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Gan Bei with Bud in China

August 24, 2005 | About:

Gan Bei with Bud in China

By Dr. Sheldon Shi

Before I explain what Gan Bei is, I'd like to talk about Bud, a.k.a Budweiser. Reportedly Warren Buffett bought shares of Anheuser-Busch (BUD), makers of the popular beer brand. There must be something in BUD that is pleasing the sage's eyes and mind. Return On Equity, for example, is a whopping 85%. The return on capital deployed (total asset - current liability) is 19% - the company is tremendously efficient at turning capital into profit. No wonder it is so highly leveraged, with a debt/equity ratio of more than 3. It is a no-brainer: borrowing cash at single digit interests, and churning out profit at 19%. In this case beer is better than cash.

What else is going on at BUD? The company is expanding aggressively internationally, especially in China. If you look at BUD's domestic beer sales, you'd be lucky to see a 1 or 2% rise in volume. Internationally, however, sales by volume grow at double digits, primary from China. So far, the company has invested $1.2B in China. Its investment in China consists of three pieces:
  • A Wuhan subsidiary, which it bought in 1995, churns out 2.7M barrels of beer in 2004, slightly over 1% of the market. Its volume is expected to grow to 3.5M in 2005
  • A 9.9% equity in Tsingtao Brewing Company, one of the largest brewery in China with a 13% market share. BUD's $182M investment in Tsingtao's convertible could eventually be converted into 27% of its equity. At the current level, BUD's market share in China through Tsingtao beer is 1.3%.
  • Harbin Brewery Group, which it bought in 2004 for $694M, is the fourth largest brewery in China, with a 4% market share.
BUD's $1.2B toll to enter Chinese market already gives it collectively a 7% market share. One can only expect the investment to continuously grow, as $1.2B translates into less than a dollar per capita, a drop in the bucket in U.S. standard.

Should investors expect a big payout from BUD's investment in China? After all, this is a market with 1.3B people, an 8% annual economic growth, a rising middle class, absolutely the dreamland of global consumerism. But things are not so rosy as it appears. Underneath the free-flowing of capitals and beers, where is the profit?
  • Its largest Chinese investment, Harbin Brewery Group, had $5.2M income before interests for the six months of 2004. That is about $10M a year. First of all, Anheuser-Busch paid a dear premium to take control of the group, an inevitable result of its bidding war with SAB Miller, the 2nd largest brewery in the world. Harbin Brewery's sales, estimated to be only $200M. Secondly, Harbin Brewery is not terribly efficient at capital utilization. Capital deployed at Harbin Brewery is about $400M, giving it only a low single digit return on capital, compared the parent's company's 19%. Thirdly, Harbin Brewery's income before interests accounts for less than half of 1% of that of its parent company. Even if its capital utilization and/or market share is increased several fold, it will not have a significant impact on Anheuser-Busch's income statement.
  • Tsingtao Brewing Co., whom BUD has a 9.9% stake, had a profit of $34.5M, and a revenue of $930M in 2004. BUD's portion is about $3.4M profit and $93M sales. Consider that BUD paid $182M for the stake that may potentially go up to 27%, it was a decent deal.
  • I can't find out the profit margin at Anheuser-Busch's Wuhan subsidiary. But given a retail price of less than $1/liter for the Budweiser brand in China (as opposed to about $2/liter in U.S.), its sales is estimated to be about $150M a year, 1% of the parent's total sales.
The single digit profit margin of breweries in China is nowhere comparable to that in U.S. The reason for it is fierce competition. There are about 200 breweries in China, even after the recent consolidations. The largest of them only command a nation-wide market share in the teens. The top three have only 30% of the market. Local brands, selling at less than $.25 a litre in retail, generally dominate regional markets. Many of the foreign investors found it very hard to stake a foothold in the fragmented market, and were met with doom. Will Anheuser-Busch be different? It is pretty sure that whoever emerges as the winners of the consolidation war, Anheuser-Busch will have the cash to buy them. But it is probably not going to be cheap. The recent Harbin Brewery Group acquisition was one indication.

To put this in perspective, however, per capita beer consumption in China averages 20 quarts per year, compared with 53 quarts in Japan, 79 quarts in Europe and 89 quarts in the United States. The consumption is expected to grow 6 percent a year for the near future. There is no doubt China is a market with a great potential. Anheuser-Busch as one of the world's largest beer brewery cannot afford to be left out. But China is not a gold mine for Anheuser-Busch, at least not yet. Value investors should concentrated on Anheuser-Busch's existing business to find out its valuation, and expect profits from China's dripping down like a leaky faucet instead of pouring in like a waterfall. There is one thing you can bet on Anheuser-Busch's investment in China - it needs to hear a lot more Gan Bei to bring a sizable profit from China.

(Gan Bei literally means "Dry the cup", a cheer when Chinese drink alcoholic beverages.)

Sheldon Shi, Ph.D., editor of Buffetteer.com, a site for intelligent investors.

Rating: 4.0/5 (5 votes)

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