Fair Value Estimate: 1850p | Uncertainty Rating: Medium | Economic Moat: Wide
Thesis (Last Updated on 19/11/10)
SABMiller's (SAB) vast global scale and strong brands in key markets give the firm a wide economic moat, in our opinion. SABMiller recently lost its number-one spot after the Anheuser-Busch InBev (BUD) merger, and although the two giants may be able to peacefully coexist in the global market in the short term, we expect competition to intensify in the longer term. SABMiller, with its more flexible balance sheet, is likely to grow through acquisition to build out scale, but larger rival A-B InBev will prove stiff competition.
SABMiller controls roughly 15% of global volume and was 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. Nevertheless, 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 that we expect to be sustained in the high 20s over the next 10 years.
The firm has considerable exposure to emerging markets, with 67% of its fiscal 2010 group EBITDA generated from Latin America, Asia, and Africa. Although emerging markets are less efficient and operationally more risky, we think this is a potentially huge opportunity for SABMiller, as per capita consumption in these markets lags 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 that in the US SABMiller is well-positioned to benefit from this potential increase in consumption as it jointly owns the leading Chinese brand, Snow, the best-selling beer brand in the world.
A-B InBev also has several market-leading positions, and has effectively shut SABMiller out of the highly profitable Brazil and Canada beer markets, which it dominates. The two giants have established kingdoms with minimal overlap, with SABMiller dominant in most of the African continent but with a weak presence in Brazil. A-B InBev has pulled back on its interest in China's Tsingtao, leaving SABMiller to dominate that market. In the US, we think SABMiller has the upper hand because we expect significant earnings growth through cost savings at the MillerCoors joint venture (with Molson Coors (TAP)).
This peaceful coexistence is not likely to last forever, however, with further global consolidation probable. With plenty of assets in emerging markets up for grabs and SABMiller's balance sheet in good shape (compared with that of A-B InBev, which has a higher debt load), we wouldn't be surprised to see the firm make a few acquisitions to step up its global scale. In the immediate term, we expect SABMiller to be interested in the beer assets of Australia's Fosters Group, and when the MillerCoors joint venture has executed its cost-cutting strategy, the firm could even swallow Molson Coors. While an acquisition strategy may generate economies of scale, it is likely to pitch SABMiller into head-to-head competition with A-B InBev in more markets.
Valuation
We are raising our fair value estimate to 1,850p per share as a result of a solid first-half performance in emerging markets. Revenue growth exceeded our expectations, as the firm's brands were able to support slightly higher prices increases than we had anticipated. Our new valuation implies forward fiscal-year price/earnings of 17 times, enterprise value/EBITDA of 10 times, a free cash flow yield of 3.5%, and a dividend yield of 2.3%. Despite the relatively stable performance in the first half of fiscal 2011, we anticipate continued weakness in developed markets, and we expect growth to be driven by emerging markets. After two years of revenue declines, we expect sales in fiscal 2011 to rebound 7%. Over the next decade, we expect SABMiller to increase revenue by 6% on average and at a long-term rate of between 4% and 5% on an internal basis.
Profitability is likely to come under pressure from rising commodity costs in the short term, and we forecast a 30-basis-point decline in the gross margin in fiscal 2011 to 53.7%. However, as SABMiller increases scale in the medium term, it should be able to generate economies of scale and expand its gross margin to above 54% by 2015. Cost savings at the MillerCoors joint venture should take out $435 million of operating expenses by the end of 2011, primarily as a result of merging the manufacturing and distribution infrastructure of SABMiller and Molson Coors, allowing SABMiller to expand its operating margin to a long-term rate of 29% from an adjusted 25% in fiscal 2010. Rising distribution costs are likely to be offset by increasing efficiency in some early-development-stage markets such as Africa.
Risk
A major risk to an investment in SABMiller, in our view, is foreign currency fluctuations, which could result in big revenue 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 MO retains significant control over SABMiller's board (owning around 28% of its shares). The current board consists of 16 members, of which 7 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, 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 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
Financial Health: SABMiller is in solid financial health. Debt/EBITDA is likely to remain under 2 times over the next decade, and EBITDA should cover interest expense by at least 6 times over the same period. These metrics are relatively healthy for a brewer, whose operations are capital-intensive and require consistent investment in PP&E. The dividend yield of around 3% weighs on the Cash Flow Cushion (cash on the balance sheet and future cash flow divided by debt and debtlike commitments) of less than 1. We currently assign SABMiller an issuer credit rating of A.
Profile: SABMiller is the second-largest brewer in the world and was created when South African Breweries bought Miller Brewing Company from Altria in 2002. The company controls roughly 15% of global volume, owns 6 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. Altria holds a 28% stake.
Bulls Say
-- SABMiller has immense scale, controlling about 15% of the global beer market, 6 of the world's top 50 brands, and the number-one or number-two spot in more than 90% of its markets.
-- SABMiller has broad exposure to emerging markets and generated about 67% of its fiscal 2010 operating profits from Latin America, Asia, and Africa. Emerging markets are performing well, delivering double-digit revenue growth.
-- SABMiller jointly owns Snow, the Chinese brand that recently surpassed the long-standing incumbent Bud Light as the best-selling beer brand in the world.
-- We forecast the MillerCoors joint venture to result in $435 million in annualised cost savings for SABMiller--an impressive amount considering the firm's EBITA in North America totalled $640 million in fiscal 2010.
Bears Say
-- A-B InBev is a tough rival, and its dominance has shut SABMiller out of highly profitable markets like Canada and Brazil.
-- SABMiller's large emerging-market exposure means the firm operates in generally inefficient markets, hampering returns on invested capital.
-- The company's results could swing greatly based on fluctuations in foreign currency.
-- 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 Danone has had many battles over trademark rights with its Wahaha investment.
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