The Bullish Case for Heineken

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Includes: BUD, HEINY, SBMRY, TAP
by: George Fisher

Founded in 1864, Heineken (HINKY.PK) is the third largest brewer in the world by volume and has built a very diverse global business. The company is headquartered in the Netherlands. It is estimated that HINKY has about 10% of the world market for beer, behind InBev (NYSE:BUD) and SAB-Miller (OTCPK:SBMRY). Heineken is the largest brewer in Western Europe and is the second largest importer of beer into the U.S. The Heineken brand is the top selling premium beer in the world. While investors attention seems to have been focused on its major competitors, Heineken has been building a nicely positioned global business through acquisitions.

HINKY brews its flagship brand, Heineken, along with Amstel, Dos Equis, Tecate, Kingfisher,Lagorda, and about 200 other local brands. Heineken has a presence in 170 countries.

Although the markets of Europe and North America are considered mature and will generate low single digit growth, HINKY has become well positioned in developing markets. Global growth in volume will be driven by increased consumption in emerging markets. These markets currently generate about 40% of EBIT, with no one country representing more than 13%.

The company says it best, from their website:

The worldwide beer consumption is expected to grow by 2%-3 % annually. Underlying growth forecasts for the different regions vary substantially. In the developed markets (Western Europe, the United States, Australia and Japan), the overall growth rate is forecast to be close to zero. Growth in these markets will be mainly realized in the premium/import and specialty segments, which will grow annually by approximately 4%, at the expense of mainstream beers. Within the premium segment the international premium segment is expected to grow over 6% annually.

In the developing regions; Central Eastern Europe, Latin America, Asia and Africa, beer consumption is growing at the solid rate of 3-4%. Increased beer consumption is driven by a growing population, an increase in personal income and the shift from the consumption of traditional (hard) liquors towards beer. Mainstream beers are showing the strongest growth here, while segments like the higher priced premium and specialty brands offer potential in the long-term.

Within the global beer market, consolidation is accelerating and the beer industry is moving towards an end-game situation.

Heineken has been in the acquisition mode for the past few years. Large competitors have been merging to form much larger competitors, like InBev and Bud, Molson Coors (NYSE:TAP) and SAB Miller. But HINKY has been picking up smaller brewers, either filling in existing markets with other brands or expanding into new markets with a focus on growth.

For example, in 2008, management bought most of the assets of Scottish & Newcastle, a European brewer with market share in the West. Late last year, HINKY bought a 37% stake in United Brewers Ltd in India, developing a strong joint venture position. UBL is estimated to have a 48% market share in India. HINKY just completed the acquisition of FEMSA Cerveza with strengths in Mexico, Brazil and the U.S., for $7.6 billion in stock. A large part of the future growth for HINKY will be from these new markets.

Valuation

As a Dutch company, Heineken trades on the Amsterdam exchange with the symbol HEIA.AS and is listed in the US as an ADR with the symbol HINKY.PK. Each ADR equals 0.5 shares of HEIAS.AS. As a Dutch firm, HINKY uses the Euro as its reporting currency and the current Euro to US $ exchange rate is 1 Euro = 1.29 USD. The balance of this discussion will be in USD using this exchange rate, and per share data will be based on the ADR calculations.

Heineken is a large cap stock with market capitalization of about $23 billion, has 547 million shares outstanding, carries long debt of $9.9 bil and had $440 million in cash as of 12/09. Look for the company to aggressively pay down upwards of 40% of its debt over the next few years, funded by annual EBIT in excess of $3 billion.

Heineken is separated into six operating groups by geographical area: Western Europe, Eastern Europe, Americas (North & South), Africa / Middle East, Asia Pacific, and FESMA. Revenue growth over the next few years will come from Eastern Europe, Africa and the Middle East, along with Mexico and Brazil. EBIT growth will a factor of higher productivity, lower input costs, better market share, and organic growth in premium beer consumption.

Revenue outlook

Below is a list of estimated annual Revenue and EBIT growth rates over the next four years by operating group:

Region

Rev Growth

EBIT Growth

Western Europe

-0.6%

5.7%

Eastern Europe

8.1%

9.3%

Americas

2.8%

7.0%

Africa/Middle East

8.8%

8.2%

Asia Pacific

2.0%

3.6%

FEMSA

20.4%

31.3%


2009 revenues totaled $18.9 billion, with ADR EPS of $1.45. There are several major brokerage firms in Europe that follow Heineken. Out of the six most recent analyst reports, four liked HINKY, and two were neutral. Their consensuses estimates for revenues this year and next are $21.3 billion and $23.3 bil, respectively. Much of this year’s revenue growth reflects the acquisition of FEMSA.

Consensus ADR EPS is estimated at $1.57 this year and $1.84 next. HINKY has a realistic potential to earn over $2.50 within the next few years. Gradual margin improvement from 13.5% in 2008 to 16.2% in 2012 will be critical to achieving an overall 5-year ADR EPS consensus annual growth rate of 13%.

Heineken pays a semi-annual dividend and distributions in 2009 were $0.41 per ADR. Dividends are expected to increase to $0.46 this year and could continue to grow by 13% a year. Current dividend yield is 1.8%, and the company tries to maintain a 30% payout ratio.

First quarter 2010 global beer volumes were down by -5.3%, and were within expectations. The premium beer market tends to suffer a bit more during recessionary times as down-pricing becomes a larger factor. For example, reported volume from Russia was especially hard hit due to down-pricing. As disposable income improves along with global economies, so does the growth of premium beer.

Investors looking for an international consumer sector company should review HINKY. Steady growth in a premium market, historically adequate dividend payout ratios, and a corporate focus on cost-containment and emerging markets are factors that should continue to reward long-term shareholders. Heineken has a historic 5-year average PE ratio of 16.5, a slight premium to its estimated long-term EPS growth rate. Based on ADR earnings potential of $2.00 within the next three years, HINKY should trade up to between $28 and $32.

Greek crisis update

This article was going along so well – then – bam, along comes the Greek debt crisis and a steep decline of the Euro exchange rate to 14-month lows. As the Euro loses value against the USD, so does the value of HINKY shares. Likewise, a strengthening of the Euro leads to higher HINKY share prices.

ADR shares have retreated from $26 in March, and just crossed its 200-day ma. Investors hate uncertainty, and there is lots of that in Europe these days. Further stock weakness could be expected as the sovereign debt problems in Europe unfolds and drags on; and a $20 share price could turn out to be worth the wait. Nibbling here with an eye on adding if there is further weakness could be considered.

Investing in Europe with the current sovereign debt uncertainty adds to the short-term risks. Volatile currency markets can impact reported profitability. HINKY, however, is a conservatively managed company that should hold up well. Heck, we all may need a Heineken when this is all resolved.

Heineken offers an excellent investor section on its website. Specifically, review the “Industry Landscape” and March 2010 Presentation sections.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: Long HINKY.PK and have been a shareholder since 2006

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