SABMiller (OTCPK:SBMRY) held its quarterly divisional seminar on its European business on 11 February 2014. Management tries to put a brave face on the prospects for a business whose profits have come down by 20% over the past five years. We like SABMiller as a company because of the exposure to Asia, Africa and Latin America which adds to over 60% of the company's operating profit. Profits from those regions have doubled over the past five years. Indeed, it is those regions that give the company an attractive growth of 7% annual revenue and 10% annual operating profit growth over the next five years. In my view that is not reflected in the current stock price which trades only in line with the European brewing sector at 16.9x current years earnings.
Below are the key points from the conference:
1) Europe accounts for 17% of group volumes and revenues and 12% of EBITA. Only 20% of the company's European EBITA is generated in Western Europe (mainly UK, Italy and the Netherlands) and 80% is generated in Central and Eastern Europe (mainly Poland, Czech Republic, Turkey, Hungary and Romania). The European EBITA margin of SABMiller stands at 18%, which is at the high end compared to the 17% of AB InBev (NYSE:BUD) (OTC:ANHVF), 16% of Carlsberg (OTCPK:CABGY) and 12% of Heineken (OTC:HINKY). The European business generates about USD600m free cash flow p.a. (which is circa ¼ of the group's free cash flow).
2) The European beer market:
- The European macro-economic context remains challenging as GDP growth remains fragile, consumer confidence subdued and there is no firm recovery of household private consumption.
- Channel shift towards off-premise continues to be margin dilutive (gross margins in off-premise are about 30% lower than in on-premise).
- Contribution of both the economy segments (17% of the market) and the premium segments (32%) continue to grow at the expense of the mainstream segment (51%).
- Declining beer consumption in Western Europe is offset by the increase in beer consumption in Central and Eastern Europe.
3) Continued focus on cost and productivity: Over the past five years real fixed costs per hl excluding IT have come down by 2.5% p.a. and going forward the company expects ongoing fixed cost productivity gains in the range of 2-3% p.a.:
- A single regional manufacturing and supply planning organisation has already delivered significant benefits (USD110m since FY10) and the next stage of functionalised supply organisation to include in-bound logistics through to customer delivery and demand planning process capability built within its supply team, should further lower costs and improve service.
- Procurement is an integrated global function and the expansion of "spend under management" to more than 80% to drive further savings in FY15 and FY16.
- Shared Services implementation will simplify processes, eliminate inefficiencies and enable functional rationalisation, and will follow the deployment of its corporate ERP system in 2014-2015 with savings to come through from 2016 onwards.
4) Medium term guidance: Looking forward SABMiller is expecting the European beer market to be flat and banks on share gains to drive low single digit volume growth. The company is also looking for low single digits revenue per hl increase on a constant currency basis as it believes that innovation and premiumisation will more than offset growth of economy brands, growth in the lower margin of off premise business, growth in the cheaper PET packs and the downward pressure of stronger growth in soft drinks. With the resulting sales growth coupled with further roll-out its Global Business Services programme and the European restructuring efforts (End to end supply chain, Commercial optimisation, Functional rationalisation, Geographical overlaps) EBITA margin is expected to grow by 30-60 bps per year. However for the year ending March 2015 (FY15) the company is guiding to a fairly flat margin net of substantial re-investment of savings behind innovation and sales capability.
The Hardy Hunter believes that the European opportunity is far less exciting than SABMiller's view: The Hardy Hunter does not see that much opportunity for SABMiller to grow volumes as per capita consumption in its core CEE regions of Poland (100l) and Czech Republic (145l) are already well above Western European levels (UK is at 85l and the Netherlands at 81l) and risk coming down and the other main European brewers (Heineken, Carlsberg and AB InBev) will have similar strategies of market share gain. This could lead to increased investments behind their brands (advertising or pricing) and limit the opportunity for margin expansion for all brewers in Western Europe.
Five years ago in its European divisional seminar the company was also expecting 2-4% annual volume growth, 2-4% revenue per hl growth and annual EBITA margin expansion of 30-50bp… meanwhile SABMiller's European profits for FY14 will be around 20% lower than five years ago.