The Latin American brewer industry can be fiercely competitive, and the market is shared among only a few players. While Ambev SA (ADR) (ABEV) dominates the Brazilian beer market, United Breweries Company Inc. ADR (CCU) is Chile’s largest brewer (with about 80% of the market’s share) and No. 2 in the Argentine market, behind Quilmes, which owns 75% of that market. With investment gurus Jim Simons (Trades, Portfolio) and Manning & Napier Advisors buying the company’s shares this past quarter, I believe this company’s business model is worth a deeper look.
Running the Market
As the only brewer in Chile with a nationwide distribution network, United Breweries benefits from significant economies of scale, in addition to its brand power. The company’s product portfolio not only features the Cristal beer brand, but also includes wine, spirits and company-owned non-alcoholic beverages. In addition to this, the firm benefits from licenses to sell PepsiCo Inc. (PEP) and Heineken beverages, while also importing Anheuser Busch Inbev SA (ADR) (BUD)’s Budweiser beer to Chile and Argentina. This strong market position has allowed the firm to generate excess returns on invested capital above 20%, making it an attractive investment.
Furthermore, United Breweries’ business model is focused on market expansion, and in 2013 the company raised 15% of its market capital (CLP 340 billion) in order to fun acquisitions in Paraguay and Argentina. This latter country has been particularly endorsing the firm’s growth, boosting 2006’s 16% market share to 23% in 2012. This raise is probably due to the CLP 27 billion that the brewer spent on capital expenditures in Argentina. Looking forward, the company is set on expanding its core businesses by targeting the non-alcoholic Argentine market, the Chilean snack and dairy industry, as well as expanding into nearby markets of Peru, Uruguay, Colombia or Ecuador. And although the risk of an overpayment for acquisitions remains, I believe the company’s cost advantage in serving the Southern region of Chile will allow for margins to stay intact.
Valuation and Risks
Nevertheless, United Breweries’ market dominance in Chile ties the firm to that country’s economic health and market competition, making financial results vulnerable to increases in commodity costs and inflation, which could erode consumers' purchasing power. Moreover, if the Chilean peso weakens, gross margins could suffer, as most of the company’s raw production materials are imported. Another headwind could consist in the company losing its Budweiser distribution rights in Chile and Argentina, as the current contracts are set to expire in 2015 and 2025.
However, the brewer’s balance sheet remains positive for fiscal 2014, showing returns on equity of 18.70% and returns on assets above 8%. Also, the five-year projection shows annual top line growth of 8%, due to the strong non-alcoholic beverage segments, as well as the Argentine and Uruguayan businesses.
While sales are expected to close at CLP 1.3 trillion for fiscal 2014, revenue will continue its 11.40% compound annual growth rate, resulting in solid shareholder returns via an average 2.0% dividend yield. With above-average operating margin (16.4%) and net margin growth (10.60%), I believe this firm will remain solid in the long term. However, the company’s stock trading price of 44.0x trailing earnings is sporting a whopping 125% price premium relative to this industry average of 19.50x, leading me to think that United Breweries may be somewhat overvalued. Therefore, I recommend investors to wait until the price drops a little before buying this company’s shares.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.