Price (1/28/11) - $27.05
Price consider buying - $22.0
Price consider selling - $33.0
Currently we consider it a "hold"
About the Company:
AmBev (ABV) is the largest brewer in Latin America by sales volume and the fourth-largest beer producer in the world. It produces, distributes, and sells beer and PepsiCo (NYSE:PEP) products in Brazil and other Latin American countries. It also owns Argentina's largest brewer, Quinsa. AmBev was formed in 1999 through the merger of Brazil's two largest beverage firms, Brahma and Antarctica (owns the famous drink “Guarana”). In 2004, AmBev merged with Labatt, and Interbrew [now Anheuser-Busch InBev (NYSE:BUD)] gained a controlling interest.
In 1995, Labatt was acquired by the large Belgian multinational brewer InBev (then Interbrew), the world market leader. Labatt is part-owner of Brewers Retail Inc., operator of The Beer Store retail chain, which — protected by legislation — has over 90% market share of Ontario off-premise beer sales.
Per capita consumption in Brazil and several other Latin American markets is lower than mature markets. Moreover, long-term economic growth in these emerging markets leads to increases in personal disposable income, which translate into per capita consumption increases and consumers shifting to premium brands.
AmBev's competitive advantage is formed by the following three characteristics:
- The firm's dominant share in its largest markets: Brazil (69% share), Canada (42%), Argentina (76%), Bolivia (97%), Paraguay (96%), and Uruguay (97%).
- Its highly efficient operations: AmBev generates significantly higher margins and return on invested capital than its peers in the brewing industry.
- High customer captivity due to frequent visits leveraging on the fact that it also distributes Pepsi products.
Brazil is the fourth-largest beer market by volume and by far the company's largest division. This division generated 52% of overall sales and 57% of earnings before interest, taxes, depreciation, and amortization in 2009.
The dynamics for continued volume and pricing growth in Brazil's beer industry are attractive. Per capita consumption in Brazil is 57.7 liters, which is lower than many mature markets such as Canada (69.3 liters), the United States (80.7 liters), and Germany (112.7 liters). As disposable income rises and the population expands, we expect significant additional volume growth over our forecast period. In addition, while premium beer as a percentage of volume has more than doubled from 2% in 1998 to 5% in 2009, the premium beer category in Brazil is still significantly lower than in mature markets such as the U.S. (15%), France (33%), and Canada (50%).
As the premium beer market gains share, we expect AmBev will realize increased revenue per hectoliter as it constantly pursues shifting its sales mix to premium, high-priced, and more profitable products. AmBev's second-largest division is in Canada, where the firm's Labatt brand holds 42% share. The firm's main competitor in Canada is Molson Coors (NYSE:TAP), which has a share +40%. With the two largest competitors in Canada holding the preponderance of market share, we expect pricing to remain rational, allowing AmBev to continue to generate strong ROIC and ample cash flow.
AmBev is Pepsi's largest bottler outside the U.S. and has the exclusive right to produce, sell, and distribute Pepsi carbonated soft drinks and Gatorade products throughout Brazil and several other Latin American countries. The franchise agreement expires in 2017 but automatically extends for additional 10-year terms. AmBev's carbonated soft drink business is the second largest in Brazil with a 17.8% share. The company uses this as leverage to further increase points of distribution (greater than 1 million) and further increase the number of visits to custumers. The effects this has on their costumers is invaluable. It allows re-stocking to occur more frequently and it allows customers to carry an increasing product variety.
AmBev has a long history of improving its operational efficiency and expanding profitability, as reflected in its steadily improving ROIC and other margins. We expect this trend to continue, as we forecast ROIC to increase to 29.6% over the next five years. Finally, AmBev management is focused on delivering shareholder value. It is required to pay a mandatory dividend of 35% of annual net income, and we expect it will pay in excess of that minimum and use excess cash flow to repurchase shares.
Risks - Macroeconomic
Devaluation of the real relative to the U.S. dollar may increase operating and financial expenses as a significant portion of cost of goods sold are denominated in or linked to dollars (cans, PET bottles, and commodities like sugar, hops, and malt) and a significant portion of debt is denominated in or indexed to dollars. Therefore, with 83% of the firm's revenue generated in Latin America, we think the greatest risk to investing in AmBev is macroeconomic and political risk.
Macroeconomic instability and political risks in Latin America in the past have led to reductions in disposable income and lower wages in real terms, which adversely affected consumer behavior and in turn hurt operations.
Brazil's already high taxation could adversely affect profitability, and increases in taxes on beverage products generally result in lower levels of consumption. About 83% of the firm's sales are conducted in Latin America.
Risks – Competitive
Competitive pressures in the markets it is trying to gain market share [e.g. Chile's Compania Cervecerias Unidas S.A. (NYSE:CCU)] can reduce margins.
The Coca-Cola Company (NASDAQ:COKE), Grupo Schincariol, Cervejaria Petropolis S.A., SAB Miller (OTCPK:SBMRY), Cerveceria Centro Americana, Florida Ice & Farm Co., Fomento Economico Mexicano S.A. (NYSE:FMX), Cerveceria Nacional Dominicana, Cerveceria Polar and Cerveceria Regional, Molson, Sleeman Breweries Ltd. and Moosehead Breweries Ltd and CCU (Chile).
- Positive Hard: Re-rating of the common stock by brokers and research analysts.
- Positive Soft: Continued improvement in margins and sales.
- Negative Hard: Devaluation of the Brazilian Currency (Real).
- Negative Hard: Interest rate rise in EM.
- Negative Soft: Political Risk in Latin America (Key Market).
- Negative Soft: Spike in inflation of key ingredients in beer such as sugar, hops, and malt.
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Disclosure: I am long ABV.