August 15, 2014
- Ambev Inc. (NYSE: ABEV)
- $7.00 recent ADS price
- 15.663 billion shares
- $109.6 billion market cap
Background. Ambev was formed in late 1999/early 2000 with the merger of Brazilian brewers Brahma and Antarctica, both of which were formed in the late 1800s. The merger gave Ambev over 70% share of the Brazilian beer market and 20% of the CSD market. Since then, through a series of mergers Ambev has expanded into Argentina, Bolivia and Canada, as well as various other Latin American countries. Through a complicated transaction between Interbrew, Labatt and Ambev, the current Anheuser Busch Inbev (ABI/BUD) became majority owner of Ambev. At present, ABI and FAHZ own 71.5% of outstanding Ambev shares.
Markets. In 2013, Ambev generated R$34.8 billion of sales on volume of 165.2 million hectoliters. Its market segments in 2013 were as follows:
- Brazil: R$22 billion sales and 113 million hectoliters
- Ambev estimates it had 67.9% share of the 122 million hectoliter Brazilian beer market and 18.4% of the CSD market in 2013
- Other LATAM: R$8.5 billion sales and 42.9 million hectoliters
- Argentina – 17 million hectoliter market, of which Ambev had 78.5% share in 2013
- Other LATAM markets – Central America, The Dominican Republic, Bolivia, Chile, Paraguay, Uruguay, Ecuador and Peru
- Canada:R$4.3 billion and 9.1 million hectoliters
- Ambev’s Labatt brand had 40.1% share of the 22.1 million hectoliter Canadian beer market in 2013
Business Strategy. Ambev’s management culture is heavily influenced by Jorge Paulo Lemann’s management philosophy instituted at Ambev-majority-owner Anheuser Busch Inbev. It is an owner/operator culture with maniacal focus on controlling costs. For instance, each division manager is required to submit a zero-based budget on an annual basis in order to avoid budget creep – Ambev’s industry-leading operating margins speak for themselves. Ambev’s stated business strategy is as follows:
- People & Culture
- Top Line Growth
- Building Strong Brands
- Excellence in Route to Market
- Permanent Cost Efficiency
- Financial Discipline
Moat. With brands dating back to the 1880’s, nearly 70% market share and almost one million point of sale, Ambev’s market position in Brazil is virtually impossible to profitability overtake. With Brazil still considered to be an “emerging” market, Ambev has a wonderful economic growth tailwind at its back, in addition to its strong pricing power and ability to innovate.
Balance Sheet. In 2013, Ambev employed an average of R$33 billion of net operating assets, 100% funded by net equity (that is, equity less net cash). While it appears Ambev is overcapitalized, this likely has to do with how ABI/BUD views the Ambev asset vis-à-vis its own debt profile, which currently stands between 2 and 3 turns of EBITDA. Regardless, the combined enterprise could lever up to ultimately takeout the Ambev equity stub…
Income Statement. Clean of non-recurring Other Operating Income (OOI), messy net interest expense and an unsustainably low tax rate, I estimate Ambev generated nearly $4 billion of net profit in 2013, for a 25.9% net profit margin. OOI stems from government grants tied to capital expenditures – clearly unsustainable in the event capex slips to D&A or below. Net interest expense is heavily influenced by interest rate hedges, and since Ambev is in a strong net cash position, I believe it is reasonable to eliminate this line item all together. Ambev’s low effective tax rate – less than 18% versus a 34% statutory rate – stems from “interest paid on shareholder equity” and goodwill amortization. Interest on shareholder equity is deductible for corporate tax purposes, but taxable at the shareholder level via a 25% withholding tax, and goodwill amortization is obviously not available in perpetuity. So while potentially overly conservative, I simply tax all Ambev profits at the 34% average Brazilian tax rate.
5-Year Valuation. In my 5-year valuation model, I assume Ambev grows its top line at 8% per annum and maintains a net profit margin of 25.9%. For reference, the “Street” consensus is for 8.1% top line growth through 2018 – clearly I have nothing new to add to that. I assume full-taxed net profits average 25.9% of net sales for the entire projected period.
For payout ratio purposes, I assume 3% of Ambev’s annual growth rate comes from pricing power that does not require reinvested earnings. As such, I estimate Ambev must retain over 15% of annual earnings, at a 35% ROE, in order to generate 5% growth – on top of this 5%, call it “growth from investment”, I assume Ambev can grow an additional 3% per annum via pricing.
Terminally, I assume a 6% growth rate, 10% cost of equity, 35% ROE and 3% pricing power, all of which adds up to a terminal PE of 25 times. Using an 8% intermediate-term discount rate gets me to an estimated fair value of $7.58 per share and a 5-year IRR of 9.8% from a recent $7 share price.
Takeout Valuation. I believe it is a reasonable assumption that ABI eventually takes over the Ambev equity stub, and if that were to happen within the next 3 years, then the FVPS rises to $8.61 with a 3-year IRR of 15.9%.
BUY UP TO PRICE. At $6.25, the take-out valuation would generate a 3-year IRR of 20%, a level at which I would be extremely interested.