Higher Profitability In South America And Asia-Pacific To Boost AB InBev’s Q3 Results
The world’s largest brewer Anheuser-Busch InBev (NYSE:BUD) is scheduled to report its third quarter results on October 31. Last quarter saw AB InBev’s volumes rise 1% on the back of strong FIFA World Cup activation worldwide. Although the impact of the large media and marketing investments centered on the World Cup held in the second quarter should also slightly overflow to the third quarter and boost net volumes, anticipated fall in volumes in some of the developed markets could stall organic growth. However, aside from organic growth, the company will depend on incremental volumes from newly acquired businesses to fuel year-over-growth this quarter. In addition, AB InBev has a history of deriving cost synergies and improving profitability, and we expect higher profits in South America and Asia Pacific this quarter to lift overall margins. The brewer already boasts high industry-leading operating margins, with the figure at 46.7% through the last four quarters. In contrast, rivals Molson Coors and Heineken posted margins of 16.6% and 8.3% respectively during this period. [1]
What Could Be The Impact Of Grupo Modelo And Oriental Brewery?
Anheuser-Busch InBev has gone through a series of mergers and acquisitions in its history, deriving strong inorganic growth by expanding into newer markets and strengthening operations in existing business units. Q3 results will be crucial in highlighting growth in the Mexico business, more than a year after the acquisition of Grupo Modelo in June 2013, and the impact of the Oriental Brewery takeover in April this year, on Asia-Pacific profits.
- Grupo Modelo:
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Latin America is the most profitable business unit for the brewer, with adjusted EBITDA margins of around 52% last year, compared to 40% for the overall company, by our estimates. This is mainly because 40% of Anheuser-Busch InBev’s beer production capacity is concentrated in this region, allowing the brewer to enjoy low labor and raw material costs as well as economies of scale in the region. As Latin America is also a high volume market for the company, producing beer near the end market also reduces additional costs of transportation and distribution. Q2 2013 was the last quarter before Anheuser completed the acquisition of Grupo Modelo, and by cutting duplicate expenses such as administrative, and sales and marketing costs, the latter’s Mexico business’ margins expanded by a massive 1074 basis points year-over-year in this year’s Q2.
According to us, cost reductions in Mexico could drive margin expansion again this quarter. Anheuser remains committed to its aim of delivering cost synergies of at least $1 billion by the end of 2016, with the majority of that by the end of next year. The total cost savings relating to Grupo Modelo till Q2 stood at $750 million. If Mexico margins rise to around 52% in a couple of years, similar to the margins reported by the rest of Latin America, there could be a 3% upside to our valuation for AB InBev.
- Oriental Brewery:
This quarter is the second full quarter for Oriental Brewery under Anheuser-Busch InBev’s ownership, and not only is the South Korean brewery expected to add incremental volumes over the previous year’s third quarter, but also improve profitability for the group. Together with Siping Ginsber in China, additional volumes from Oriental Brewery increased Anheuser’s Asia Pacific volumes by almost 30% in the last quarter. As demand for beer in South Korea is expected to remain strong due to increasing disposable incomes, the country’s beer market is estimated to grow at a CAGR of 3% through 2017. This could further boost volumes for Oriental Brewery, which holds over half the net market volumes with beer brands such as Cass.
But what we would like to highlight is the possible growth in profits this quarter from Asia-Pacific, due to the inclusion of Oriental Brewery. South Korea forms only 1% of the Asia-Pacific population but over 5% of the beer industry’s profits in this region, owing to higher sales of premium beer, which tend to carry heftier margins. Due to a favorable product mix and strong volume growth, Anheuser’s EBITDA in South Korea rose 20% in Q2 and could rise again this quarter.
We have a $113 price estimate for Anheuser-Busch InBev, which is roughly 3% above the current market price.
See Our Complete Analysis For Anheuser-Busch InBev
Russia Could Drag-down AB InBev’s Top Line In Q3
Europe is another important market for Anheuser-Busch InBev, constituting 12% of the net revenues last year. Russia is the largest market for Anheuser-Busch InBev in the European zone, constituting over 24% of the volumes for this division and around 3% of Anheuser’s net volumes. Due to geopolitical tensions in the country invoking negative consumer sentiment, spending in general and on beer could decline. In addition, although markets such as U.K., Germany and Belgium are slowly recovering after the double dip recession, seeing how per capita consumption is already relatively high in Europe, growth in these markets for Anheuser could be limited this quarter. Europe forms less than 6% of Anheuser’s valuation by our estimates and we estimate sluggish beer performance in the continent going forward.
After declining 8% in 2013, beer volumes in Russia are expected to fall by a mid-single-digit percent in 2014, according to Carlsberg, a leading brewery. Russia volumes for Anheuser fell 10% in the first half of 2014, after declining 14% last year. Ukraine is also a top ten market for Anheuser and is expected to witness a considerable volume declines in the second half of the year owing to the geopolitical tensions, following a 27% year-over-year volume decline in Q2. With almost one-third of Anheuser’s Europe volumes vulnerable to political impacts, we forecast the brewer’s volumes to remain slightly negative through the end of the decade.
As consumers ditch beer for other alcoholic beverages such as spirits, ciders and wine, and with a gradual shift away from a massive beer-drinking culture in the developed markets, due to growing health and wealth concerns, Anheuser’s beer volume growth in North America and Europe might be limited in Q3. But volumes in the emerging markets of South America and Asia-Pacific could more than offset this decline this quarter. Moreover, higher proportionate sales from these regions should lift the net profitability for AB InBev due to the broader margins in these low-cost high volume operating units.
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