Heineken (HINKY.PK) is the third largest brewery in the world and holds the leading position in Western Europe, followed by Carlsberg (OTCPK:CABGY). Since growth estimates are expected to be somewhat stagnant in Western Europe, both companies have been engaging in a lot of acquisitions to gain market share in emerging markets: Heineken has been expanding their operations in America and African, and Carlsberg has mainly been focusing on Russia and Asia.
From the below stock chart it is clear that neither company has done very well (compared to S&P increasing by around 20%). Carlsberg did the worst with a slight loss over the last two years, while Heineken made returns below cost of equity with a 10% increase in the stock price.
Why did both companies perform below expectations, and what about future earnings?
The short answer is that the regions in which Carlsberg and Heineken were present performed poorly.
From looking at the bare (EBIT) numbers for each region, one could at first think that both companies were doing very well with high EBIT growth rates, but these EBIT numbers do not account for the Capex investments related to acquisitions and other non-current assets. Therefore, they are in my opinion useless in establishing whether Heineken or Carlsberg (historically) has been profiting from their presence in these regions. But I included the below numbers to help me in the process of forecasting future results for both companies.
|We. Europe - Results (EUR)||2006||2007||2008||2009||2010||2011|
|Asia - Results (EUR)||2006||2007||2008||2009||2010||2011|
|East. EUR - Results (EUR)||2006||2007||2008||2009||2010||2011|
|Americas - Results (EUR)||2006||2007||2008||2009||2010||2011|
|Africa, Middle East Result||2006||2007||2008||2009||2010||2011|
One of the things that most worries me about both companies is that a lot of the profits from both companies are related to regions which will most likely perform poorly in 2012. Heineken sells around 25% of their beers in Spain. While beer is not the most elastic consumer good, I would still expect a decline in sales. One might even dare to compare Spain to Greece: the EBIT of the Greek region declined by 9% in 2010 and by double digits in 2011. I doubt that the Spain region will do that badly in 2012, but what about 2013? 2014? There is definitely some uncertainty there.
On the other hand, Heineken is (unlike Carlsberg) obtaining a larger part of their EBIT from the African/Middle East region, where I expect double digit organic growth over the next years. The Americas division will probably be somewhat in the middle of Western Europe and Africa, and the Middle East is expected to have modest growth.
Both Carlsberg and Heineken have suffered from the 200% duty increase on beer in 2010 in Russia. The operating profit of Carlsberg has declined each year from 2009 to 2011 and 2012 is most likely going to be a lot worse as Carlsberg in the first quarter of 2012 had an operating profit of close to 0 for Eastern Europe. Heineken on the other hand went back to EBIT growth in Russia after terrible 2010 results and I expect a continuing modest growth in 2012 for Russia (note - Eastern Europe will possibly still contract as Heineken includes Greece in Eastern Europe).
Both companies are trying to increase their market share in Asia through acquisitions (especially Carlsberg), as double digits growth rates are expected. It is likely we will see a few smaller acquisitions over the next few years made by Carlsberg and I expect the Asia EBIT to make a larger contribution to the total EBIT of the company.
To get some average total growth numbers out of the above, I expect Heineken to average organically around 2% and around 7% on a consolidation basis. I expect Carlsberg to grow around 1% organically and 5% on a consolidation basis.
On a free cash flow basis both companies have experienced a lot of ups and downs since 2006. Most of the variations are due to Capex and Working Capital influencing the free cash flow.
Source: My own calculations, which differ slightly from official results.
In my opinion, looking at the historic FCF numbers in isolation does not make a lot of sense, and in estimating future cash flow I will mostly be relying on historical average values of Capex, Working Capital and depreciations. Furthermore, I use the following assumptions to estimate the fair price of Carlsberg:
- FCF in 2012 to be 1040 euro (millions) with an average growth of 3% in the budget period,
- WACC equal to 8%,
- Average growth in terminal period = 0%,
- Budget period of eight years,
- Market value of debt = book value of debt.
Results: I get a fair value of Carlsberg to 7740 million euro. Adjusting this figure to the ADR OTC, the fair share price is $16 compared to the current share price of $15.38.
In a vacuum, this makes Carlsberg look somewhat fairly priced, but when using DCF a lot of assumptions have to be made and the reason why I decided to include two companies in this analysis was to assure that my assumptions were somewhat realistic (if both companies turned out to be heavily undervalued, I would probably be doing something completely wrong, and vice versa.)
When using the same methodology for Heineken: (with the following assumptions: 1720 FCF in 2012 followed by 5% average growth rate 1% average growth in terminal period, 7.3% WACC) the fair price of the ADR Heineken is $21 compared to the actual $25.2.
This makes me think one of two things: 1) I am either very conservative regarding future earnings for both companies, or 2) Carlsberg is underrated relative to Heineken.
I think the latter could be correct, as some investors may focus too much on the ability of Heineken to create double digit ROI (while Carlsberg barely seem to be able to beat the cost of equity) instead of cash flow valuations (which I prefer). Hence the long Carlsberg/short Heineken option seems interesting for the long-term investor.