Heineken - Premium Valuation For A Premium Brand

| About: HEICO Corporation (HEI.A)


Heineken divests its Mexican packaging business to reduce its debt and focus on core assets.

The deal is fine, as shares have already risen a lot this year following relatively solid results.

I am cautious on the back of the premium valuation, the relatively high leverage and multi-year shares momentum.

Investors in beer brewer Heineken (HEI.A) hardly reacted to the announced sale of its Mexican packaging business.

The modest deal followed solid momentum so far this year on the back of the good weather and the World Cup, driving shares of Heineken to fresh multi-year highs.

Despite the disposal of non-core assets, I am very cautious on the prospects for a potential investment at this point in time. The valuation includes too much of a premium in my eyes based on the historical valuation and the relatively high leverage. This is despite the long-term track record of growth, expected consolidation and strong emerging assets.

I remain cautious, avoiding an investment at this point in time.

Highlights Of The Deal

On the first day of September, Heineken announced that it has reached a deal with Crown Holdings to sell its Mexican packaging business called EMPAQUE in a $1.22 billion deal.

The company is selling the business, which it acquired as part of the 2010 deal to buy FEMSA Cerveza, in order to focus on its core operations and reduce the debt load.

The business generated sales of $660 million over the past year, while generating EBITDA of $130 million in the meantime. Note that the vast majority of these sales have actually been achieved on a intra-company basis. The business will continue to operate in close relationship with Heineken's Mexican business with long-term contract between both businesses being put in place.

The deal should allow Heineken to deliver on its promise to reduce the net debt load to less than 2.5 times EBITDA as targeted by the firm.

A Strong First Half In 2014

Less than two weeks ago, Heineken posted a relatively strong set of first half year results, driven by the good weather among others.

The company posted a 1.4% fall in sales to EUR 10.2 billion with the fall being attributable to adverse currency movements, among others. Reported organic growth of 4.6% was relatively solid. One thing to take notice off, on a consolidated basis revenues came in at EUR 9.3 billion.

The business posted earnings of EUR 772 million before exceptional items which was up by 19% compared to the year before, while GAAP earnings totaled EUR 631 million. Given the performance so far this year and the outlook for the entire year, Heineken is on track to report annual revenues of about EUR 19 billion, as earnings could come in around EUR 1.3 billion on a GAAP basis. Of course, the divestment could shave off a few percentage points in reported sales and earnings going forwards.

The company runs a net debt position of about EUR 10.9 billion despite having over EUR 800 million in cash. The net debt position is already at 2.5 times trailing EBITDA, and will fall below the ten billion mark following the announced deal.

Premium Beer, Premium Valuation

With leverage being in check following the divestment, what is the business really worth?

Heineken currently has some 575 million shares outstanding which trade at around EUR 58 per share, thereby valuing the business at about EUR 33 billion. Shares had a healthy run this year, trading up nearly 20% so far amidst the good weather across major parts of the globe and hopes about further global consolidation of the beer market.

The valuation for the equity implies a valuation at roughly 1.7 times annual sales and 25 times GAAP earnings, quite a premium valuation for a premium beer brand. While rumors about consolidation and owning premium assets in growth areas like Africa, Central and Eastern Europe and Asia can justify a premium valuation to some degree, the risk-reward might not be that appealing.

Final Implications

Despite owning a rock solid global brand, having promising emerging market assets and having acquired several non-core beer assets, Heineken's stock price track record has been mixed over the long run.

For years and even decades, the brewer has posted a solid growth in terms of its sales and earnings, although the performance in 2014 will be flattish compared to last year despite the World Cup event taking place this year in Brazil. Organic growth has been complemented with acquisitions like the 2012 acquisition of Asian Pacific Breweries and FEMSA in the Americas.

Yet investors have been on quite a rollercoaster ride despite the steady growth of its operations. Back in the 2000s shares traded at a peak of $60-70 to fall to just $25 in 2004. Shares doubled ahead of the financial recession to fall to lows of $20 again in the aftermath recession years after which shares have tripled again to levels approaching $60 at the moment.

In that light and given the high valuation and limited opportunities to incur leverage or make deals without diluting the shareholder base, I would be very cautious at this point in time. This is despite rumors about consolidation, which might be complicated due to the family still holding a majority stake in the business, and the promising assets.

As such, I remain cautious and won't jump this year momentum bandwagon.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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