AB InBev Is a Quality Franchise, but Margins and Deleveraging Central To Investment Case

Director

Philip Gorham

Anheuser-Busch InBev, or AB InBev, has been acquisitive, having made transformative deals for Interbrew and Anheuser-Busch, and more recently acquiring Grupo Modelo, Oriental Brewery, and SABMiller. Management's strategy is to buy brands with a promising growth platform, expand distribution, and ruthlessly squeeze costs from the business. 

Previous acquisitions have created a monster with vast global scale as well as regional density. AB InBev has one of the strongest cost advantages in our consumer defensive coverage and is among the most efficient operators. Vast global scale, along with its monopolylike positions in Latin America and Africa give AB InBev significant fixed cost leverage and procurement pricing power. This plays out in the firm's excess returns on invested capital and best-in-class operating and cash cycles, asset turnover ratios, and working capital management. AB InBev delays payments to trade creditors more than 20% longer than its closest rival Heineken, and its free cash flow conversion has been consistently higher than peers in recent years.

Central to the investment case are the deleveraging of the balance sheet and rebuilding of margins in Latin America. On deleveraging, some progress has been made. Net debt/EBITDA peaked (excluding the coronavirus disruption) at 5 times in 2017, the year after the SABMiller acquisition, but despite road bumps in EBITDA growth since then, was reduced to 3.6 times in 2022. Nevertheless, leverage of this magnitude still increases financial risk and earnings volatility, and we think expansion will be subdued until leverage is reduced to a more manageable level.

On the margin rebuild, we expect a reversion to mean in commodity costs and the U.S. dollar against other major currencies would go a long way to improving profitability. Mix and operating leverage should also drive margins. In Latin America and in Asia, combined almost two thirds of consolidated EBIT, the consumer is trading up to premium global brands, and ABI holds a strong portfolio with Budweiser, Corona, and Stella Artois, all strong brands in the premium segment.

Business Strategy & Outlook

Anheuser-Busch InBev has a wide economic moat, in our opinion, benefiting from both a cost advantage and intangible assets in its strongest markets.

Cost Advantage

In markets where it exists, AB InBev’s cost advantage is very powerful and helps to maintain its high market shares. Beer is a scalable business, with scale advantages coming in the procurement of raw materials, packaging, distribution, advertising and fixed cost leverage. AB InBev has by far the greatest global scale in the brewing industry. In 2022, it sold reported volumes of 595 million hectoliters, more than double that of the second-largest global brewer, Heineken. This scale means that AB InBev procures around 8% of the annual U.S. rice crop, according to Rice Almanac. The company makes three global beer brands: Budweiser, Corona, and Stella Artois.

Global scale can contribute to brewing economies of scale, but its impact is perhaps surprisingly limited. Our analysis of cost of goods sold per hectoliter of beverages manufactured for the brewers under our coverage shows that while there is a relationship between consolidated volume and cost of goods sold per hectoliter, the correlation is not statistically significant. There are several factors that distort this metric that weaken the comparability of the data, including the complex network of licensing and contract brewing arrangements in global brewing, product mix and the variation in the raw materials and brewing processes across products, and foreign exchange. Nevertheless, we believe the provincial nature of most beer brands restricts the leverageability of global scale in the brewing industry.

Regional scale, on the other hand, is a much more powerful driver of cost advantages. While there are some global beer brands (in AB InBev’s case, those brands are Budweiser, Stella Artois and Corona) that benefit from global procurement and marketing, the majority of the industry is composed of brands with fairly limited geographic reach. Consequently, brands, marketing, packaging and distribution can vary regionally, and cost advantages are gained by local concentration. This is borne out in our analysis of average cost of production when volumes are adjusted for capacity utilization. A regression of cost of goods sold per hectoliter of beverage manufactured against volume per brewery for the nine brewers under our global coverage generates a statistically significant relationship at the 95% confidence level, and a coefficient of determination of 0.9 when outlier Boston Beer is excluded. Boston Beer’s traditional brewing process and more expensive raw materials contribute to its significantly higher average cost structure, and distort the analysis, in our view.

In addition to its global scale, AB InBev operates in several markets in which it possesses high market share and local scale. Through its 62% ownership of Ambev, the company is dominant in Latin America, where it holds dominant leadership positions in very concentrated markets. For example, according to GlobalData, AB InBev held beer volume shares of 75% in Colombia and Ecuador, 73% in Bolivia, 68% in Uruguay, and 65% in El Salvador and Peru. We estimate the company commands more than half of the market in more than half of the countries in Central and South America.

In Africa, AB InBev is less ubiquitous across the continent, but in its core markets it tends to dominate. Mainly through the SABMiller acquisition, the company holds a volume share of more than 50% in 7 markets (excluding its equity stake in Castel), including shares of 65% in Mozambique, 65% in South Africa and Lesotho, 60% in Botswana, and a high 50% share in Swaziland, Tanzania and Zimbabwe. 

Regional dominance to this degree creates a critical cost advantage that will remain both robust and relevant for many years. In previous research, we identified three phases that alcoholic beverage markets evolve through: the entry phase, the growth phase, and the aspirational phase. Africa clearly exhibits the characteristics of an entry phase market, with low but fast-growing per capita alcohol consumption, high levels of unrecorded consumption, rapid urbanization, and fairly low price and income elasticity. A key driver of demand growth is the emerging consumer that move from the shadow economy into the recorded economy, purchasing branded consumer products in small pack sizes and at low price points. An average cost of production structurally lower than competitors is, therefore, a critical economic moat source in markets in which price is the key area of competitive friction. AB InBev markets some economy brands such as Impala, that retails at around $0.75 per bottle and straddles the mainstream and home-brew segments. Impala is brewed using cassava, a low-cost locally grown plant, but the scale and scope efficiencies from AB InBev’s near dominance in the market is a significant contributor to its ability to offer product at such a low price point.

Although AB InBev does not break out its cost structure in Africa, SABMiller reported in its final annual report in 2016 that Africa was its second most profitable market with a 25% EBITA margin, well ahead of most of the rest of the business. This also included significant volumes of non-beer volumes, which we believe to be lower margin than the core beer brands. Notably, its most profitable market was Latin America, where it also possessed monopolylike shares in certain markets.

De-emphasizing but Retaining Intangible Asset Moat Source

We believe AB InBev benefits from several intangible asset competitive advantages in many of its markets, but that these benefits are less potent than cost advantages in creating barriers to entry.

In markets in which it holds a commanding volume share, AB InBev has relationships with its customers in both the on trade and off trade that allow it to react quickly to negative competitive events. Its leadership positions ensure it has influence over distributors and gives the company unique access to consumer data that it can leverage to adapt to changing consumer tastes and preferences. This has been evident in Latin America, where AB InBev has moved quickly into the craft segment.

For all the brand recognition of Budweiser and its association with Americana, we think brand equity is actually quite limited as a competitive advantage for AB InBev. Lager is a fairly fungible product, and although brands in mainstream light lager have somewhat different tastes, we believe the primary area of competition (between Bud Light and Miller Lite, for example) is price and that the mainstream consumer is fairly price sensitive. Nevertheless, the ability to launch new products in adjacent categories under the company’s large brand umbrellas can lower customer acquisition costs and is an indication of brand equity. For example, AB InBev’s alcohol-free beer brands include Budweiser Prohibition ad Beck’s Blue in the U.K.. 

Brand power is arguably much stronger in the “entry phase” markets, where the consumer’s search costs and risk aversion are arguably highest. Product positioning is particularly important in premiumising markets because beer is often consumed in a social environment, particularly in the on-premise channel, so brand choice is fairly conspicuous. Most of AB InBev’s emerging markets are premiumising, including most of Latin America, Africa and China, with the consumer moving up the price ladder within the beer category.

Wide

Economic Moat

Anheuser-Busch InBev

O'Doul's is a ubiquitous non-alcoholic beer.

O'Doul's

Corona is a pale lager that is one of the top-seling beers worldwide.

Corona

Beck's is one of the largest breweries in Germany.

Beck's

Budweiser is an American-style pale lager produced by Anheuser-Busch available in over 80 markets worldwide.

Budweiser

Stella Atrois

Michelob is a pale lager with a key focus on producing diet beers.

Michelob

Goose Island a brewery in Chicago, Illinois, that began as a single brewpub opened in 1988. It now offers a variety of premium beers throughout the U.S. and in other markets.

Goose Island

Modelo is a brand of Grupo Modelo which is a large brewery in Mexico that exports beer to most countries of the world. Its export brands include Corona, Modelo, and Pacífico.

Modelo

Busch an economy brand pale lager. At a slightly lower price point than flagship brand Budweiser, it serves as Anheuser-Busch's second most popular brand.

Busch

Anheuser-Busch InBev SA/NV operates as a holding company, which engages in the manufacture and distribution of alcoholic and non-alcoholic beverages. It operates through the following geographical segments: North America, Middle Americas, South America, EMEA, Asia Pacific, and Global Export and Holding Companies. The company was founded on August 2, 1977 and is headquartered in Leuven, Belgium.

Earnings data Q2 2023

Shares of Anheuser-Busch InBev SA BUD slumped 2.2% in morning trading Wednesday, and was headed toward the lowest close since Nov. 9, 2022, as they continued to feel the weight of declining Bud Light sales amid the consumer backlash from the beer brand's partnership with a trans influencer. The stock has tumbled 18.0% in May, which puts it on track for the worst monthly performance since it tumbled a record 24.4% in March 2020.

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