INDEPENDENT RESEARCH UPDATE AB InBev/Ambev 14th June 2017 The Party Will Begin Food & Beverages Fair Value EUR128 vs. EUR115 (price EUR101.55) BUY
Bloomberg ABI BB In this note, we focus on Ambev/AB InBev's Brazilian operations for Reuters ABI.BR which we expect a very strong rebound in revenue and profitability 12-month High / Low (EUR) 118.8 / 93.8 Market capitalisation (EURm) 171,949 after a disappointing 2016 and first half 2017. The market's longer- Enterprise Value (BG estimates EURm) 301,497 term prospects also remain favourable. This leads us to upgrade our Avg. 6m daily volume ('000 shares) 1,411 earnings forecasts such that we are now 12% ahead of the consensus Free Float 39.3% 3y EPS CAGR 31.2% for 2019 operating profit for Ambev and 10% for AB InBev. We have Gearing (12/16) 119% lifted our FV for the company to EUR128 from EUR115. Dividend yield (12/17e) 2.03%
Brazil to bounce back strongly: As the macro-economic environment is YE December 12/16 12/17e 12/18e 12/19e Revenue (USDm) 45,517 56,913 60,210 63,319 improving, the beer market should return to volume and price growth. EBIT (USDm) 13,276 18,032 20,565 22,843 Furthermore, the locked-in USD (the company hedges its USD costs 1 Basic EPS (USD) 0.71 3.47 4.86 5.99 year in advance) provides high visibility that in the second half, forex will Diluted EPS (USD) 2.77 4.40 5.40 6.25 EV/Sales 7.48x 5.92x 5.56x 5.24x become a tailwind for COGS and we expect a decrease in costs. With EV/EBITDA 20.3x 15.3x 13.6x 12.2x revenue up and costs down, we believe that EBIT margin should EV/EBIT 25.7x 18.7x 16.3x 14.5x rebound strongly from 36.4% in 2016 to 42.0% in 2018. P/E 41.1x 25.8x 21.0x 18.2x ROCE 7.1 6.9 7.8 8.7
Significant volume upside in Brazil: Affordability is still an important 129.0 factor as it takes an average Brazilian 20 minutes to earn a pint of beer. 124.0 As disposable income is set to grow, we expect further growth in beer 119.0 consumption. This should be even more pronounced in the poorer 114.0
109.0 Northern regions. Overall, we estimate that Brazilian beer consumption
104.0 per head could increase to 80 litres from 65 litres in 2016.
99.0
94.0
89.0 Premiumisation to continue: high-end beers are a faster growing and 11/12/15 11/03/16 11/06/16 11/09/16 11/12/16 11/03/17 11/06/17 ANHEUSER-BUSCH INBEV SXX EUROPE 600 more profitable segment already accounting for 12% of Brazilian volumes but could more than double over time. In the more mature markets, high-end beers are 30-40% of the market.
Brazilian beer market moving towards a duopoly: after the acquisition of Kirin Brazil, Heineken will hold a 19% share of the market behind Ambev and could well be interested in the no. 3 player Petropolis (11%) that SABMiller was about to buy before it got itself bid for. Consolidation is good for the pricing environment.
Analyst: Sector Analyst Team: Nikolaas Faes Loïc Morvan 33(0) 6 11 12 44 44 Antoine Parison [email protected] Virginie Roumage Cédric Rossi
r r AB InBev
Income Statement (USDm) 2014 2015 2016 2017e 2018e 2019e Revenues 47,063 43,604 45,517 56,913 60,210 63,319 Change (%) 9.0% -7.3% 4.4% 25.0% 5.8% 5.2% Adjusted EBITDA 18,663 16,921 16,753 22,054 24,714 27,119 EBIT 15,308 13,768 13,276 18,032 20,565 22,843 Change (%) 7.8% -10.1% -3.6% 35.8% 14.0% 11.1% Financial results (1,319) (1,453) (8,564) (6,544) (5,297) (4,769) Pre-Tax profits 13,989 12,315 4,712 11,488 15,268 18,073 Exceptionals (197) 136 (394) (300) (300) 0.0 Tax (2,499) (2,592) (1,613) (2,685) (3,592) (4,338) Profits from associates 9.0 10.0 16.0 0.0 0.0 0.0 Minority interests (2,086) (1,594) (1,528) (1,629) (1,741) (1,869) Net profit 9,216 8,275 1,193 6,874 9,635 11,867 Restated net profit 8,865 8,513 4,853 8,721 10,710 12,387 Change (%) 11.7% -4.0% -43.0% 79.7% 22.8% 15.7% Cash Flow Statement (USDm) Operating cash flows 17,873 16,277 15,871 21,754 24,414 27,119 Change in working capital 815 1,337 173 (3,573) 1,360 1,379 Capex, net (4,172) (4,135) (4,649) (3,687) (4,952) (5,029) Financial investments, net (6,888) (101) (55,428) 17,000 0.0 0.0 Dividends (7,400) (7,966) (8,450) (8,331) (9,807) (11,077) Other (4,876) (6,734) (8,697) (9,229) (8,889) (9,107) Net debt 42,245 42,392 94,158 97,225 95,099 91,813 Free Cash flow 9,557 7,740 2,698 5,264 11,934 14,362 Balance Sheet (USDm) Tangible fixed assets 20,263 18,952 27,522 27,640 28,894 30,099 Intangibles assets 100,681 94,738 181,101 180,649 180,197 179,745 Cash & equivalents 8,877 7,074 28,585 11,585 11,585 11,585 current assets 11,551 12,476 13,407 13,659 13,848 13,930 Company description Other assets 1,178 1,395 5,595 5,595 5,595 5,595 Anheuser-Busch InBev is the largest Total assets 142,550 134,635 256,210 239,128 240,120 240,954 brewer in the world selling 518m hl (a L & ST Debt 51,122 49,466 122,743 108,810 106,684 103,398 27% global market share) of beer and Others liabilities 41,456 43,032 62,126 58,053 58,845 59,552 50.8m hl of other beverages (soft Shareholders' funds 49,972 42,137 71,341 72,264 74,590 78,005 Total Liabilities 142,550 134,635 256,210 239,128 240,120 240,954 drinks, water) in 2016. The company Capital employed 113,052 108,373 150,625 199,175 200,515 199,922 has a balanced portfolio with exposure Financial Ratios to both mature markets (35% of Operating margin 32.53 31.58 29.17 31.68 34.16 36.08 2017e EBIT) and developing markets Tax rate 18.12 20.82 19.10 24.00 24.00 24.00 (65%). Its main area of operations is Net margin 18.84 19.52 10.66 15.32 17.79 19.56 North America (31% of EBIT) and ROE (after tax) 17.74 20.20 6.80 12.07 14.36 15.88 ROCE (after tax) 11.09 10.06 7.13 6.88 7.79 8.68 Latin America (47%). AB InBev’s Gearing 83.48 98.68 119 123 118 110 brand portfolio comprises strong Pay out ratio 49.58 58.05 104 52.50 52.50 52.50 international and local brands Number of shares, diluted 1,665 1,668 1,755 1,982 1,982 1,982 including Budweiser, Bud Light, Stella Data per Share (USD) Artois, Beck’s, Skol and Brahma. EPS 5.54 4.96 0.71 3.47 4.86 5.99 Restated EPS 5.32 5.10 2.77 4.40 5.40 6.25 % change 10.7% -4.1% -45.8% 59.1% 22.8% 15.7% BVPS 31.08 26.22 44.42 37.40 38.61 40.38 Operating cash flows 10.73 9.76 9.04 10.98 12.32 13.68 FCF 5.64 4.63 1.03 4.46 5.33 6.55 Net dividend 2.64 2.96 2.89 2.31 2.84 3.28
Source: Company Data; Bryan, Garnier & Co ests.
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Table of contents
1. Executive Summary ...... 4 Key graphs executive summary ...... 5 2. AB InBev investment case ...... 7 Key charts investment case...... 9 3. AB InBev financial outlook ...... 10 3.1. Strong earnings growth in 2018 and 2019 ...... 10 3.2. Valuation of AB InBev ...... 13 3.2.1. Peer comparison ...... 13 3.2.2. DCF valuation ...... 14 4. Ambev introduction ...... 16 5. The Brazilian beer market ...... 18 5.1. Mid-term drivers of market growth ...... 19 5.1.1. Demographic growth is slowing ...... 19 5.1.2. Increasing beer consumption in the North/North East...... 20 5.1.3. Premiumisation still offers significant opportunities ...... 22 5.1.4. Duopoly in the making ...... 24 5.1.5. Growth in beer consumption driven by affordability...... 26 5.2. Ambev’s initiatives to capture growth potential ...... 27 5.2.1. On-premise retail initiatives ...... 27 5.2.2. A well-structured pricing ladder ...... 29 5.2.3. Returnable bottles to counter price pressure ...... 35 5.2.4. Distribution is key ...... 39 5.2.5. Innovations ...... 39 6. Ambev financial outlook ...... 41 6.1. Brazil back to volume growth by end-2017 ...... 42 6.2. Central America and the Caribbean ...... 44 6.3. Latin America South ...... 45 6.4. Canada ...... 46 6.5. Financials Ambev ...... 47 6.6. Valuation Ambev ...... 50 Price Chart and Rating History ...... 52 7. Bryan Garnier stock rating system ...... 55
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1. Executive Summary In 2016 Brazil delivered poor results for Ambev (61.9% owned by AB InBev): volumes were down 6.5%, price/mix was up a meagre 1.3%, which was below the inflation rate of 6.5% (tax increases could not be recovered) and cash COGS rose 7.9% as the hedged costs were impacted by the severe devaluation of the BRL in the second half of 2015 (cash COGS Q4 16 were up 20%). That resulted in a Brazilian EBIT margin tumbling to 36.4%, down 980bps from the 46.2% posted in 2015. In this note we investigate what happened exactly and conclude that not only will volumes, prices and margins rebound quickly, but also that Brazil's long term attractiveness remains intact and its getting even better as the market consolidates.
As volumes and pricing 1) Brazil margins set to rebound and faster than expected: AB InBev’s Brazilian profits suffered are set to improve and the most in 2016 given that the stronger USD increased the cost of goods sold, while price aggressive costs fall, operating behaviour by Kirin Brazil limited price increases in the market, a tax increase could not be passed on margin should bounce and volumes suffered from the macro-economic environment. However, we believe all that is about back quickly. to change. From H2 2017 onwards the company will benefit from the weaker USD against the BRL which weakness occurred in the second half of 2016 but which only now will come through as the company hedges 12 months in advance. So in H2 2017, the strength of the BRL against the USD will lower the COGS at the same time as we expect strong pricing (+10%) and a recovery in volumes (driven by an increase in disposable income). This momentum should continue into 2018 and 2019 and by 2019, we believe that Brazil should restore an EBIT margin of 44.3% compared with 36.4% in 2016 (and 46.2% in 2015). This puts our Ambev and AB InBev group forecasts well ahead of the market. Our 2019 Ambev operating profit of BRL24.5bn is 10% ahead of the BRL22.3bn consensus. For AB InBev we expect operating profit of USD22.8bn, which is 12% ahead of the consensus at USD20.4bn.
2) Disposable income growth to drive volume growth and premiumisation: We believe that demographic growth will play a far less part in beer consumption growth than in the past. Over the past 30 years, the legal drinking age population in Brazil has grown by an average 2.1% p.a. which helped Brazilian beer consumption to increase. However over the next 30 years, that growth will be significantly less at 0.7% p.a.. Moreover, the high consumption age bracket of 20 to 40 year-olds is expected to decline by 0.6% p.a. compared with growth of 1.2% p.a. over the past 30 years.
Significant volume On the other hand, affordability remains an issue in Brazil as it takes 20 minutes on average to earn a increase ahead as pint of beer. By comparison, in France it takes nine minutes and consumption per capita is 28 litres, affordability improves. in the UK it takes nine minutes and consumption per capita is 71 litres, and in the US six minutes for 73 litres per head. As GDP and disposable income growth are expected to pick up again we expect further growth in beer consumption. That should be even more pronounced in the North and Northeast regions where GDP and disposable income per head is lower. Currently per capita beer consumption in the North and Northeast regions are respectively 30 and 49 litres per annum, which is well below the national average of 65 litres. In the South and the Southeast regions, per capita beer consumption is respectively 75 litres and 80 litres (and in Sao Paolo it is even close to 90 litres but 75litres in Minas Gerais). Combining both the cyclical rebound and a partial catch-up in the northern regions could drive per capita beer consumption in the medium term (2024 in our model) to 80 litres compared to 65 litres in 2016.
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High end beers have In Brazil, high end beers (premium and super premium) have been growing fast over the past 10 years grown from 5% of the (volume CAGR 06-16 of 13% vs 3% for the overall market) and in 2016 were estimated to account market 5 years ago to 12% for 12% of the beer market (in volumes). Although 12% is at the level that Argentina is, it is well today and that growth below the 17% in Uruguay and Paraguay and well below the 24% of South Africa. Furthermore, should continue. surveys by Ambev concerning its consumers’ favourite beer, indicate that about 30% of these would prefer a more premium beer. And Ambev has the high-end beers to serve its customers including domestic premium beers Bohemia and Serramalt, craft beer Colorado and international premium beers Budweiser, Stella Artois and Corona.
Heineken mopping up 3) Duopoly in the making: Through the acquisition of Femsa (Mexico), Heineken also inherited a competitors, which should Brazilian portfolio centred around the Kaiser value brand at which Core+ Amstel and premium be good for pricing. Heineken were added, and the company grew to a 10% market share in 2016. Meanwhile the no. 4 in the market, Kirin Brazil, continued to experience difficulties in re-launching its Schin brand and was lossmaking even on an EBITDA level. Heineken bought that business in May 2017 and added its 9% to become the no. two in the market with a 19% share behind Ambev’s 69%. We believe that the consolidation will continue and that Heineken will also buy no. 3 Petropolis (11% share), which owns the successful mainstream Itaipava brand. We understand that owner Walter Faria was ready to sell Petropolis to SABMiller as late as September 2015 (for a speculated USD5.5bn or 3x sales and 10x EBITDA), but the deal fell through as SABMiller pursued the AB InBev transaction. If Walter Faria (Petropolis' owner) was happy to exit in 2015, he might be even keener to sell out now as it looks he (and Petropolis) are implicated in Brazil’s car-wash corruption scandal where Petropolis is claimed to be an intermediator between the Odebrecht construction group and a number of politicians. As such, we believe that the consolidation of the Brazilian beer industry needs to go one step further with Heineken buying Petropolis (11% market share in 2015), creating a strong no. 2 in Brazil (30% market share) behind Ambev (69% share).
In the meantime, we believe that Heineken is likely to reposition the Schin brand as a regional lower mainstream brand rather than as a discount brand. This should be beneficial for all remaining brewers as it would lift the price cap allowing other brewers to increase prices and recapture the tax increase of 2016.
Key graphs executive summary Fig. 1: Brazil – beer market shares, 2015 Fig. 2: Ambev – 31 breweries across Brazil
Petro- Other polis 1% 11% Heine- ken/Kirin Brazil 19%
AmBev 69%
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Source: Canadean Source: Bryan Garnier
Fig. 3: Brazil - relation between affordability Fig. 4: Population distribution and beer per and beer consumption (2005-2015) capita (2015)
80 70 60 50 40 30 Beer per capita Beer per capita (l) 20 10 10 15 20 25 30
Minutes worked to afford a pint
Source: ILO, World Bank, Canadean, Bryan Garnier Source: Bryan Garnier estimates
Fig. 5: High end beer % of total volumes Fig. 6: Brazil – price index (2015)
France 49% Corona UK 40% Skol Beats USA 36% Stella Artois Germany 31% Serramalte Belgium 28% Heineken Chile 24% Original South Africa 24% Budweiser World 20% Brahma Extra Peru 18% Bohemia Uruguay 17% Amstel Paraguay 17% Skol Canada 16% Brahma Nigeria 16% Antarctica Argentina 12% Itaipava Brazil 11% Antarctica Sub-Zero Colombia 9% Kaiser Guatemala 8% Schincariol Japan 8% Mexico 5% 0 100 200 300
Source: Canadean Source: Canadean
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2. AB InBev investment case
2017e operating profit Geographic diversification: with the acquisition of SABMiller, AB InBev added strong positions in contribution: US 27%, Colombia, Peru, South Africa, Australia and numerous sub-Saharan African markets diminishing to a Brazil 17%, Mexico 8%. certain extent its reliance on the US and Brazil. Indeed, the weight of the US in operating profits fell to 27% from 37% and of Brazil to 17% from 23%.
Market leader in all its top Market leadership: In most of the markets in which AB InBev operates, it is the market leader. 10 markets except for in Market leadership allows price leadership and ability to spread costs over a larger base. In the chart on China, where it is taking the next page we highlight the group's positions in the top 10 markets (over 80% of its volumes), share very quickly. where it is the market leader everywhere except in China. However, even in China, which is geared towards higher margin Core+ and premium brands, business is going from strength to strength. In the first quarter, the company claims to have reached a 20% volume share, which we believe would make it the second largest brewer in China after CR Beer (24%), but ahead of Tsingtao (17%). This would be a significant acceleration from the 15% market share it held in 2015.
Only about 15% of AB Premiumisation: Premiumisation in the beer industry is the most exciting driver of growth and InBev volumes are high- profits in the industry. Indeed, premium beers are 50% more profitable (USD/hl) than mainstream end, which is well below and superpremium is 4x more profitable. On top of that, growth in the high-end beer segment is the 37% at Heineken and outpacing category growth in each region. Over the past decade, globally, premium beer has grown by the 25% at Carlsberg, but 3.8% p.a. and superpremium beer by 4.8% p.a. compared to 2.5% growth in mainstream beer. But the aim is to catch-up. also, growth in the beer category itself in emerging markets is a reflection of premiumisation. Indeed, in Africa it takes four hour's work to buy a pint of beer. The three main areas for premium growth, in which AB InBev is active, are:
Africa and Latin America, where consumers are trading up from the informal/home-brew market (currently respectively 75% and 25% of the total alcohol market). AB InBev has bought SABMiller to increase its exposure to these two regions. Indeed, in the overall alcohol consumption of 6.2litre in pure alcohol terms is the same as the global average. However, there is a significantly higher level of informal alcohol production in Africa. Once disposable income increases, this share of informal alcohol consumption decreases. This has been the case in South Africa, where the share of illicit and home brew consumption accounts for only 20% (about 11m hl) and packaged beer consumption is already 50% of alcohol consumption (about 25m hl). Tapping into that trend, which could guarantee 50 years of growth in Africa, has been the main driver for AB InBev to acquire SABMiller.
High-end beer in emerging markets, (in Africa and Latin America, high-end beer is only 15% of volumes and in Asia it is only 10% compared to 30% in the rest of the world). AB InBev is in the process of introducing Budweiser, Stella Artois and Corona, to the acquired SABMiller regions.
High-end in mature markets, where there is a continuous consumer shift to differentiate and where the latest craze is craft (which is likely to remain as long as the Millennials are the biggest consumer group from 30% of population in 2019 to 36% by 2020). AB InBev has been buying 10 US craft brewers but has also acquired craft businesses in Argentina, Brazil, Colombia, Mexico, Spain, Italy, Belgium, UK and China. After the integration of SABMiller, we believe that high-end beer is about 15% of AB InBev volumes, which is well below the 37% at
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Heineken and the 25% at Carlsberg. Equally, it is also an indication of AB InBev’s upside in this segment.
M&A is a core Plenty of consolidation opportunities: Although AB InBev owns 27% of the global beer market competency of AB (ahead of Heineken with 10%), there are still plenty of consolidation opportunities left. In Europe, InBev’s management and the company only has a 9% market share (7% in Eastern Europe and 10% in Western Europe). In a large number of targets Asia, the company only has a 14% share of the market and outside China, its share is only 10%. In remain Africa, AB InBev has a 37% share of the market, but this is mainly in South Africa, where it has a 90% share. In the rest of Africa (75% of the volumes on the continent), it has only 20%. And even in the Americas, where it owns 55% of the market (in volumes), there are still opportunities left in the Central American region. In our note "Guide to Brewing M&A (21st March 2017)", we identified Carlsberg, Kirin, Castel, Polar, San Miguel, Sabeco, Zhujiang, Boon Rawd, Damm and Budvar as some of the targets that AB InBev could go after (total deal value USD100bn), and that would propel its global market share to 41%.
On a fast track to unlock SABMiller synergies to support earnings in 2017 and 2018: Originally AB InBev budgeted the the synergies from the synergies from the SABMiller acquisition at USD2.4 bn (1.4bn of new synergies and USD1.0bn from SABMiller acquisition. the cost savings initiatives announced by SABMiller). At the start of 2017, that figure was increased to USD2.8bn of which by the end of 2016 already USD829 was captured by SABMiller and AB InBev). AB InBev expects the balance of USD2.0bn to capture in the next three to four years. We believe that in line with previous transactions that will go faster. Indeed, already in Q1 2017, AB InBev announced another USD252m of cost synergies.
Brazilian revenues and Rebounding Brazilian revenues and profits: AB InBev’s Brazilian profits suffered most in 2016 as profits to rebound the stronger USD increased the cost of goods sold while price aggressive behaviour by Kirin Brazil quickly. limited price increases in the market, a tax increase could not be passed on and volumes suffered from the macro-economic environment. However, we believe all that is about to change. From the second half of 2017 onwards, the strength of the BRL against the USD (which is hedged one year in advance) will lower COGS at the same time as we expect strong pricing (+10%) and a recovery in volumes (driven by an increase in disposable income). This momentum should continue into 2018 and 2019 and by 2019, we believe that Brazil will be back at an EBIT margin of 44.3% compared with 36.4% in 2016 (and 46.2% in 2015). As we expect that Brazil is no longer a drag on revenues, we are expecting AB InBev to grow top-line organically by 5.5% p.a over the 2017-2021 period, which is at par with the 5.8% p.a. in the 2012-2016 period (and includes the weaker 2.4% from 2016.
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Key charts investment case Fig. 7: AB InBev – more diversified source of operating Fig. 8: Leading positions across the board, income after SABMiller deal, 2017e market shares 2016e
Germany South 1% Korea USA 45% 1% Brazil Peru UK Other 68% 2% 2% 13% USA China 20% Canada 27% Mexico 56% 3% South Africa 90% Australia 3% Colombia 98% Rest Africa Argentina 82% 4% Brazil 17% Peru 97% Colombia South Korea 4% South 44% Africa Canada 48% Argentina 5% China Mexico 5% 5% 8%
Source: Bryan, Garnier & Co ests. Source: Canadean Fig. 9: Tapping Africa’s great potential of switching Fig. 10: Plenty of consolidation opportunities, from informal to branded beer, make-up of the size of the regions in m hl and AB InBev alcohol market market share
800 14% 600 Informal 9% 56% 400 Spirits Wine 200 37% Beer 0 Europe Americas Asia Africa North C&E Latin Africa America Europe America Others AB InBev
Source: SABMiller estimates Source: Bryan Garnier Fig. 11: Synergy promise and delivery, synergies % of Fig. 12: Brazil margin turnaround driven by acquired revenues currency tailwind, net revenue and volume growth 24% 6% H2 2017 16% 4% 4% 2018 11% 12% 2%
-2% -3% Volume Price/mix Costs
Source: AB InBev Source: Bryan Garnier
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3. AB InBev financial outlook 3.1. Strong earnings growth in 2018 and 2019 North America: the good price/mix trend in both the US and Canada that is offsetting volume declines is expected to continue.
Latin America West: Volume growth should continue to be strong after the tough comparables in Colombia in Q1 (good Summer in 2016). Mexico should continue to grow in low single digits and Peru should rebound from the flooding in Q1, while Equador is coming up to easy comps as last year was impacted by the earthquake in March 2016. The element of uncertainty is how in Colombia the VAT increase to 19% from 16% will be digested by consumers, but who on the other hand are feeling the benefits of the pace agreement with the FARC. Introducing the premium brands Budweiser, Stella Artois and Corona, should allow for continued price/mix improvement. And the Colombian/Peru/Ecuador business should deliver cost benefits through the integration into AB InBev.
Latin America North: This is the region where AB InBev has suffered most in the recent years and we believe that it will be the region where the company will experience the strongest rebound. Indeed, from the H2 2017 onwards, the strength of the BRL against the USD will lower COGS (the USD is hedged one year forward so the impact is delayed by one year) in Brazil at the same time as we expect strong pricing (+10%) and a recovery in volumes. This should carry over into 2019 and for 2019 we are expecting EBIT margin for Latin America North of 42.2% compared to 35.3% in 2016 and 35.5% in 2017, close again to its all-time high EBIT margin of 43.9% achieved in 2014 and 2015.
Latin America South: High inflation in Argentina, limits the opportunities for increased beer consumption, but the environment looks favourable to safeguard margins. There is plenty of scope for volume growth in the Latin America South region as consumption per head in Argentina is only 42 litres, in Chile 43 litres, in Bolivia 35 litres, in Paraguay 42 litres and in Uruguay 30 litres. But growth especially in Argentina will depend on the economic revival (there are some significant measures to boost the agricultural production and export). However, we have not put in any volume growth for the coming years in our model.
EMEA: With AB InBev’s European portfolio geared towards premium brands (Stella, Budweiser, Bud Light in the UK, Leffe in France), the company is set to benefit from the improved macro situation. The other part of the EMEA business is the African business where volume growth should be a feature for the next two decades and the introduction of Budweiser and Stella Artois could drive the mix.
Asia Pacific: Good volume growth in China and Australia, coupled with continued improvement in price/mix. Q1 was particularly good in China with strong activation on Budweiser during the Chinese New Year (AB InBev reached 20% market share). In Australia, the Corona brand has been back in the portfolio (5% market share in itself) since 1st October 2016 (before it was distributed by Kirin). Margins should benefit from the integration of Corona, ongoing premiumisation in the region and cost savings in the Australian business.
There are different elements in the financials costs at AB InBev. The largest part is the interest charge on loans, which we believe will add in 2017 to USD3.6bn. Next there are pension charges of
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USD120m and accretion expenses of USD600m. There is also a large element of hedging costs in financial charges. These hedging costs consist of hedging for currencies and hedging for the share based payments (on the share based payments there were 48.5m options outstanding at the start of 2017 and we assume that the share price is EUR120 by the end of the year). Both hedging costs together add another USD1.3bn. The company also separately reports non-recurring financial charges, which consist of the share based payment for Modelo shareholders (43m shares) that is due to stop in 2018. In 2016, the group also had hedge costs for the SABMiller transaction that are not repeated in 2017.
Minorities: the biggest minority stake is the 38.1% that AB InBev does not own in Ambev. Next to that there are the different minority shareholders of the African quoted businesses, like Nigeria, Tunisia, Botswana and the 38% stake that Castel holds in the African business ex South Africa.
Organic growth in As a result of these elements for 2017 and 2018, we are expecting organic growth in operating profit operating profit of 11.9% of 11.9% and 14.7% with organic revenue growth of 5.1% and 6.3%. Adjusted net profit is expected in 2017 and 14.7% in to grow by 79.7% and 22.8%. 2018. Fig. 13: AB InBev – revenue and EBIT margin Fig. 14: Operating profit contribution (2015- (2014-2019e) 2019e)
70 37% 25 000 Asia Pacific 60 35% 20 000 50 33% EMRA 40 31% 15 000 30 Latin America South 20 29% 10 000 Latin America 27% 10 North 0 25% 5 000 Latin America 2014 2015 2016 2017e 2018e 2019e West 0 North America Revenue (USDbn, lhs) EBIT margin (rhs) 2015 2016 2017e 2018e 2019e
Source: Company Data; Bryan, Garnier & Co ests.
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Fig. 15: P & L highlights AB InBev
USD m Dec-14 Dec-15 Dec-16 Dec-17e Dec-18e Dec-19e CAGR CAGR 11/16 17/22
Net Revenue 47,063 43,604 45,517 56,913 60,210 63,319 3.1% 4.6% reported growth 9.0% (7.3%) 4.4% 25.0% 5.8% 5.2% organic growth 5.9% 6.3% 2.4% 5.1% 6.3% 6.2% 5.8% 5.5% EBITDA 18,466 17,057 16,359 21,754 24,414 27,119 2% 7% A&P % revenues 15.0% 15.9% 16% 16% 16% 16% EBIT 15,111 13,904 12,882 17,732 20,265 22,843 1% 8% reported growth 7.7% (8.0%) (7.4%) 37.7% 14.3% 12.7% EBIT adjusted 15,308 13,768 13,276 18,032 20,565 22,843 1% 8% adjusted growth 7.8% (10.1%) (3.6%) 35.8% 14.0% 11.1% organic growth 6.7% 7.8% (2.9%) 11.9% 14.7% 12.2% Net interest expense (1,634) (1,466) (3,519) (3,694) (3,462) (3,364) Net interest on defined benefits (124) (118) (113) (120) (120) (120) Accretion expense (364) (326) (648) (600) (600) (600) Other financial results 294 671 (928) (1,270) (685) (685) Other non recuring financial items 509 (214) (3,356) (860) (430) Net financial income (expenses) (1,319) (1,453) (8,564) (6,544) (5,297) (4,769) Interest charge -4.0% -3.6% -3.6% -3.6% -3.6% -3.6% Affiliates 9 10 16 Other 48 Tax (2,499) (2,592) (1,613) (2,685) (3,592) (4,338) Minorities (2,086) (1,594) (1,528) (1,629) (1,741) (1,869) Net profit 9,216 8,275 1,241 6,874 9,635 11,867 reported growth (36.0%) (10.2%) (85.0%) 453.9% 40.2% 23.2% Net profit adjusted 8,865 8,513 4,853 8,721 10,710 12,387 (6%) 11% adjusted growth 11.7% (4.0%) (43.0%) 79.7% 22.8% 15.7%
Source: Company Data; Bryan, Garnier & Co ests.
Fig. 16: Per share data
USD Dec-14 Dec-15 Dec-16 Dec-17e Dec-18e Dec-19e CAGR CAGR 11/16 17/22 Average no of shares, diluted (m) 1,665 1,668 1,755 1,982 1,982 1,982 2% 0% EPS 5.54 4.96 0.71 3.47 4.86 5.99 (28%) 16% EPS adjusted 5.32 5.10 2.77 4.40 5.40 6.25 (7%) 11% adjusted EPS growth 10.7% (4.1%) (45.8%) 59.1% 22.8% 15.7% Free cash flow pre WCR 5.6 4.6 1.0 4.5 5.3 6.6 (27%) 13% Book value 31.1 26.2 44.4 37.4 38.6 40.4 14% 4% Net dividend 2.64 2.96 2.89 2.31 2.84 3.28 20% 11% Source: Company Data; Bryan, Garnier & Co ests.
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3.2. Valuation of AB InBev
3.2.1. Peer comparison At the current share price of EUR101.6, AB InBev is trading on 2017 P/E of 25.8x, which is a premium to its average P/E of 24.3x over the past five years. However, excluding 2016, the stock tends to trade at an average of 20.0x earnings. At its peak levels, the average P/E multiple over the 2012-2015 period was 22.4x.
Fig. 17: Stock market ratios
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 AVG 12/16 P/E average (x) 16.7 19.7 19.8 22.8 42.4 25.8 21.0 18.2 16.8 15.9 15.0 24.3 P/E high (x) 20.2 22.0 21.9 25.3 49.2 27.7 P/E low (x) 13.2 17.5 17.6 20.3 35.5 20.8 P/CF (x) 12.5 14.8 14.8 17.3 26.1 18.3 15.6 13.9 13.0 12.3 11.7 17.1 P/FCF pre WCR 13.4 11.2 18.6 25.2 114.0 24.9 20.9 17.3 15.9 14.9 13.9 FCF yield pre WCR (%) 7.5% 8.9% 5.4% 4.0% 0.9% 4.0% 4.8% 5.8% 6.3% 6.7% 7.2% 5.3% P/BV (x) 2.9 3.0 3.4 4.4 2.6 3.0 2.9 2.8 2.7 2.5 2.4 3.3 EV/adjusted EBIT (x) 14.9 16.9 17.2 19.8 24.8 19.7 17.2 15.3 14.4 13.6 12.9 18.7 EV/EBITDA (x) 12.2 14.1 14.2 16.0 20.1 16.1 14.3 12.9 12.1 11.5 10.9 15.3 Net dividend yield 2.3% 2.2% 2.5% 2.5% 2.5% 2.0% 2.5% 2.9% 3.1% 3.3% 3.5% 2.4% Total shareholder return 14.2% 9.7% 13.2% -1.6% -43.4% 61.2% 25.4% 18.6% 11.0% 9.2% 9.5% -1.6%
Source: Company Data; Bryan, Garnier & Co ests.
The valuation of 25.8x 2017 earnings compares to 22.3x for Heineken and 21.4x for Carlsberg. However, we believe that the premium is justified by the company’s strong growth rate coupled with a higher dividend yield. Indeed, its price to growth and dividends multiple (i.e. shareholder return) is 1.9x compared to 2.1x for both other stocks, implying 8% upside assuming a valuation in line with its rival brewers. Ambev (2017 PE of 24.6x) with an expected average growth rate of 12% and a dividend yield of 4.5% trades on a PEGD of only 1.5x.
local Share Market P/E EV/EBIT EV/EBI FCF Net Dividen 5yr EPS PEGD c'cy price Cap TDA yield debt/EB d yield CAGR (EURbn) not adj. ITDA 2017 2018 2019 2017 2017 2017 2018 2017 2018 2016 2017
Brewers
AB InBev EUR 101.6 213.5 25.8 21.0 18.2 19.7 16.1 4.0% 4.8% 4.5 4.0 2.5% 2.0% 11% 1.91
Carlsberg DKK 712.5 14.6 21.4 19.4 17.9 17.9 11.3 6.4% 6.0% 1.6 1.2 1.2% 1.5% 9% 2.06
Heineken EUR 87.3 49.8 22.3 20.7 18.4 18.0 13.0 4.3% 4.7% 2.5 2.1 1.5% 1.3% 9% 2.06
Molson Coors USD 87.4 17.9 20.3 18.5 16.8 18.9 14.0 6.2% 6.6% 5.4 4.7 1.7% 2.1% 8% 1.96
Royal Unibrew DKK 290.4 2.1 19.1 17.8 16.6 15.7 12.3 5.7% 6.1% 0.8 0.9 2.1% 2.2% 8% 1.96
Ambev BRL 18.1 286.4 24.6 19.3 17.0 16.7 13.9 4.4% 6.0% 0.0 -0.1 3.6% 4.5% 12% 1.49
Source: Company Data; Bryan, Garnier & Co ests.DCF valuation
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AB InBev
3.2.2. DCF valuation In developing our DCF valuation for AB InBev we start with the Bryan Garnier assumptions of a risk-free rate of 1.6% and a risk premium of 7%. To this we have added an unleveraged beta of 1.0x (which becomes a leveraged beta of 1.2x given that about 25% of the company’s market value of invested capital is financed with debt) resulting in a leveraged cost of equity of 10% in the first years and in our long-term assumptions for a cost of equity of 9.6% (leveraged beta falls back to 1.1x assuming net debt/EBITDA of 2.0). Given the debt to invested capital ratio of 18% (which follows from a net debt/EBITDA target of 2.0), the long term WACC that we apply in our DCF model is 8.3%. In terms of growth rate, we use a long-term growth rate of 4.3%. The company reaches an ROE of 16.3% once the SABMiller synergies are incorporated (2020e) and an assumed profit retention rate of 32%, implies a growth rate of 5.2%. Indeed, over the past five years, organic revenue growth at the company has averaged 5.8% and for the coming five years, our model, implies a 5.5% average organic growth rate. Despite these slightly higher suggested growth rates on the back of profit retention, we use an arbitrary lower 4.3%.
In computing our DCF-based fair valuation of AB InBev, we use for our long-term assumption a necessary net capex figure of 2.1% of revenues, which is in line with past levels (investing between 1.7% to 2.3% of revenue). The last assumption is what we believe would be the required working capital level at AB InBev. These figures have fluctuated sharply in the recent past from 19.3% in 2014 to 36.6% in 2016. However, we believe that during this period the underlying figure was between 24% and 26%, which is in line with the 2012 and 2013 figures. As such, going forward we assume negative net working capital of 25% (starting at 23% in 2015 but with opportunities to improve at the previous SABMiller operations). FV of EUR128 Fig. 18: DCF valuation USD m Dec-17e Dec-18e Dec-19e Dec-20e Dec-21e Dec-22e Dec-23e Dec-24e Sales 56,913 60,210 63,319 65,976 68,542 71,232 73,623 76,054 EBIT 18,032 20,565 22,843 24,203 25,320 26,500 27,516 28,564 Tax rate 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% Taxes (4,328) (4,936) (5,482) (5,809) (6,077) (6,360) (6,604) (6,855) Operating profit after taxes 13,704 15,630 17,360 18,395 19,243 20,140 20,912 21,709 + Depreciations 4,022 4,149 4,276 4,408 4,545 4,749 4,800 -Investments in fixed assets (3,687) (4,952) (5,029) (5,893) (6,060) (6,225) (6,370) Total net investments in fixed assets 334 (803) (753) (1,485) (1,515) (1,476) (1,571) (1,597) -Investments in working capital (3,573) 1,360 1,379 664 642 667 689 712 working capital as % revenues -23% -24% -25% -25% -25% -25% -25% -25% =Operating cash flow 10,466 16,187 17,987 17,574 18,370 19,331 20,030 20,823 Discount factor 0.98 0.91 0.84 0.78 0.72 0.67 0.62 0.57 Present value of free cash flow 10,268 14,720 15,157 13,719 13,282 12,941 12,379 11,880 Cum. present value of free cash flow 104,346 Long term assumptions +Present value of terminal value 307959 Risk free 1.6% =Enterprise value 412,305 Equity premium 7.0% Adjusted net debt incl pension provisions (97,653) Unleveraged Beta 1.00 (restated cash) Other liabilities and commitments Leveraged Beta 1.14 Revalued minority interests (34,649) Company debt spread 1.0% (Assoc. + revalued investments) 4,324 RRE 9.6% =Fair value 284,327 LT Growth 4.3% Fair value fully diluted per share (USD) 143 Target Debt/IC 18% Fair value fully diluted per share (EUR) 128 LT WACC 8.3% Source: Company Data; Bryan, Garnier & Co ests.
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AB InBev
An alternative more conservative DCF valuation derives a Fair Value of EUR118. This assumes that in the long term, the company becomes debt free (hence a lower leveraged beta of 1.0x), which increases the long-term WACC to 8.6 given that the absence of leverage equals the required return on equity. This computation derives a Fair Value of EUR118, which offers 16% upside relative to the share price on 9th June 2017 (EUR101.55). Although there are targets on keeping leverage in the company and hence the valuation that we use above seems more appropriate, it is useful to look at it from a debt -ree point of view. This is because in our DCF of Ambev, which has no debt, we derive upside of 13% to BRL20.5 from the current BRL18.1 share price (on 9th June 2017). As such, whichever way we look at it, upside potential for investors currently looks higher for AB InBev than Ambev.
Fig. 19: DCF valuation assuming the company becomes debt free
USD m Dec-17e Dec-18e Dec-19e Dec-20e Dec-21e Dec-22e Dec-23e Dec-24e Sales 56,913 60,210 63,319 65,976 68,542 71,232 73,623 76,054 EBIT 18,032 20,565 22,843 24,203 25,320 26,500 27,516 28,564 Tax rate 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% Taxes (4,328) (4,936) (5,482) (5,809) (6,077) (6,360) (6,604) (6,855) Operating profit after taxes 13,704 15,630 17,360 18,395 19,243 20,140 20,912 21,709 + Depreciations 4,022 4,149 4,276 4,408 4,545 4,749 4,800 -Investments in fixed assets (3,687) (4,952) (5,029) (5,893) (6,060) (6,225) (6,370) Total net investments in fixed assets 334 (803) (753) (1,485) (1,515) (1,476) (1,571) (1,597) -Investments in working capital (3,573) 1,360 1,379 664 642 667 689 712 working capital as % revenues -23% -24% -25% -25% -25% -25% -25% -25% =Operating cash flow 10,466 16,187 17,987 17,574 18,370 19,331 20,030 20,823 Discount factor 0.98 0.91 0.84 0.78 0.72 0.67 0.62 0.57 Present value of free cash flow 10,268 14,720 15,157 13,719 13,282 12,941 12,347 11,820 Cumulative present value of free cash flow 104,254 Long term assumptions +Present value of terminal value 286698 Risk free 1.6% =Enterprise value 390,953 Equity premium 7.0% Adjusted net debt incl pension provisions (97,653) Unleveraged Beta 1.00 (restated cash) Other liabilities and commitments Leveraged Beta 1.00 Revalued minority interests (34,649) Company debt spread 1.0% (Assoc. + revalued investments) 4,324 RRE 8.6% =Fair value 262,975 LT Growth 4.3% Fair value fully diluted per share 133 Target Debt/IC 0% Fair value fully diluted per share (EUR) 118 LT WACC 8.6%
Source: Company Data; Bryan, Garnier & Co ests.
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AB InBev
4. Ambev introduction
AB InBev holds 61.9% of Ambev was created in 1998 from the merger of Brahma and Antarctica. The company’s main brands the Ambev shares are Skol, Brahma, Antarctica, Quilmes, Labatt, Presidente, among others. Apart from beer the company also operates in the soft drinks and non-alcoholic and non-carbonated businesses with proprietary brands such as Guaraná Antarctica and Fusion, in Brazil and through a partnership with PepsiCo in many countries where we operate. The company’s expansion in the Americas started in 1994, when Brahma began its international presence through beer operations in Argentina, Paraguay and Venezuela. In 2003, after the creation of Ambev, the company accelerated its expansion outside Brazil through a business combination with Quinsa, establishing a leading presence in the beer markets of Argentina, Bolivia, Paraguay and Uruguay. In 2003 and also during 2004, Ambev completed a series of acquisitions in markets such as Central America, Peru, Ecuador and the Dominican Republic. In the following year, the Company also started to operate in the beer industry in Canada through the merger of an indirect holding company of Labatt. Finally, in May 2012, Ambev expanded its operations in the Caribbean through a strategic alliance with E. León Jimenes S.A.. and in 2016 it entered Panama. Ambev is controlled by AB inBev that holds 61.9% of the shares and FAHZ that holds 10.1%.
Brazil is 67% of Ambev’s In this note we will look mainly at the company's Brazilian operations. Not only are they Ambev's volumes, 55% of revenue largest business accounting for 67% of volumes, 55% in revenues and 57% of EBIT, they also played and 57% of EBIT a significant role in the deterioration of its fortunes in 2016.
Fig. 20: Breakdown by volume, 2016 Fig. 21: Breakdown by EBIT, 2016
Latin Canada America 6% South Latin 21% Canada America 12% South Brazil - Brazil - 24% Beer Beer Brazil - Soft 50% 48% drinks 17% Central America & Central the America & Brazil - Soft Caribbean the drinks 6% Caribbean 9% 7%
Source: Company Data; Bryan, Garnier & Co ests.
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Fig. 22: Key data on the different countries in which Ambev is active
Size of the market (m Market Per capita consumption Main competitors hl) share (litres) Brazil 139 68% 69 Heineken 19%, Petropolis 11%
Argentina 19 82% 42 CCU 16%
Chile 8 22% 43 CCU 68%
Bolivia 4 92% 35
Paraguay 3 71% 42 Heineken 17%, Molson Coors 6%
Uruguay 1 92% 30 CCU 5% Dominican 5 98% 48 Heineken 1% Republic Panama 3 60% 77 Heineken 26%, Molson Coors 4%
Guatemala 2 18% 13 Cerveceria Centroamericana 75%, Heineken 5% Canada 18 42% 59 Molson Coors 33%
Source: Canadean.
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AB InBev
5. The Brazilian beer market Brazil is the third largest The Brazilian beer market is the third largest beer market in the world and has grown consistently beer market in the world ahead of the global beer market despite recent weakness following macro-economic challenges. and has grown consistently. Fig. 23: Top 20 beer markets by volume (2015)
Volume m hl CAGR 05-15 CAGR 10-15
China 504 5.0% 1.7%
United States of America 235 0.1% 0.1%
Brazil 139 4.4% 1.6%
Germany 85 -1.1% -0.5%
Russia 86 -0.5% -4.8%
Mexico 74 2.6% 2.7%
Japan 57 -1.4% -1.0%
United Kingdom 45 -2.5% -1.5%
Vietnam 38 10.7% 6.6%
Spain 38 0.7% 1.1%
Poland 38 2.3% 2.3%
South Africa 31 1.8% 2.0%
India 25 11.1% 6.5%
South Korea 23 3.5% 4.8%
Colombia 23 3.0% 4.0%
France 20 0.0% 1.4%
Canada 20 -1.0% -2.0%
Thailand 19 0.8% 1.9%
Romania 18 2.1% 0.9%
Argentina 19 2.8% 0.8%
World 1952 2.1% 0.9%
Source: Canadean
Ambev is market leader Ambev has a leading market position in Brazil with a 69% share of the beer market, ahead of with 69% Heineken/Kirin (19% assuming Heineken’s acquisition of Kirin goes through) and Petropolis 11%. Over the past 15 years, the company’s share of the market has fluctuated between 67% and 70%, occasionally (in a specific month or quarter) dipping outside those boundaries often following pricing ahead of the market or actions to regain share. For example, at the end of 2016, the company’s share had fallen to 66.3% but in Q1 2017, its share of the market was again at 70% following strong investment/execution around carnival.
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AB InBev
Fig. 24: Brazil beer market shares, 2016 Fig. 25: Ambev beer market share Brazil, 1999-2016
71% Petropolis Other 1% Heineken/ 11% 70% Kirin 19% 69%
68% AmBev 69% 67%
66%
65%
Source: Canadean Source: Canadean
Skol, Brahama and Ambev owns the top three brands in Brazil: Skol (31% market share), Brahma (17% share) and Antarctica are the three Antarctica (12%), which also make up 87% of the company’s portfolio in Brazil. largest brands and all belong to Ambev.
Fig. 26: AB InBev main brands in Brazil, 2016 Fig. 27: Brazil market share by brand, 2015
Serramalte Stella Budweiser 1% Artois 31% 2% 1% Others Bohemia 1% 8% Skol Antarctica 44% 17% 18% 12% 8% 7% Brahma 6% 5% 25% 4% 2% 1%
Source: Canadean Source: Canadean . 5.1. Mid-term drivers of market growth
5.1.1. Demographic growth is slowing Demographics are not Over the past 30 years, the legal drinking age population in Brazil has grown by 2.1% p.a. on average much of a support thereby helping Brazilian beer consumption to increase. However, over the next 30 years this growth anymore. will be significantly less at 0.7% p.a. Moreover, the high consumption age bracket of 20 to 40 year olds is expected to decline by 0.6% p.a. compared to growth of 1.2% p.a. over the past 30 years. As a result, we believe that demographic growth will play a far smaller part in beer consumption growth than has been the case.
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AB InBev
Because of the changing demographic profile, we believe that Ambev is faced with two challenges: 1) continue to premiumise its offering to cater for the needs of the older population and 2) continuing to attract its share of the new legal age drinkers. For that, the company has stepped up efforts to recruit younger drinkers by approaching university students, organising beer parties and helping bars close to universities with special trade programmes. Indeed, although beer is the prevailing alcoholic drink (52% of pure alcohol compared to 48% for spirits), Cachaça remains a cheap alternative to beer with plenty of local producers that do not pay all the taxes. Although up-trading to beer occurs as consumers’ disposable income grows, there is always an element of brand loyalty that Ambev needs to foster. Especially in the last two years, the share of beer in total pure alcohol consumption has notched down to 51% from 52% in 2014 (and 47% in 2007)
Fig. 28: Population in Brazil and key alcohol Fig. 29: Brazil – make-up of alcohol consumer group of 20-40 year olds consumption
250 80 20 70 200 15 60 50 150 10 40 100 30 5 m hl pure alcohol pure m hl Total population 20 50 20 to 40 year olds 10 0 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Cachaça Other spirits Beer
Source: Census Bureau Source: Canadean, Bryan Garnier estimates
5.1.2. Increasing beer consumption in the North/North East. Potential to increase beer Per capita beer consumption in the North and Northeast regions are respectively 30 and 49 litres per consumption in the annum, which is well below the national average of 65 litres. In the South and the Southeast regions, poorer North/Northeast per capita beer consumption is 75 litres and 80 litres respectively (while in Sao Paolo it is even close to regions 90 litres but 75litres in Minas Gerais). Despite the strong upside in per capita beer consumption, the North only accounts for 8% of the total Brazilian population and the Northeast is 28%. Given the large area, the resulting lower density of population and drop size makes distribution more expensive.
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AB InBev
Fig. 30: Population distribution and beer per Fig. 31: Beer per capita consumption versus capita by region (2015) personal income (2016)
Source: Bryan, Garnier & Co ests. Source: Ambev 2017 IR presentation
We believe the main reason for this lower per capita consumption in the North and Northeast is lower GDP and disposable income. However, as the economies in these regions catch up (there are some national programmes to develop these regions), beer consumption should increase. While it is probably unrealistic to expect that these northern regions could reach the same economic development as in the south any time soon, we could expect them to approach the current national average and with that a beer consumption per capita of 65 litres. Furthermore, as macro-economic conditions improve, we would expect a cyclical rebound of per capita beer consumption. Combining both the cyclical rebound and a partial catch-up in the northern regions could drive per capita beer consumption in the medium term (2024 in our model) to 80 litres compared to 65 litres in 2016.
Fig. 32: GDP per capita by state (2010) Fig. 33: GDP growth rates (constant 2010 USD)
8% 6% 4% 2% 0% -2% -4% -6%
Source: Brazil Institute of Geography and Statistics Source: WorldBank
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AB InBev
Ambev’s market share in the North and Northeast has always been lower than its national market share because the group has focused more on the densely populated South, whereas competitors were given more room in the North. Nevertheless, with targeted actions like offering a low value brand Antarctica Sub Zero, the gap has narrowed and its current share in the North and Northeast is closer to 65% (Bryan Garnier estimate) compared to 69% nationally and 72% in the South.
5.1.3. Premiumisation still offers significant opportunities High-end beers are 12% In Brazil, high-end beers (premium and super premium) have been growing fast over the past 10 years of volumes but 30% of (volume CAGR 06-16 of 13% vs 3% for the overall market) and in 2016 were estimated to account Brazilians indicate they for 12% of the beer market (in volumes). Although 12% is at the level that Argentina is, it is well prefer a premium beer. below the 17% in Uruguay and Paraguay and well below the 24% of South Africa. Furthermore, surveys by Ambev on its consumers’ favourite beer, indicate that about 30% of consumers would prefer a more premium beer. So, we believe it is simply a matter of time and economic development before the Brazilian beer market will continue to premiumise.
Fig. 34: Selected countries: High-end beer % Fig. 35: Brazil: High-end beer % of total of total volumes (2015) volumes (1999-2016e)
14% France 49% UK 40% USA 36% 12% Germany 31% Belgium 28% 10% Chile 24% South Africa 24% 8% World 20% Peru 18% Uruguay 17% 6% Paraguay 17% Canada 16% 4% Nigeria 16% Argentina 12% 2% Brazil 11% Colombia 9% Guatemala 8% 0% Japan 8% Mexico 5%
Source: Canadean Source: Canadean Fig. 36: Argentina: High-end beer % of total Fig. 37: Canada: High-end beer % of total volumes (1999-2016e) volumes (1999-2016e)
14% 18% 12% 16% 14% 10% 12% 8% 10% 6% 8% 6% 4% 4% 2% 2% 0% 0%
Source: Canadean Source: Canadean
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AB InBev
Ambev has a complete We also believe that Ambev is well placed to benefit from this trend since it has a much larger share portfolio of brands in high-end beers (76%) than its overall market share (68%). Indeed, high-end is 13% of its portfolio whereas the level only stands at 10% at Heineken and 1% at Petropolis.
Fig. 38: 2015 market shares
Discount Mainstream High end Overall
Segment share 22% 67% 11%
Market shares
Ambev 15% 84% 76% 68%
Heineken 66% 5% 16% 19%
Petropolis 18% 11% 1% 11%
Portfolio Discount Mainstream High end Overall
Ambev 5% 82% 13% 100%
Heineken 75% 16% 10% 100%
Petropolis 34% 64% 1% 100%
Source: Company Data; Bryan, Garnier & Co ests.
One of the main reasons for this is that the group has a more comprehensive portfolio than its competitors. Ambev has domestic premium brands Bohemia and Serramalt; international premium brands Budweiser, Stella Artois (and now also Corona), and craft beer Colorado.
Fig. 39: Ambev - high-end portfolio 2015 Fig. 40: Brazil - main international premium brands (2015, m hl)
2.0 Serra- 1.8 malte Bud- Skol 1.6 6% weiser 7% 1.4 1.2 15% Stella Artois 1.0 0.8 4% 0.6 Caracu 0.4 Bohemia 4% 0.2 62% 0.0 Colorado 1% Others 1%
Source: Canadean Source: Canadean
Ever since Heineken purchased the Kaiser business in Brazil (through the acquisition of Femsa and made clear that it was going to develop the Heineken brand in Brazil), Ambev has been re-focusing with more urgency to develop the high-end segment. Stella Artois was already launched in 2005, mainly in Sao Paulo. In 2011 the group launched the Budweiser brand and in 2015 it launched Corona (price point 300).
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AB InBev
Develop a core+ price However, in addition to the further development of the high-end segment, which starts at 120 price point with Brahma Extra points with Budweiser, Ambev has launched Brahma Extra (later, red lager and weiss beer) at a 115 price index which prompts mainstream customers to trade up.
Further premiumisation should be good for both revenue per hl as for margin. Below, we have simulated how the impact of premiumisation on the Ambev accounts could work. For 2016 results, we believe that margins at premium and superpremium were 3% and 10% higher than the mainstream operating margin (estimated at 35% in 2016). However, because these margins are applied to higher selling prices, operating profit for premium beer should be 40% higher and for superpremium beer 130% higher.
Premium beers carry 30% Fig. 41: Profitability model for high-end beers at Ambev in Brazil to 50% higher operating Discount Mainstream Premium Superpremium margins than mainstream brands Selling price 80 100 130 180 Cost of sales/production -31 -36 -41 -44
Gross profit 49 64 89 136
Gross margin 61% 64% 68% 76%
Distribution -11 -11 -14 -17
Sales and marketing -6 -13 -20 -33
% revenue 8% 13% 15% 18%
Administrative costs -5 -5 -5 -5
Operating profit 27 35 50 81
Operating margin 34% 35% 38% 45%
Source: Company Data; Bryan, Garnier & Co ests.
5.1.4. Duopoly in the making Heineken bought the Heineken entered the Brazilian beer market in 2010 given that acquisition of Femsa (Mexico) also Brazilian operations from provided Brazilian operations. Since then the company had managed to build up a market share of Kirin to increase its share 10%. In February 2017, the Heineken announced that it was buying Kirin Brazil that had a 9% from 10% to 19%. market (2015). On 24th May 2017, Heineken received the required regulatory approval from the Brazilian Competition Authority (CADE) for the acquisition of Kirin Brazil. At USD1.1bn, the acquisition price is only about 1x revenue (Kirin bought its Brazilian operations for USD3.9bn). However, Kirin Brazil was losing money (2016 operating loss of USD75mn before amortisation of goodwill) as the company was aggressively repositioning its Schincariol brand in the discount segment and clearly pricing below cost.
Heineken is likely to What can we expect from Heineken? It is difficult to second guess what Heineken’s brand strategy remove some of the deep will be but its two domestic brands together (Kaiser and Schincariol) will have a 66% market share in discounting of Schin the Brazilian discount segment. This is not necessary and it is especially not necessaryy to have the (Kirin Brazil). two lowest priced brands in the market competing on price. As such, we believe there are two options: the first is to move one of the two discount brands to mainstream. This could happen with Schincariol since it has only been in the mainstream for a couple of years, rebranding from Schin back to Nova Schin might do the trick (of course at the expense of volume loss). The other strategy would be for Heineken to develop a regional lower mainstream portfolio with Heineken’s Kaiser brand already being strong in the South and South East and Bavaria in Sao Paolo and Schincariol already being well-positioned in the North and Northeast. This would allow a low mainstream re-positioning for Schincariol and would remove price pressure in the South (where its price aggressiveness seems to
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have been heaviest and which is the largest regional beer market accounting for 70% of national volumes). On top of that a Core+ position of the Amstel brand and the premium position of the Heineken and Sol brands could be further developed in the North/Northeast. The advantage of that structure is that it leaves room for another Brazilian brand: Itaipava.
Fig. 42: Schin recent advertising Fig. 43: Combined Heineken/Kirin Brazil portfolio
30%
25% Schin 20% Bavaria 15% Kaiser
10% Amstel Heineken 5% Sol 0% 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source: Schin.br.com Source: Canadean
Fig. 44: Brazil – beer market shares, 2015 Fig. 45: Heineken will have a 66% in the Brazilian discount segment
Petro- Other Others polis 1% 1% Heineken 11% 66% Crystal Heine- Kaiser 18% ken/Kirin 26% Brazil Cerveja 19% Antarc- AmBev tica 15% 69% Schin Cintra 37% 3%
Source: Canadean Source: Canadean
It seems that no. 3 Indeed, we are convinced that the current no. 3 in the market: Petropolis, with its Itaipava brand Petropolis is also for sale. could come up for sale. As we understand it, Petropolis was ready to sell itself to SABMiller as late as in September 2015 (for a speculated USD5.5bn or 3x sales and 10x EBITDA), but the deal fell through as SABMiller pursued the AB InBev transaction. If Walter Faria (Petropolis' owner) was happy to exit in 2015, he might be even keener to sell out now as it seems that he (and Petropolis) are implicated in Brazil’s car wash corruption scandal. The car wash scandal concerns certain Brazilian
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companies that paid bribes to politicians in exchange for Petrobras contracts (all happily paid to companies set up by the Panamanian law firm Mossack Fonseca). One of these companies was the Odebrecht construction group, which has admitted its part of the bribery and paid a USD2.6bn fine. In April 2017, one of Odebrecht’s former top people said in court that his firm used Petropolis to donate about USD15m to the presidential campaign of Dilma Rousseff-Michel Temer in 2014. If this proves true, then Petropolis is clearly in for a big fine, commercial backlash (who wants to be associated with the car wash scandal?) and a loss of tax advantages (e.g. for investing in breweries). Furthermore, a buyer of these assets will want to make sure that there is cover for eventual further corruption or tax investigations. Indeed, in the past, Petropolis has been implicated in tax evasion a couple of times and had to pay fines for it. The benefits of this tax evasion has been that the company had enough funds to make its Itaipava brand a strong competitive brand with the perception of being good value for money.
As such, we believe that the consolidation of the Brazilian beer industry has to go one step further with Heineken buying Petropolis (11% market share in 2015) and thereby creating a strong no. 2 in Brazil (30% market share) behind Ambev (69% share).
5.1.5. Growth in beer consumption driven by affordability Increasing GDP and The Braziloan beer market can be defined as a strong beer market with consumption per capita at disposable income should 68.2 litres despite the fact that it takes an average of 20 minutes to earn a pint of beer. By comparison, lead to further volume in France it takes nine minutes and consumption per capita is 28 litres, in the UK it takes nine growth in the market. minutes and consumption per capita is 71litres while in the US, six minutes is needed for 73 litres per head. But as a developing market, consumption is very much a function of affordability and given the fact that salaries have hardly kept up with inflation over the past three years, volume and value growth in beer has been limited.
Fig. 46: Brazil is a strong beer market Fig. 47: Brazil - relation between affordability and beer consumption (2005-2015)
120 80 70 100 Germany 60 80 US UK Brazil 15 50 60 SA Brazil 05 40 40 China Vietnam 30 France Beer per capita (l) Beer per capita (l) 20 Nigeria 20 India 0 10 0 20 40 60 80 100 10 15 20 25 30 Minutes worked to afford a pint Minutes worked to afford a pint Source: Company Data; Bryan, Garnier & Co ests.Source: Source: ILO, World Bank, Canadean, Bryan Garnier ILO, World Bank, Canadean, Bryan Garnier
A ramp-up in the economy would be good news for beer consumption. And there are the first indications that after two difficult years the economy is returning to growth:
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Central bank data showed economic activity grew 1.1% in the first quarter from the last three months of 2016. The GDP increase came after two years of consecutive GDP decreases in which the Brazilian economy fell by 8%.
Brazils’ unemployment rate fell unexpectedly (for the first time in two years) in the first quarter of 2017 to 13.6% from 13.7%.
Real monthly income increase in March to BRL2,110, up 2% from BRL2,068 in March (after being stuck in the BRK2020-2060 range since end 2015)
Consumer prices in Brazil increased 4.1% year-on-year in April of 2017, following a 4.6% rise in March. The inflation rate slowed for the eighth month in a row to the lowest since July of 2007, standing below the central bank target of 4.5%for the first time since December of 2009.
Coupled with the falling inflation rate and outlook, the Central Bank of Brazil cut its key Selic rate by 100 basis points to 10.25 percent on 31st May. This was the sixth straight rate decline, bringing borrowing costs to the lowest since December of 2013.
The seasonally adjusted Markit Brazil Manufacturing PMI rose to 52 in May 2017 from April's 50.1 and way above market expectations of 50.5. The reading pointed to the strongest month of expansion in the manufacturing sector since February 2013, leading to the sharpest increase in production in almost 4.5 years.
5.2. Ambev’s initiatives to capture growth potential
5.2.1. On-premise retail initiatives On-premise is an Beer is mostly consumed in on-premise outlets, which represent about 59% of volumes and for which estimated 59% of the main packaging presentation is the 600 ml returnable glass bottles. Supermarkets account for volumes, which is down around 41% of volumes and in this channel, the 350 ml aluminium cans are the main presentation. from the 70% 10 years ago. Ten years ago, on-premise was 70% of the market but that share has gradually been declining as consumers structurally shifted to more on-trade consumption as consumers were able to afford televisions and fridges in their own home. That structural change has accelerated over the past two years as the more difficult macro-economic environment has encouraged consumers to stay at home.
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Fig. 48: Brazil beer - on-trade versus off- Fig. 49: Brazil beer – packaging presentation, trade, 2016e 2016e
Keg Others 3% 6% 474ml can 12% Off premise 600ml 41% On 269ml bottle premise can 49% 59% 13% 350ml can 17%
Source: Ambev Source: Canadean
Ambev developed a whole Given its strength in distribution, Ambev tends to have a higher share in the on-premise segment series of initiatives to (72% Bryan Garnier estimate) than in off-premise (64% Bryan Garnier estimate). For that to continue stimulate the on-premise. it needs to execute very well, with its sales force visiting each point of sales on average 2.2x per week. Furthermore, Ambev constantly rolls out initiatives to strengthen its relations with these on-premise outlets:
1) Reference bars: Protecting its market share in the on-premise segment is an important part of the company’s strategy and for that it will want to avoid its products being too expensive. Because it cannot impose a price, Ambev works with about 2,000 reference bars that in their neighbourhood are a reference fpr the suggested price (and they get better prices for doing so). These suggested prices are clearly announced at the door of the bar (so competitors can come and have a look).
Fig. 50: Reference bar Fig. 51: Reference bar price list
Source: Internet Source: Internet Source: Company Data; Bryan, Garnier & Co ests.
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2) Nosso bars (Our bars): Ambev has been rolling out branded bars across Brazil via a quasi-franchise arrangement, whereby a third party will own and run the bars while Ambev advises on location, provides marketing, training and basic furnishings. Currently there are about 1,200 nosso bars (up from 150 in 2011), which are located in poorer neighbourhoods and which have a modern, clean image offering traditional Brazilian food, beer, soft drinks and snacks. A similar concept is the Skol Facul bars which are located around universities and are geared to capture younger drinkers. Ambev has about 2,000 Skol Faculs.
Fig. 52: Nosso bar Fig. 53: Skol Facul
Source: Internet Source: Internet
3) Another initiative is to make it a less bureaucratic process to become a customer at Ambev (a new bar can receive beer the next day instead of it taking one month to establish an account). The company now has a dedicated management team to improve service levels to the on-premise segment.
4) Ambev is also increasingly using technology to understand customer behaviour and to improve service levels for on premise customers. New tools are gradually being introduced and seem to have a positive impact.
5.2.2. A well-structured pricing ladder The Brazilian beer market has a well-developed price ladder, with until recently only a limited part of the market in a value segment. Indeed, back in 2012, the value segment (price index 90 or lower) was only 12% of the market with Ambev playing into that field with its Antarctica Sub Zero brand, Petropolis with Crystal and Heineken with Kaiser. However, in 2013, Kirin, repositioned its mainstream Nova Schin brand to discount Schin. A classical price structure would be Skol/Brahma/Antarctica at price index 100 with Itaipava at 95. Schincariol would be the cheapest brand at a price index of 75, Kaiser at 85 and Antarctica Sub-Zero at 90. Above Skol would be Amstel Bohemia, Brahma Extra at Core + level. Budweiser would be at 140 and Stella Artois at 180. Heineken would be positioned in between at 160.
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Schin is in deep discount Fig. 54: Typical price ladder in Brazil territory price per 350ml can Price index Schincariol 1.84 75
Kaiser 1.96 80
Antarctica Sub-Zero 2.21 90
Itaipava 2.33 95
Antarctica 2.45 100
Brahma 2.45 100
Skol 2.45 100
Amstel 2.82 115
Bohemia 2.94 120
Brahma Extra 2.94 120
Budweiser 3.43 140
Original 3.68 150
Heineken 3.92 160
Serramalte 4.17 170
Stella Artois 4.41 180
Skol Beats 4.78 195
Corona 6.62 270
Source: Bryan, Garnier & Co ests.
From the tables above one can see how even today, a price point of less than 75% of the mainstream reference point Skol 350ml, is well below what competitive brands have been priced at. As a result, there has been some price pressure in the market. Even Ambev is offering volume discounts on its cans that bring the price down to the Schin level. The entire returnable bottle business that has been developed (and that in 2016 was already 23% of off trade sales) is also a response to that. Indeed, the price for a returnable 300ml bottle is BRL1.7 for the liquid and BRL1 for the bottle. At BRL1.7, the price point should allow it to compete with the Schincariol 350ml can priced at BRL1.8/1.9.
We checked the typical price ladder with prices in the Extra supermarket in Sao Paolo and the Mofato Hypermarket in the South. Although in each outlet, the pricing structure is more or less followed, there are significant price differences between the two. The reason is that the Muffato is more of a hypermarket, which tends to have lower prices (and use beer to tempt customers into the shop) and that Extra has a more premium image in Sao Paolo.
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Fig. 55: Beer prices - Extra Sao Paolo - 19th May 2017
Brand Cans ml Price Price/litre Price ladder
Duvel – bottle 330.00 21.25 64.39 754
Goose IPA - bottle 355.00 16.90 47.61 557
Leffe Blonde - bottle 330.00 12.90 39.09 458
Hoegaarden - bottle 340.00 12.90 37.94 444
Guinness 440.00 15.90 36.14 423
Faxe 1000.00 23.25 23.25 272
Skol Beats 269.00 3.99 14.83 174
Stella Artois 310.00 3.29 10.61 124
Heineken 350.00 3.39 9.69 113
MGD 350.00 3.25 9.29 109
Bohemia 350.00 2.99 8.54 100
Skol 350.00 2.99 8.54 100
Amstel 350.00 2.99 8.54 100
Budweiser 350.00 2.99 8.54 100
Brahma Chopp 350.00 2.89 8.26 97
Antartica 350.00 2.35 6.71 79
Itaipava 350.00 2.19 6.26 73
Schin 350.00 1.69 4.83 57
With volume discount
Brahma Chopp 269.00 1.87 6.95 81
Brahma Chopp - buying 45 cans 269.00 1.59 5.91 69
Brahma Chopp 473.00 2.88 6.09 71
Brahma Chopp - buying 3 cans 473.00 2.45 5.18 61
Budweiser 269.00 2.26 8.40 98
Budweiser - buying 45 cans 269.00 1.92 7.14 84
Source: Extra Sao Paolo
Fig. 56: Beer prices - Super Muffato - 19th May 2017
Brand Cans ml Price Price/litre Price ladder
Skol Beats 269.00 2.79 10.37 192
MGD 269.00 2.49 9.26 171
Heineken 350.00 2.79 7.97 148
Budweiser 350.00 2.59 7.40 137
Antarctica 350.00 2.29 6.54 121
Kaiser 350.00 2.05 5.86 108
Brahma Chopp 350.00 1.95 5.57 103
Skol 350.00 1.89 5.40 100
Bohemia 350.00 1.89 5.40 100
Itaipava 350.00 1.79 5.11 95
Bavaria 473.00 2.15 4.55 84
Source: Supermuffato.com
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Fig. 57: Price breaker Nova Schin at BRL4.83 per Fig. 58: Brahma with volume discount litre at BRL5.18 per litre if you buy 3 packs of 12 cans
Source: Extra Sao Paolo - 19 May 2017 Source: Extra Sao Paolo - 19 May 2017
Ambev also has a well-developed pricing ladder and competes in all segments of the market. Ambev would regard all three brands Skol, Antarctica and Brahma as mainstream brands, and their price point should vary depending on the region. In Sao Paulo for instance, Skol would be the main brand, Brahma the second brand within the core portfolio and Antarctica the third one. That means Skol would be at a 100 price index, Brahma would be 105 and Antarctica at 90 (putting Antarctica as a lower mainstream brand. However, in Rio de Janeiro, where Antarctica is the preferred brand, Skol would be the second brand and Brahma the third one. Budweiser would start at 140 and Stella Artois at 180.
Fig. 59: Canadean definition for price segments
Taking the leading brand in the most popular pack type as the standard (=100), all other brands have been indexed against this brand/pack type. Brands which have an index of 115-150 have been taken to be premium, while those brands which have an index in excess of 150 are counted as super premium. Brands which fall below an index of 90 form the value or discount segment, while the mainstream segment is formed of brands which fall into the 91-114 band.
Source: Canadean
Next to pricing, the image of the different brands is equally important and there have been significant developments with all brands at Ambev becoming more inclusive and shedding their sexist image. One example is how four feminist artists have been asked to redesign previous campaigns (below in the table you find an example under the Skol brand).
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Fig. 60: Ambev Brazilian beer brands pricing ladder Price Positio Recent campaigns index n Colorado 280- Domestic premium 300
Skol Beats 190- Domestic premium 200
Stella Artois 180 International premium
Original 150 Domestic premium
Budweiser 135- International premium 145
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Price Positio Recent campaigns index n Bohemia 120 Domestic premium
Skol 100 Local mainstream
Brahma 100 Local mainstream
Antarctica 90 Local low mainstream
Source: Various.
Stop Press first impact of Heineken owning Schincariol? Is Schin out Extra hyper Just two weeks after Heineken got the keys to Schincariol, we have noticed that there is something and supermarkets? moving - or maybe it is coincidence. In the Extra hypermarket where we do our price check, Schin is not available anymore and Itaipava 350ml cans (which were the second cheapest cans in the hypermarket have moved up to BRL2.49 from BRL2.19). However, Antarctica’s price moved to BRL2.25 from BRL2.35 (prices do fluctuate from one week to another as the retailers use beer to attract consumers).
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5.2.3. Returnable bottles to counter price pressure In Brazil, the on-premise sales points (bars, restaurants etc), which accounted for 59% of total volumes in 2015, are nearly all returnable 600ml bottles, whereas in the off-premise segment (41% - traditional and modern retail), the market has been shifting from returnable glass bottles to non- returnable bottles and cans. Indeed, in the overall market, the share of returnable bottles declined to 52% in 2014 from 74% in 1999. And the share of cans increased to 49% in 2014 from 25% in 1999. However, in 2015 and 2016, these trends seem to have turned with returnable glass bottles increasing share (to 56% in 2016e – 90% in on-premise and 15% in off-premise and cans decreasing share (to 41% 2016e). This came on the back of Ambev’s launch of the returnable 300ml bottle in off-premise.
Fig. 61: Returnable bottles as % of all Brazil Fig. 62: Brazil beer packaging material beer volume
80% 160 Metal 70% 140 60% 120 Glass 50% 100 40% 80 m hl 30% 60 20% 40 10% 20 0% 0
Source: Canadean Source: Canadean
Returnable 1 litre bottle Already back in 2008, Ambev was the first group to introduce the 1 litre returnable bottle (for the on for on-premise, launched premise), which delivered a more affordable product with beer at a 20 to 30% discount to the same in 2008 volume in a 600ml returnable bottle. The introduction of the 1 litre returnable bottle also helped to secure market share: not only was Ambev the first one to introduce this packaging format, but also it used bottles engraved with Ambev on it, preventing competitors from obtaining a free ride (the 600ml bottles are inter-changeable).
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Fig. 63: Brazil beer main packaging, 2015 Fig. 64: Brazil beer main packaging, 1999- 2016e
1 lire Others 160 Others botte 474ml can Keg 4% 140 3% 2% 269ml can 120 350ml can 474ml 600ml bottle can 100 12% 600ml 80 269ml bottle 60 can 49% 40 13% 350ml 20 can 0 17%
Source: Canadean Source: Canadean
Source: Company Data; Bryan, Garnier & Co ests.
Returnable 300ml bottle Confronted with an aggressive price setting from Kirin Brazil that lowered the price on its Schincariol for the off premise brand, Ambev introduced the 300ml returnable bottle for the off premise in order defend its share of launched in 2013 to that market. In the meantime, the price for a returnable 300ml bottle is BRL1.7 for the liquid and counter discount prices BRL1 for the bottle. So a first time purchase price of BRL1.7 compares to a price of an aluminium from Schin 350m Skol can of BRL2.4/2.5, however any subsequent purchases cost only BRL1.7 per bottle. The BRL1.7 price point should allow it to compete with the Schincariol 350ml can priced at BRL1.8/1.9 (Kaiser tends to be priced at 1.9/2.0 and Itaipava at 2.1/2.2). So, the use of returnable bottles is key to have an answer to the competition from the value brands (mainly Schincariol). And because of the use of a returnable bottle, profitability is the same as for the company’s can business. Indeed, the advantage of beer in returnable bottles is that the investment in the bottle can be spread over 20-40 trips, significantly lowering the packaging costs. That packaging cost advantage seems to add up to 25% of the retail price of the cans and we believe that the cost advantage is fully passed on to consumers, (lowering average revenue but providing same profit for the brewer and hence increasing margin). An added cost advantage for the brewer is that it lowers the volatility of the packaging cost (i.e. less dependent on USD energy costs, PET or aluminium prices) and that it has the lowest carbon footprint. For the consumer the lower price point is an attraction although taking back the bottles to the point of sale is less practical.
Next to the element of an attractive competitive price, the returnable bottles should create some loyalty (and locks in price driven customers) and is an environmentally friendly packaging type. However, Ambev was not long the only one offering this type of packaging – it was quickly followed by Petropolis (Itaipava brand).
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Fig. 65: Brazil beer - breakdown off premise, Fig. 66: Brazil beer - the growth of the 2016e modern retail, 1999-2016e
Home 90 Trad. Retail Delivery 80 Modern Retail 2% 70 Home Delivery 60 Trad. 50
Retail m hl 40 48% Modern 30 Retail 20 50% 10 0
Source: Canadean Source: Canadean
Fig. 67: Mercadinho Tio Doca - São José dos Campos (near São Paulo) – with Ambev returnable crates at the left
Source: Mercadinho Tio Doca
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Fig. 68: Pit Stop at a gas station – container Fig. 69: Pit stop – bigger fridge doors for that can be closed at night keeping full crates cold
Source: Skol Source Skol . 300ml returnable bottles Although retailers are often against returnable bottles because they take valuable retailer space and are are successful in the off time consuming, Ambev has continued to push them and in 2016, they accounted for 23% of the premise group’s off-premise volumes. One way of helping retailers to accept the returnable bottle is the “Pit Stops” idea.
Fig. 70: Ambev market share in on- and off- Fig. 71: 300 ml returnable bottle in Ambev’s premise off-premise
23% 72%
15%
64% 4%
On premise Off premise 2014 2015 2016
Source: Bryan Garnier estimates Source: Ambev
Retailers are often opposed to returnable packaging due to space constraints and labour. Hence, to showcase the advantages of returnable bottles, Ambev has created the Pit Stops concept. Pit Stops are kiosks at fuel station and retail carparks, where consumers can exchange their returnable bottles. At Pit Stops at fuel stations, there are big fridges where consumers can buy full returnable bottles crates cold. However, at retailers' carparks, the Pit Stops offer coupons, which can be used at the retailer as a discount on new Ambev branded bottles. The Pit Stops are paid for by Ambev, but use retailers’ employees and the sales go to the retailer. Currently there are about 500 Pit Stops and the aim is to increase to 700.
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5.2.4. Distribution is key The Brazilian drinks market is very fragmented and with over 1 million sales point that are visited 1.5x per week on average, distribution is key. Ambev owns 110 distribution centres (covering 70% of volume) and works with another 20 independent distributors. The company used to have a policy to increase the volume covered by its own distribution centres allowing it to capture the distributors’ margin. However, over the past two years the number has not changed anymore as the remaining distributors have been operating very efficiently, often in remote areas.
Beer and soft drinks are produced in 37 plants spread across the nation (31 breweries, a soft drink concentrate factory, a label production unit, a crown cap factory, a glass plant and two malting plants).
Fig. 72: Direct distribution as % of total sales Fig. 73: Ambev – 31 breweries across Brazil
80% 70% 60% 50% 40% 30% 20% 10% 0%
Source: Ambev, Bryan Garnier estimates Source: Bryan Garnier
5.2.5. Innovations Since 2007, Ambev has been looking for ways to improve the health and relevance of its brands and innovation has paid an important part in that. One category of innovations is about the packaging (1litres returnable in 2008, the 300ml returnable in 2013). Another category is about the liquid (the double cold filtered Antarctica Sub Zero in 2009, Skol 360 in 2011 (rounder, lighter taste, easy drinking, less hoppy) Brahma 0,0% (2013) or the higher alcohol night club favourite Skol Beats Blue (2013), Green (2015) and Red (2016).
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Fig. 74: Extra Brahma Lager, Red Lager and Fig. 75: Skol Beats Red Weiss
Source: Internet Source: Skol
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6. Ambev financial outlook A depreciating Brazilian real has (in 2016) and continues (in H1 2017) to impact the cost of goods sold as 50% of these are linked to the USD (eg. aluminium, energy). At the same time, local governments have raised taxes by about 5% (in 2016) and this has been difficult to pass on to consumers on top of the inflation rate of 6%. And to make things even worse, Kirin Brazil was attempting to sell itself and wanted to push as many volumes onto the market as possible (losing money on an EBITDA level in 2016!), which kept pricing power very limited. All that resulted in a Brazilian EBIT margin tumbling to 36.4% in 2016 from 46.2% in 2015. With Brazil accounting for 57% of Ambev’s EBIT, group EBIT margin was dragged down to 35.0% from 41.0%. That also impacted AB InBev where EBIT margin fell to 29.2% from 31.6%. The first half of Brazil/Ambev/AB InBev will be more of the same. There was some surprise volume growth in Brazil (+3.4%) but that was because of a 20-day longer summer season (end of Carnival is end of summer) in Brazil. Without that volumes for the market would have been down 5% (Ambev gained a lot of share because of some strong commercial initiatives). At the same time, the competitive pricing environment was still difficult and the real weakness continued to inflate costs. We do not expect much of a change in the underlying picture in the second quarter. However, during the second half all is set to change: 1) locked in USD weakness becomes a tailwind (USD is hedged one year in advance); 2) volumes should back up as the macro environment is improving (GDP grew already in Q1 by 1.0%) and 3) a strong price increase of around 10%. This cyclical rebound should continue in 2018 and by the end of 2018, we expect the Brazilian operations to have returned to profitability levels of 2015 (except for some tax advantages).
What will drive Brazil in In the medium term the outlook for Brazilian beer consumption is very positive as increases in the medium term is disposable income should continue to drive volumes. On top of that beer consumption in the cyclical growth depending North/Northeast is still below the levels in the South and also that should add growth. Combining on disposable income, a both the cyclical rebound and a partial catch-up in the northern regions could drive per capita beer catch-up from the consumption in the medium term (2024 in our model) to 80 litres compared to 62 litres in 2016. Next North/Northeast, premiumisation and less to that the premiumisation is only just starting: premium beer makes up 12% of volumes but in a poll price competition. consumers gave a preference for premium beer of 30%, which is a level seen in mature markets but also South Africa and Chili are already at 24%.
Probably even more important is the consolidation in the Brazilian beer industry with Heineken having bought Kirin Brazil (at the end of May 2017), creating a stronger no. 2 player with a 17% share of the market (behind Ambev with 69%). We also believe that the no. 3, Petropolis which holds a 11% share of the market, has already been trying to sell itself (to SABMiller in 2015) and its current implication in the car wash scandal can only accelerate that process. The impact of this consolidation is less price competition but more choice and service for consumers.
Outside Brazil, business in Argentina continues to preserve profitability and there are some tentative signs that the macro is improving which should lead to a return of volume growth in the years to come. In Central America and the Caribbean, growth in the business relies on strong positions in the Dominican Republic (100% market share) and a growing share in Guatemala (through a better offering). In Panama, Ambev has just acquired the market leader (from SABMiller) and there is significant potential to improve margins to the level of the rest of the region (14% EBIT margin compared to 29%). In Canada, the company has a steady top-line with opportunities to further premiumise the market (imports, craft, near beer).
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Overall, we are expecting organic operating profit growth of 15.7% in 2017 and 21.7% in 2018 with net revenue organic growth of 10.6% and 3.4% respectively. Operating margin is set to return to 39.4% in 2018 close to the 41% of 2015 and far higher than the 35% in 2016. A return to expanding margin should result in renewed growth in EPS and we are expecting EPS of BRL.73 (+12.8%) for 2017, and BRL0.93 (+27.3%) for 2018. 6.1. Brazil back to volume growth by end-2017 Brazil is the company’s biggest business accounting for 57% of operating profit in 2016 (48% beer and 9% soft drinks). In this document we have painted a picture of continued good growth in the Brazilian beer market. Although population growth (also legal drinking age consumers) is slowing, there is still significant upside for beer consumption as disposable income grows. Already today Brazilians consume 68.2 litres beer per annum although it takes on average 20 minutes to earn a pint of beer. By comparison, in France it takes nine minutes and consumption per capita is 28 litres, in the UK it takes nine minutes and consumption per capita is 71litres and in the US six minutes is required for 73 litres per head.
This aspect of beer consumption will be driven by macro-economic conditions and there are the first signs that in the Q1 2017, GDP growth has returned, which bodes well for volume growth for the second half of the year onwards (assuming that the political crisis does not spoil the party) (for recent macro-economic data see page 28). The World Bank is forecasting 0.3% GDP growth for the full year and 1.8% for 2018. GDP growth is good for In the first quarter of 2017, there was already volume growth of 3.4% but that was mainly on the back volumes of market share gains as the market was still down by an estimated 0.5%. However, that decline was despite a much later Carnival (20 days later on 24th February 2017 vs 5th February 2016) which meant that Brazilian summer consumption of 250,000 litres per day vs winter consumption of 194,000 per day (BG estimates), lasted much longer as Carnival is regarded as the end of summer. We believe this lifted the market by 5.5% in Q1 indicating that the underlying trend was down 6%. For AB InBev it means that its underlying trend was down 2%. Going into the coming quarters, starting Q2, we look for a return to the underlying trend of around a 5% decline, before a cyclical boost kicks in by the end of the year. The outperformance by AB InBev comes on the back of a set of strong commercial initiatives around the Carnival period.
Fig. 76: Brazil GDP growth by quarter Fig. 77: Strong Brazil Carnival activations showcased Ambev’s brands throughout the country
1.8 1.0 0.64 0.2 0.3 0.0
-0.3 -0.6 -0.7 -1.0 -0.9 -1.2 -1.2 -1.5
-2.2 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 2017e 2018e
Source: FED, World Bank estimates Source: AB inBev
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Also by the second half of the year we would expect price discounting from Schincariol will ease, allowing others Brazilian brewers and also Ambev to raise prices ahead of inflation. Indeed, Heineken has acquired Schincariol and it is very unlikely that the brewer will continue to heavily discount (and lose money) the brand. Back in 2015/2016, heavy discounting of Schincariol was one reason why Ambev and other Brazilian brewers were not able to raise prices to capture both inflation (6.3%) and tax increase (5%). We believe that the tax increase could be captured over the next two years, on the back of lower price competition and a better economic environment.
Fig. 78: Brazil - annual inflation Fig. 79: Brazil – monthly inflation
16% 1.0% 14% 12% 0.5% 10% 8% 0.0% 6% 4% -0.5% 2% 0% -1.0% -1.5% Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17
May-17 Jan-17 Feb-17 Mar-17 Apr-17 May-17
National Beer Spirits National Beer Spirits
Source: IBGE Source: IBGE
Short term uptick in Operating profit margin suffered in 2016 falling to 36.4% for Brazil from 46.2% in 2015 as a decline margin likely in volumes (-6.5% because of the macro) and limited price increase (1.3% well below the general inflation of 6.3% due to the tax increase not yet passed on), put pressure on margins. We believe that the passing on of the 2016 tax increase will be finished by the end of 2018 and that we will also see volume growth from H2 2017 onwards. At the same time the company suffered significant cost increases as 50% of its cost of goods sold are linked with the USD evolution (but with a time lag of 1 year because of forward hedging). The USD-linked margin pressure is expected to have gone by Q4 2017 and on the contrary, will turn into a tailwind. The combination of a return to volume growth, passing on of the 2016 tax increase and the unwinding of the currency headwind, should allow for the company to return to the previous 2015 operating profit margins. However, there is one additional element that is unlikely to be recaptured and that is the BRL85m per quarter other operating income linked to the fiscal incentives for investments.
Strong 8% price increase In Q1, revenue per hl was still up against high levels of net price increases as the tax increase only in the second half, well gradually got implemented. However from Q3 2016 onwards price mix turned negative (that is price ahead of inflation of 4% net after tax) and that continued into Q1 2017. Also in Q2 2017, there will be a further drag although the picture will look more flattish, but from Q3 onwards Ambev should benefit from strong price/mix well ahead of the 4% inflation.
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Fig. 80: Brazil - Beer price/mix vs general Fig. 81: BRLUSD 1 year delayed impact inflation
12% price/mix 30% 10% inflation 20% 8% 10% 6% 0% 4% -10% 2% 0% -20% -2% -30% -4% -40% Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018 Q4 2018
Source: Company Data; Bryan, Garnier & Co ests. Source: Company Data; Bryan, Garnier & Co ests.
After the first signs of improvement in the first quarter on the back of better activation and a later Carnival, margin losses should diminish by the second quarter and net revenue per hl price growth in Q3 (diminishing price competition) coupled with accelerating forex tailwinds and volume growth in the last quarter of the year, should confirm the turnaround in the Brazilian operations.
Fig. 82: Latin America North - Year on year Fig. 83: Latin America North – Revenue and EBIT margin evolution EBIT margin
4% 45 50% 2% 40 45% 0% 35 40% 35% -2% 30 25 30% -4% 25% 20 -6% 20% 15 -8% 15% 10 10% -10% 5 5% -12% 0 0% -14%
-16% 2010 2011 2012 2013 2014 2015 2016 2017e 2018e 2019e 2020e Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 EBIT margin (rhs) Revenue (lhs, BRLbn) 15 15 15 15 16 16 16 16 17
Source: Company Data; Bryan, Garnier & Co ests. Source: Company Data; Bryan, Garnier & Co ests. 6.2. Central America and the Caribbean In Central America, Ambev’s operations are in Guatemala, El Salvador, Nicaragua, Honduras, where beer is mainly sold in returnable bottles through small retailers. Since the end of 2016, Ambev is owner of the SABMiller Panamanian business that it received from AB InBev in exchange for its businesses in Colombia, Peru and Ecuador. In the Caribbean, Ambev’s business is mainly in Cuba, the Dominican Republic and Barbados .
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The three main markets are, in order, Dominican Republic, Guatemala and Panama. In the Domencian Republic, Ambev has 100% of the market which offers opportunity to price in line with inflation but comparable items are tough for 2017 (Q1 volumes were up only 1%). In Guatemala, Ambev has a 30% share of the market and is the second largest brewer with the market leader being a local one, offering Ambev to gain share through its wider portfolio. In Panama, the company is the market leader with a 65% share. Ambev got the Panamas’ activities at the beginning of 2017 through an asset swap, swapping the smaller Colombia, Peru and Ecuador business (revenues of an estimated BRL300m and an operating loss of BRL130m) for the Panamas’ operations from SABMiller (revenues of BRL830m and operating profit of BRL130m). With these operations being less profitable carrying an operating profit margin of 14% compared to nearly 29% for the other businesses in this unit, and given the 65% market share, we believe that Ambev will be able to extract synergies and bring margin of Panama on par with the other CAC business.
Focussed M&A Relative good volume growth and pricing in line with inflation (which tend to be higher than Brazil’s) opportunities to double should allow the unit to continue to deliver steady progress. Furthermore, the area will see big M&A profits from the CAC opportunities for Ambev. First of all Ambev owns only 55% of the Dominican business and it has an region option to buy out in 2019 (after the results of 2018 are known) the other 45% (the owners of the 45% also have a put). We assume this is going to happen and probably very early into 2019. Secondly, Ambev has a stated objective to reach USD1bn of operating profits in this region (vs USD427m last year), which we believe, mostly will be driven by the M&A opportunities in this region. In our Guide to Brewing M&A from 21 March 2017 we have flagged Union de Bebidas y Licores (Guatemala), Companies Cervecera de Nicaragua (Nicaragua) as the two biggest opportunities in Central America.
6.3. Latin America South Ever since Ambev bought the Quilmes business in 2003, the Argentinean operations (55% of EBIT of Latin America South) have been operating in crisis. Still with the high inflation that is in the country, it is sometimes easier to keep margins. Volumes were up in the first quarter (+3% on comps of -10%) on the back of easy comps and also in the second quarter the company will have easy comps. Last year with inflation of over 40%, wage increases did not keep up in the first half, which led to a decline in disposable income and a 19.8% drop in volumes in Q2 2016 (the rest of the year was back to a low single digit decline). As a result the positive figures that we expect for the first half are unlikely to continue in the second half.
Given the company’s 72% share of the market, it does have a full portfolio of brands with mainstream Quilmes and Brahma; premium Budweiser, Stella Artois, Corona and Patagonia craft beer. Innovative line extensions for Bud Light, called Mixx Tail, is adding spirits flavour to beer. Mixx Tail was launched in 2014 and after the mojito flavour launch in 2015, the Mixx Tail family is already 2% of Ambev’s 2016 beer volumes in Argentina. Returnable bottles are successful in Argentina and already make up 90% of off-premise volumes.
If ever the economy There is plenty of scope for volume growth in the Latin America South region as consumption per improves in Argentina, head in Argentina is only 42 litres, in Chile 43 litres, in Bolivia 35 litres, in Paraguay 42 litres and in there is plenty of volume Uruguay 30 litres. But growth especially in Argentina will depend on the reviving of the economy upside (there are some significant measures to boost the agricultural production and export).
The 2017 margin should also receive a boost from swapping the loss-making operations in Colombia, Peru and Ecuador for the profitable Panamas’ business (which falls into the CAC region profits).
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Fig. 84: Argentina beer market shares, 2016 Fig. 85: Ambev main brands in Argentina, 2016
Stella Others Andes Norte Other Artois 4% 2% 4% 5% 5%
Budweiser CCU (distr. by 24% CCU) 8%
Brahma Quilmes AmBev 17% 59% 72%
Source: Canadean Source: Canadean . Fig. 86: Latin America South – Revenue and Fig. 87: Canada – Revenue and EBIT margin EBIT margin
20 43% 7 45% 18 42% 6 40% 16 41% 35% 5 14 40% 30% 12 39% 4 25% 10 8 38% 3 20% 6 37% 2 15% 4 36% 10% 2 35% 1 5% 0 34% 0 0% 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 2017e 2018e 2019e 2020e 2017e 2018e 2019e 2020e EBIT margin (rhs) Revenue (lhs, BRLbn) EBIT margin (rhs) Revenue (lhs, BRLbn)
Source: Company Data; Bryan, Garnier & Co ests Source: Company Data; Bryan, Garnier & Co ests 6.4. Canada In 2016, 12% of Ambev’s EBIT came from Canada, where the company is market leader (47% share according to Canadean, 44% share according to Ambev) with competition from Molson Coors and a number of smaller brewers. Ambev acquired the Canadian operations in 2004 when Ambev and Interbrew combined their operations and created InBev (which after the acquisition of Anheuser Busch in the US became AB InBev). The Canadean beer market before 2008 grew at about 1% p.a., but since 2008 it has been declining by over 1% p.a. Nevertheless, the population is still growing by 0.5% p.a. (over 1% pre 2008) and GDP grows at round 2% p.a. (1.1% in 2016). This discrepancy does indeed underline the fact that Canada is a mature market where disposable income is not a driver of beer consumption. Given limited market growth, the biggest opportunity for Ambev in Canada is trading up. Budweiser and Bud Light are the company’s main brands, but the company finds more growth and margins in driving sales of international premium beers (Corona), craft beers (only 5% of the market compared to 13% in the US) and the near beer formats like cider and RTDs .
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In 2014, the change in accounting method for its joint venture distribution companies from proportionate consolidation to equity accounting and the addition (from 1 march 2014) of Corona volumes after the acquisition of Grupo Modelo by AB InBev did negatively impacted Canadian margins, as the integration added volumes and revenues and a loss (cost of Corona which is imported). As a result, EBIT margin declined to 34.4% from 37.9%. Devaluation of the Canadian dollar from the end of 2014 to the beginning of 2016 (against the USD) from 1.1 to 1.3 did put additional pressure on operating margins which weakened further to 32.1% in 2015 and 30.6% in 2016. Furthermore, in 2016 Canadian beer volumes were down by 1.2% but price/mix was up by 1.9%. In the first quarter of 2017, that trend was similar with volumes declining by 0.9% and price/mix improving by 3.3%. For the full year, we are expecting a volume decline by 1% and price/mix improvement by 2.5%. In addition, the recent weakening of the Mexican peso against the CAD will impact imported Corona prices and is improving the cost efficiency of the imported portfolio. We believe that should help some 220bps margin expansion to 32.6% from 30.4%.
Fig. 88: Canada beer market shares, 2016 Fig. 89: Ambev main brands in Canada, 2016
Stella Artois Sleeman Lucky 3% 6% Others Lager Others Bud- 12% 4% 12% weiser Kokanee 32% Labatt 7% 47% Molson Lakeport Coors 7% Bud Light 35% Keiths 15% IPA Labatt 8% Blue 12%
Source: Canadean Source: Canadean
6.5. Financials Ambev Revenues: On the back of an expected gradual uptick in both volumes and prices in the Brazilian beer market all through 2017 and 2018, an improved volume picture in Argentina but coupled with still high inflation and currency devaluation against the BRL, and slow revenue growth in Canada, we are looking for organic revenue growth in 2017 of 10.6% and reported growth of 6.8%. On average for the next five year our organic growth estimate is at 10% and reported at 8%.
Stable Argentinean and EBIT: With the delayed impact of the BRL strengthening against the USD (hedging of on average 1 Canadian profits but year in advance), profitability of the Brazilian operations should improve dramatically in the second sharply rebounding Brazil half especially as we do expect some volume growth and significant price/mix in the second half. profits. Going into 2018, with further expected price rises ahead of inflation (to still capture the tax increases of 2016), margin of the Brazilian operations should restore to close to 2015 levels. Those in Argentina and Canada are expected to remain stable. Overall we are looking for organic EBIT growth in 2017 of 15.7% and 13% on average for the next five years. Reported EBIT growth should be 12% in 2017 and also on average for the next five years.
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Interest: With the BRL rate against the USD improving, the cost of hedging should go down. On top of that interest rates in Brazil are coming down as well, which should both lead to a substantially lower financial charge than in 2016. We are expecting that in 2017, financial costs will be down 28% and another 22% in 2018. Going forward, Ambev continues to generate a significant amount of cash (30% of revenues and 105-110% of net profit). Given the limited acquisition opportunities (there are still some in Central America and the Caribbean), the company is expected to continue to return cash to shareholders mainly through dividends which as an Interest on Capital are tax deductible, which share buy backs are not.
Fig. 90: Free cash flow % revenues Fig. 91: Use of operating cash flow, cumulative over the past five years (2012-2016 in BRL m)
7 45% 100 000 40% 6 80 000 35% 5 30% 60 000 4 25% 40 000 3 20% 2 15% 20 000 10% 0 1 5% 0 0% Other Capex EBITDA 2010 2011 2012 2013 2014 2015 2016 Dividends 2017e 2018e 2019e 2020e
EBIT margin (rhs) Revenue (lhs, BRLbn) Investments Free cash flow Operating cash… Operating Debt reduction Interest Interest and tax Shares buy back buy Shares
Source: Company Data; Bryan, Garnier & Co ests. Source: Company Data; Bryan, Garnier & Co ests.
Tax: The nominal tax rate in Brazil is 34%, but because of the tax deductibility of goodwill from acquisitions, interest on capital deduction and government tax benefits, the tax charge is 22-24%. And as long as there is no initiative to touch at the IOC, the company is confident that it can keep tax at that level. However, even if there is a change in IOC, the company will be looking for other measures to offset that including revision of its capital structure, leverage the company through the Labatt subsidiary.
Minorities: The BRL537m of minorities in 2017 were for about half from the Dominican Republic and half from the minorities in the local Brazilian businesses, the Colorado craft beer and the acquired juice brand.
Ambev’s impressive track record of EBITDA growth and margin expansion led by Brazil, reached a 50% high in 2013 before falling back to 45% in 2016 and we expect 44% in 2017. However, we expect that from the second half of 2017, EBITDA margins will veer up again as the USD weakening against the BRL does improve the company’s cost structure and the Brazilian macro-environment is supportive for both volume and price improvement. We are expecting that EBITDA margin for the company will be back at 47.0% in 2018 and 48.3% in 2019.
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Fig. 92: Ambev EBITDA and margin Fig. 93: Beer Brazil EBITDA and margin
35 000 52% 15 000 60% 30 000 50% 55% 25 000 48% 10 000 20 000 50% 46% 15 000 5 000 10 000 44% 45% 42% 5 000 - 40% - 40% 2007 2009 2011 2013 2015 2017 2019
EBITDA (BRLm, lhs) EBITDA (BRLm, lhs) EBITDA margin (rhs) EBITDA margin (rhs)
Company Data; Bryan, Garnier & Co ests. Company Data; Bryan, Garnier & Co ests.
A return to expanding margin should result in a renewed growth in EPS and we are expecting for 2017, EPS of BRL0.74 (+13.2%) and for 2018, BRL0.94 (+27.1%).
Fig. 94: P & L highlights Ambev
BRL m Dec-14 Dec-15 Dec-16 Dec-17e Dec-18e Dec-19e CAGR CAGR 11/16 17/22
Net Revenue 38,080 46,720 45,603 48,685 54,753 60,040 11% 8% reported growth 9.5% 22.7% (2.4%) 6.8% 12.5% 9.7% 8% organic growth 10.9% 12.0% 1.9% 10.6% 13.4% 10.6% 10% EBITDA 18,102 21,688 20,406 21,558 25,740 29,028 9% 11% A&P % revenues 11% 12% 13% 13% 13% 13% EBIT 15,827 18,779 17,105 17,886 21,671 24,513 8% 11% reported growth 3.0% 18.7% (8.9%) 4.6% 21.2% 13.1% EBIT adjusted 15,916 19,136 15,971 17,946 21,671 24,513 6% 11% adjusted growth 3.4% 20.2% (16.5%) 12.4% 20.8% 13.1% 12% organic growth 6.3% 11.3% (11.2%) 16.4% 21.6% 14.0% 14% Net financial expenses (1,475) (2,268) (3,702) (2,686) (2,093) (2,093) Interest charge 22.3% 32.0% 83.6% -10.0% -10.0% -10.0% 73% 78% Affiliates 17 3 (5) (6) (6) (7) Tax (2,007) (3,634) (315) (3,040) (4,014) (4,708) Minorities (297) (455) (537) (600) (735) (832) Net profit 12,066 12,424 12,547 11,554 14,824 16,873 reported growth 26.5% 3.0% 1.0% (7.9%) 28.3% 13.8% Net profit adjusted 12,231 13,059 10,305 11,662 14,824 16,873 4% 12% adjusted growth 27.6% 6.8% (21.1%) 13.2% 27.1% 13.8%
Source: Company Data; Bryan, Garnier & Co ests.
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Fig. 95: Per share data
BRL 204 2015 2016 2017e 2018e 2019e CAGR 11/16 CAGR 17/22 Share price 16.4 17.9 18.2 18.1 18.1 18.1 Average no of shares, diluted (m) 15,820 15,820 15,823 15,823 15,823 15,823 38% 0% EPS 0.76 0.79 0.79 0.73 0.94 1.07 (22%) 12% EPS adjusted 0.77 0.83 0.65 0.74 0.94 1.07 (25%) 12% adjusted EPS growth 3.4% 6.8% (21.1%) 13.2% 27.1% 13.8% Free cash flow 0.7 1.2 0.5 0.8 1.1 1.1 (30%) 12% Book value 2.7 3.1 2.9 2.8 2.7 2.6 (19%) (4%) Net dividend - common share 0.77 0.73 0.66 0.81 1.03 1.17 (16%) 12%
Source: Company Data; Bryan, Garnier & Co ests.
6.6. Valuation Ambev At BRL18.1, Ambev stock is trading at 24.6x 2017 earnings and 19.3x 2018 earnings compared to an average rating of 22.7x over the past five years, but excluding 2016, the average P/E was 21.4x. At our fair value of BRL19.6x the stock would trade at 20.9x 2018 earnings, which we believe would be fair given its 5 year EPS CAGR of 7% p.a. starting 2018 and its dividend yield of 5.3% (in 2018 at BRL19.6), delivering a total shareholder return of around 12 percent p.a.
Fig. 96: Stock market ratios (share price at 9 June 2017 of BRL18.1)
Dec-14 Dec-15 Dec-16 Dec-17e Dec-18e Dec-19e AVG 12/16 P/E average (x) 21.3 21.6 27.9 24.6 19.3 17.0 22.7 P/E high (x) 23.1 24.2 30.8 P/E low (x) 19.4 19.1 24.9 P/CF (x) 18.0 17.8 21.3 18.8 15.2 13.5 18.6 FCF yield (%) 4.4% 6.6% 2.9% 4.4% 6.0% 6.3% 4.9% P/BV (x) 6.1 5.8 6.4 6.5 6.7 7.0 6.1 EV/adjusted EBIT (x) 16.3 14.8 18.9 16.7 13.8 12.2 16.3 EV/EBITDA (x) 14.4 13.1 14.8 13.9 11.6 10.3 14.0 Net dividend yield 4.7% 4.1% 3.6% 4.5% 5.7% 6.5% 3.7%
Source: Company Data; Bryan, Garnier & Co ests.
Using a risk-free rate of 2.7%, a risk premium of 7%, a beta of 1.0x and a long term growth rate of 3%, we derive a fair value for Ambev of BRL20.5. Our long term growth rate of 3% might look low given the opportunities in the country. However, this has to do with the fact that all profits are returned to shareholders and no additional cash stays in the company to fund growth. Hence a growth rate which is dragged down through the pay-out ratio of over 100%. A 3% growth rate is assumed to be the country’s inflation by 2025 and that the company is not growing volumes anymore.
Fair Value for Ambev of Still from a stock market perspective, we would expect the shares to overshoot our Fair value given BRL20.5 per share, but the tremendous rebound we are expecting in profits for 2017, 2018 and 2019 with net profit growth earnings momentum is of respectively 13.2%, 27.1% and 13.8%. Indeed, in terms of PEGD (price earning to growth and probably going to drive dividend), the stock trades on 1.5x compared to 1.9x for AB InBev and 2.1x for Carlsberg and shares well ahead of that. Heineken.
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Fig. 97: DCF Valuation
BRLm Dec- Dec-17e Dec- Dec-19e Dec- Dec- Dec- Dec- Dec- Dec- 16e 18e 20e 21e 22e 23e 24e 25e Sales 45,603 48,685 54,753 60,040 63,912 67,615 71,542 74,321 77,222 79,539 EBIT 17,105 17,886 21,671 24,513 26,373 28,091 29,923 31,133 32,494 33,469 Taxes (402) (3,577) (4,334 (4,903) (5,275) (5,618) (5,985) (6,227) (6,499) (6,694) ) Operating profit after taxes 16,703 14,309 17,337 19,610 21,098 22,472 23,938 24,907 25,995 26,775 + Depreciations 3,301 3,672 4,069 4,515 5,004 5,525 6,076 6,659 7,265 -Investments in fixed assets (3,999) (4,412) (4,962 (5,441) (5,792) (6,128) (6,483) (6,735) (6,998) ) Total net investments in fixed (699) (740) (893) (926) (788) (602) (407) (76) 267 0 assets -Investments in working capital (1,581) 1,239 2,538 1,363 998 954 1,012 716 748 748 =Operating cash flow 14,424 14,808 18,982 20,047 21,308 22,824 24,543 25,547 27,010 27,523 Discount factor 0.98 0.89 0.81 0.74 0.68 0.62 0.56 0.51 0.47 Present value of free cash flow 14,473 16,926 16,310 15,817 15,458 15,166 14,403 13,893 12,917 Cum. present value of FCF 135,363 +Present value of terminal value 201,583 LT Growth 3.0% =Enterprise value 336,945 LT WACC 9.6% Adjusted net debt incl pension (730) Risk free 2.6% provisions (restated cash) Other liabilities and commitments Risk 7.0% premium Revalued minority interests (14,969) (Assoc. + revalued investments) 300 =Fair value 321,546 Fair value fully diluted per share 20.5
Source: Company Data; Bryan, Garnier & Co ests.
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Price Chart and Rating History
AB InBev
128.0
123.0
118.0
113.0
108.0
103.0
98.0
93.0
88.0 11/12/15 11/03/16 11/06/16 11/09/16 11/12/16 11/03/17 11/06/17
ANHEUSER-BUSCH INBEV Fair Value Achat Neutre Vente
Ratings Date Ratings Price 04/05/17 BUY EUR103.7 04/01/17 NEUTRAL EUR100.2 11/10/16 BUY EUR116.1 05/05/15 NEUTRAL EUR108.8
Target Price Date Target price 04/05/17 EUR115 14/12/16 EUR107 01/12/16 EUR109 28/10/16 EUR120 11/10/16 EUR124 07/04/16 EUR109 08/01/16 EUR111 25/11/15 EUR122 12/11/15 EUR110 24/09/15 EUR96 05/05/15 EUR109
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AB InBev 7. Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a BUY recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to NEUTRAL be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a SELL recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Distribution of stock ratings
BUY ratings 47.9% NEUTRAL ratings 36.2% SELL ratings 16%
Research Disclosure Legend 1 Bryan Garnier shareholding Bryan Garnier & Co Limited or another company in its group (together, the “Bryan Garnier Group”) has a No in Issuer shareholding that, individually or combined, exceeds 5% of the paid up and issued share capital of a company that is the subject of this Report (the “Issuer”). 2 Issuer shareholding in Bryan The Issuer has a shareholding that exceeds 5% of the paid up and issued share capital of one or more members No Garnier of the Bryan Garnier Group. 3 Financial interest A member of the Bryan Garnier Group holds one or more financial interests in relation to the Issuer which are No significant in relation to this report 4 Market maker or liquidity A member of the Bryan Garnier Group is a market maker or liquidity provider in the securities of the Issuer or No provider in any related derivatives. 5 Lead/co-lead manager In the past twelve months, a member of the Bryan Garnier Group has been lead manager or co-lead manager No of one or more publicly disclosed offers of securities of the Issuer or in any related derivatives. 6 Investment banking A member of the Bryan Garnier Group is or has in the past twelve months been party to an agreement with the No agreement Issuer relating to the provision of investment banking services, or has in that period received payment or been promised payment in respect of such services. 7 Research agreement A member of the Bryan Garnier Group is party to an agreement with the Issuer relating to the production of No this Report. 8 Analyst receipt or purchase The investment analyst or another person involved in the preparation of this Report has received or purchased No of shares in Issuer shares of the Issuer prior to a public offering of those shares. 9 Remuneration of analyst The remuneration of the investment analyst or other persons involved in the preparation of this Report is tied No to investment banking transactions performed by the Bryan Garnier Group. 10 Corporate finance client In the past twelve months a member of the Bryan Garnier Group has been remunerated for providing No corporate finance services to the issuer or may expect to receive or intend to seek remuneration for corporate finance services from the Issuer in the next six months. 11 Analyst has short position The investment analyst or another person involved in the preparation of this Report has a short position in the No securities or derivatives of the Issuer. 12 Analyst has long position The investment analyst or another person involved in the preparation of this Report has a long position in the No securities or derivatives of the Issuer. 13 Bryan Garnier executive is A partner, director, officer, employee or agent of the Bryan Garnier Group, or a member of such person’s No an officer household, is a partner, director, officer or an employee of, or adviser to, the Issuer or one of its parents or subsidiaries. The name of such person or persons is disclosed above. 14 Analyst disclosure The analyst hereby certifies that neither the views expressed in the research, nor the timing of the publication of Yes the research has been influenced by any knowledge of clients positions and that the views expressed in the report accurately reflect his/her personal views about the investment and issuer to which the report relates and that no part of his/her remuneration was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report. 15 Other disclosures Other specific disclosures: Report sent to Issuer to verify factual accuracy (with the recommendation/rating, No price target/spread and summary of conclusions removed). Summary of Investment Research Conflict Management Policy is available www.bryangarnier.com
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Important information This document is classified under the FCA Handbook as being investment research (independent research). Bryan Garnier & Co Limited has in place the measures and arrangements required for investment research as set out in the FCA’s Conduct of Business Sourcebook. This report is prepared by Bryan Garnier & Co Limited, registered in England Number 03034095 and its MIFID branch registered in France Number 452 605 512. Bryan Garnier & Co Limited is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 178733) and is a member of the London Stock Exchange. Registered address: Beaufort House 15 St. Botolph Street, London EC3A 7BB, United Kingdom This Report is provided for information purposes only and does not constitute an offer, or a solicitation of an offer, to buy or sell relevant securities, including securities mentioned in this Report and options, warrants or rights to or interests in any such securities. This Report is for general circulation to clients of the Firm and as such is not, and should not be construed as, investment advice or a personal recommendation. No account is taken of the investment objectives, financial situation or particular needs of any person. The information and opinions contained in this Report have been compiled from and are based upon generally available information which the Firm believes to be reliable but the accuracy of which cannot be guaranteed. All components and estimates given are statements of the Firm, or an associated company’s, opinion only and no express representation or warranty is given or should be implied from such statements. All opinions expressed in this Report are subject to change without notice. To the fullest extent permitted by law neither the Firm nor any associated company accept any liability whatsoever for any direct or consequential loss arising from the use of this Report. Information may be available to the Firm and/or associated companies which are not reflected in this Report. The Firm or an associated company may have a consulting relationship with a company which is the subject of this Report. This Report may not be reproduced, distributed or published by you for any purpose except with the Firm’s prior written permission. The Firm reserves all rights in relation to this Report. Past performance information contained in this Report is not an indication of future performance. The information in this report has not been audited or verified by an independent party and should not be seen as an indication of returns which might be received by investors. Similarly, where projections, forecasts, targeted or illustrative returns or related statements or expressions of opinion are given (“Forward Looking Information”) they should not be regarded as a guarantee, prediction or definitive statement of fact or probability. Actual events and circumstances are difficult or impossible to predict and will differ from assumptions. A number of factors, in addition to the risk factors stated in this Report, could cause actual results to differ materially from those in any Forward Looking Information. Disclosures specific to clients in the United Kingdom This Report has not been approved by Bryan Garnier & Co Limited for the purposes of section 21 of the Financial Services and Markets Act 2000 because it is being distributed in the United Kingdom only to persons who have been classified by Bryan Garnier & Co Limited as professional clients or eligible counterparties. Any recipient who is not such a person should return the Report to Bryan Garnier & Co Limited immediately and should not rely on it for any purposes whatsoever. Notice to US investors This research report (the “Report”) was prepared by Bryan Garnier & Co Limited for information purposes only. The Report is intended for distribution in the United States to “Major US Institutional Investors” as defined in SEC Rule 15a-6 and may not be furnished to any other person in the United States. Each Major US Institutional Investor which receives a copy of this Report by its acceptance hereof represents and agrees that it shall not distribute or provide this Report to any other person. Any US person that desires to effect transactions in any security discussed in this Report should call or write to our US affiliated broker, Bryan Garnier Securities, LLC. 750 Lexington Avenue, New York NY 10022. Telephone: 1-212-337-7000. This Report is based on information obtained from sources that Bryan Garnier & Co Limited believes to be reliable and, to the best of its knowledge, contains no misleading, untrue or false statements but which it has not independently verified. Neither Bryan Garnier & Co Limited and/or Bryan Garnier Securities LLC make no guarantee, representation or warranty as to its accuracy or completeness. Expressions of opinion herein are subject to change without notice. This Report is not an offer to buy or sell any security. Bryan Garnier Securities, LLC and/or its affiliate, Bryan Garnier & Co Limited may own more than 1% of the securities of the company(ies) which is (are) the subject matter of this Report, may act as a market maker in the securities of the company(ies) discussed herein, may manage or co-manage a public offering of securities for the subject company(ies), may sell such securities to or buy them from customers on a principal basis and may also perform or seek to perform investment banking services for the company(ies). Bryan Garnier Securities, LLC and/or Bryan Garnier & Co Limited are unaware of any actual, material conflict of interest of the research analyst who prepared this Report and are also not aware that the research analyst knew or had reason to know of any actual, material conflict of interest at the time this Report is distributed or made available..