, if we were to assume a long-term sales growth rate of 3% and EBITA profit including joint-venture income to reach 30% of sales net of excise taxes by fiscal 2014, our fair value estimate would drop to 1,181p per share.
Risk
A big risk to an investment in SABMiller, in our view, is foreign
currency fluctuations, which could result in big revenues and earnings
swings. In addition, alcoholic beverages companies are subject to heavy
regulation and taxation, both of which can change rapidly and
dramatically in emerging markets. Also, the Chinese government's fickle
treatment of foreign companies could threaten SABMiller's joint venture
there. Finally, a pricey acquisition by the firm could be
value-destructive.
Management & Stewardship
After selling Miller to South African Breweries in 2002, tobacco giant Altria
retains significant control over SABMiller's board (owning 28.5% of its
shares). The current board consists of 16 members, of which seven are
insiders: CEO Graham Mackay, former CEO and current chairman Meyer Kahn,
CFO Malcolm Wyman, two members nominated by Altria, and two members
nominated by the Santo Domingo Group (SABMiller's second-largest
shareholders behind Altria). Although we applaud the company for
separating the chairman and CEO roles between two people, as we believe
this better promotes good corporate stewardship, we think Kahn's tenure
as chairman, a position he has held for 10 years, may cultivate too cosy
a relationship with management to foster true independence. Otherwise,
we like that both Mackay's and Wyman's compensation is 25% fixed and 75%
variable, as we believe this better aligns management's interests with
those of shareholders.
Overview
Growth: Although we expect a decline in the top line in
SABMiller's 2010 fiscal year, we assume a long-term annual sales growth
rate of 5%-6% driven primarily by growth in emerging markets such as
Asia and Latin America.
Profitability: We believe SABMiller's profitability will improve because of both the cost savings the MillerCoors joint venture should generate and more efficient operations in growing markets. We forecast returns on invested capital to average 12% through 2014, relative to our 9.1% cost of capital assumption, further evidence that this firm has a moat.
Financial Health: SABMiller is in good financial health. Net debt/capital is 37%, which is on the low end for a highly profitable alcoholic beverage company of this size, and operating profits sufficiently cover interest expense.
Profile: SABMiller is the second-largest brewer in the world, controlling roughly 15% of global volume, and was created when South African Breweries bought Miller Brewing Company from Altria in 2002. The company owns six of the top 50 beer brands in the world and has the number-one or number-two spot in more than 90% of the markets in which it competes.
Strategy: SABMiller seeks to be a global leader in the beer industry through developing strong brand portfolios in growing markets like China, Africa, and India as well as keeping larger brands in developed markets relevant. The company has not shied from making major acquisitions in the past, and we expect it to continue to use this as a means for growth.
Bulls Say
1. SABMiller has immense scale, controlling about 15% of the global beer
market, six of the world's top 50 brands, and the number-one or
number-two spot in more than 90% of the markets in which it competes.
2. SABMiller has broad exposure to emerging markets and generated about 64% of its fiscal 2009 operating profits from Latin America, Asia, and Africa.
3. SABMiller jointly owns Snow, which recently surpassed the long-standing incumbent Bud Light as the best-selling beer brand in the world.
4. We forecast the MillerCoors joint venture to result in $290 million in annualized cost savings for SABMiller--no small peanuts considering the firm's EBITA in North America totaled $477 million in fiscal 2008.
Bears Say
1. A-B InBev is a tough rival, and its dominance has shut SABMiller out
of highly profitable markets like Canada and Brazil.
2. SABMiller's large emerging-market exposure means the firm operates in generally inefficient markets, hampering returns on invested capital.
3. The company's results could swing greatly based on fluctuations in foreign currency.
4. Although China is a highly valuable growth market, the government's treatment of foreign ownership has been fickle at best. China recently struck down a juice acquisition by Coke, and Groupe Danone has had many battles over trademark rights with its Wahaha investment.
5. If SABMiller overpays for an acquisition, returns on invested capital would suffer.
