After reporting the continuation of slow but steady growth in February, Heineken´s (OTCQX:HEINY) stock has rallied over 8% to approach all time highs. While management´s story portrays confidence, backed up by a boost in dividends, there are different areas of concern that seem to be overlooked.
The latest annual report is a school example for the relativity of results. At a first glance, both revenues and cash flows increased significantly. The problem is that the sources of those increases are not sustainable. Revenues increased by 6.5% to more than EUR 20B. However, nearly EUR 500M of this growth came from positive currency effects. A similar type of problem holds for the EUR 431M increase in operating cash flow: nearly 80% of that increase comes at the cost of the working capital position. While these effects are legitimate in the sense that they contribute to the bottom line numbers, they are in no way a sustainable and healthy source of growth.
Focus on premium
Heineken focuses its strategy on being strong in premium beers. The primary Heineken brand is already the largest premium beer by volume, and the company wants to expand on this success. This should naturally arise from either higher margins obtained or higher quantities consumed. Heineken seems to have difficulties with the former. Its operating margin of 15% is, though slowly increasing, not impressive. Volume of beer consumed in developed countries has been stable for the last decade, so organic growth is most likely to be found in emerging economies. Indeed, both Africa and Asia show growing beer consumption (SABMiller's strong presence in these areas is believed to have been an important aspect for Anheuser-Busch (NYSE:BUD) within the whole merger rationale). It is however questionable if Heineken's strong focus on premium will lead to success in these developing markets, or that people will reach out to other, more affordable alternatives.
Industry dynamics, battling two fronts
The beer industry is at an interesting time. The up and coming merger between Anheuser-Busch and SABMiller will result in by far the world´s biggest brewery. At the same time, craft beer companies all over the world gain in popularity (often locally). Heineken is stuck right in the middle. It fails to achieve the cost efficiencies of Anheuser-Busch, that has twice(!) the operating margin (32%) and a 40% higher return on invested capital (12.4% vs. Heineken's 9.0%). On the other hand it faces a potential hard time battling with small craft breweries, that enjoy increased popularity.
Stock price potential
Heineken's stock trades at more EUR80, or nearly 24 times earnings. At that level, a strong multiple increase seems unlikely, while significant increases in earnings are doubtful. Another point of interest is the controlling stake of the Heineken family, that has expressed no interest in a possible merger or takeover, excluding that potential from the stock price as well. Finally, the dividend yield of 1.6% (based on the proposed increase) is fairly low, and since the current dividend already took up nearly 70% of FCF, it is unlikely that we'll see big increases in that area.
While the overall message at the annual report release was one of strength and growth, there are multiple caveats that question Heineken's ability to be the stable grower it wants to be. The financials aren't as strong as they seem at first sight, and the strategic focus on premium is one that holds many risks. Combined with the near all time high stock price, I would definitely not consider this company a buy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.