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Why Beer Could Be the Answer Many Were Looking For
Posted by: Patricio Kehoe (IP Logged)
Date: November 6, 2013 04:36PM

The beer brewing industry is getting tougher in developed nations as regulations and heavy taxation take their toll on profitability. Hence, firms such as Heineken (HEINY) and Anheuser-Busch InBev (BUD) look increasingly to emerging nations, in an attempt to increase their margins. However, these companies have different trajectories and strategies, which will set them apart in the coming years.

Expansion into Emerging Markets

Heineken not only has a global presence, but is also the largest beer brewer in Western Europe. However, this region is not as profitable as it once used to be. Currently, European sales contribute only 45% to operating profits, although 60% of the firm’s total revenue is derived from the old continent. Hence, the company is looking to expand its international operations in an attempt to drive revenue forward.

Heineken’s strong brand recognition and economies of scale allow the firm to generate high returns on invested capital. Yet its primary rival, Anheuser-Busch InBev, still outperforms Heineken in terms of superior scale and cost advantages in most markets. In order to obtain a larger market share from its rival, ambitious actions were undertaken that have led to an increasing scale. Especially useful was the incursion into emerging markets, such as with the acquisition of FEMSA Cerveza back in 2010, and the purchase of Asia Pacific Breweries.

Adding brands such as Dos Equis, Tecate and Sol beer to its portfolio, Heineken was able to increase production, and obtain 26% of its operating profit from the Americas. Since the brewery derives most of its revenue from Europe, increasing its presence in emerging countries, can counteract the pressure imposed by economic austerity on the old continent. Also, Europe offers smaller margins than other regions, in addition to presenting a far more fragmented beer market than in Asia or the Americas.

Despite this expansion strategy, Heineken has to face certain facts. It is not as profitable as Anheuser-Busch InBev, and its core market is facing economic troubles. In the UK, for example, the recession has led to pub closures and a steady drop in beer consumption. Another fact which has me doubting the firm’s future outlook is Tweedy Browne’s recent sale of his entire stock holdings. Nevertheless, the firm is trading at 9.9 times its trailing earnings, compared to an industry average of 19.9. This means shares are currently available at an important price discount, for those willing to take the risk of investing in the company. Nevertheless, I would not be too confident about Heineken’s ability to outperform rivals.

Huge Scale and Premium Brands

Anheuser-Busch InBev is the largest player in the beer brewing industry, with a market cap of over $39 billion, and retail sales of over $1 billion. The firm boasts an important portfolio, which includes seven of the world’s top 10 selling beers, and distributes 17 different brands worldwide. The company was formed in 2008, following the merger between the Belgian InBev and the U.S.-based Anheuser-Busch.

With a massive scale and an incredible management team, which is highly dedicated to cost-cutting initiatives, Anheuser-Busch InBev has grown at a tremendous pace. Recently, the company purchased the remaining shares of Modelo, which is another step in the direction of expanding its business operations in Mexico. The high profit this region has to offer will definitely benefit Anheuser-Busch InBev in coming years, along with its leadership position in Argentina, Brazil, Canada, and the U.S.

By globally spreading out its operations, the firm will not only continue to profit from lower fixed costs, but can shorten the distance each unit has to travel until it reaches customers. Improving its scale is thus Anheuser-Busch InBev’s primary concern, since it represents its largest competitive advantage over rival breweries.

In addition to improvements in scale, the company has put in place a strategy that intends to benefit from an increased focus on premium brands. The idea is to drive profitability and capture new sales by targeting a fresh customer base. In emerging nations such as Brazil and Argentina, Anheuser-Busch InBev’s top beer brands already hold large market shares of 69 percent, and 77 percent respectively. Hence, it comes as little surprise that investment gurus such as John Burbank, Tom Russo and Lee Ainslie have been increasing their stake in the company as of late. I too feel highly optimistic about Anheuser-Busch InBev’s future, as rival breweries pose no significant risk in terms of competition.

It’s All in the Mix

As both the firms discussed seek to continue expanding their operations and driving profitability, expansion into the emerging markets seems to be the key factor. However, Anheuser-Busch InBev has a competitive advantage that Heineken cannot compete with. The commanding position in key markets, along with a renewed portfolio of premium brands, and a huge scale, are all arguments that make me feel bearish towards the largest beer brewery in the world.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned .

Guru Discussed: John Burbank: Current Portfolio, Stock Picks
Lee Ainslie: Current Portfolio, Stock Picks
Stocks Discussed: BUD, HEINY,
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