BUD: Anheuser-Busch Should Provide Heady Returns in a Downturn

The following is a reprint of my January 10, 2008 RealMoney column

John Hughes and Scott Maragioglio recently wrote that there are only three groups worth playing: international, commodities and defensive sectors like consumer staples. Within the consumer staples, I think one worthwhile play is Anheuser-Busch (BUD).

For one thing, there are the rumors of price increases that would help sales and margins. With overall beer sales flatter than the beer you set down and then forgot about, price hikes remain the most likely source of growth.

For another thing, the company is acknowledging the slower sales growth prospects by improving its cost structure and returning cash to shareholders. In the process, its EPS growth has the potential to exceed estimates by a wide margin.

Something that stays steady in a recession and throws off cash I will be able to use to buy recession bargains in other sectors? Sounds like a plan worth considering.

104 Million Barrels of Beer on the Wall

Anheuser’s latest sales report illustrates the good, the bad and the defensiveness of BUD. U.S. shipments to wholesalers were 104.4 million barrels in 2007 — up 2.1 million barrels or 2 percent over 2006, but nearly all of that growth (1.7%) was due to acquired and import brands. Sales of the domestic staples remain stuck in neutral.

But the import brands presumably sell at higher prices per barrel, which could contribute top-line growth even with flattish unit volume. For the first nine months of 2007, that is exactly what happened – sales grew 5.7%, well ahead of unit growth.

Up until now, the higher pricing has not resulted in higher margins. In fact, gross profit margin of 36.9% in 2007 was down from 37.1% in 2006. However, the planned across-the-board price increases could help on that front.

Anheuser-Busch generated more than $2 billion of free cash flow in the last 12 months, giving it a free cash flow yield of 4.4% against the current enterprise value of $46 billion. Although this yield is not the most compelling I have seen, it does offer a premium to the Treasury yield and would require cash flow growth of just 2% annually to meet my double-Treasury yield benchmark rate. Not to mention the value of a stock that could zig up as the market zags down.

Of the cash flow it generates, BUD shareholders receive the lion’s share. Earnings not paid out as dividends have gone to share buybacks, resulting in a 2% reduction to shares outstanding over the last year. Of course, the share buybacks have resulted in reductions to shareholders’ equity and elevated BUD’s price/book ratio to 11x, three times the industry average.

The flip side to a low book value, however, is a high return on equity. In Anheuser’s case, ROE exceeds 50%. With the high ROE available to fund further share repurchases and dividends, the company should continue to grow its EPS at a faster rate than its sales. In fact, the high ROE suggests a (theoretical) sustainable EPS growth rate of nearly 30%, though I would expect at least half of this growth to be offset by a declining price/book ratio.

Anheuser-Busch also owns a 35% stake in Mexican brewer Grupo Modelo. This investment contributed $540 million to net income in the first nine months of 2007, but because it is accounted for using the equity method there was no top-line contribution. Modelo is growing far faster than Anheuser-Busch itself, which should lead to increased contributions, which will cause EPS to grow at a significantly faster rate than sales, as well as a higher value for its ownership position.

All of these factors contributing to higher EPS growth bring me to the main reason I am intrigued by BUD: the potential for EPS growth to exceed the 8.5% analyst expectations over the next five years. The analysts have planted their expectations smack in the middle of the company’s 7-10% guidance for long-term growth, but the factors I have outlined lead me to believe double-digit growth is within reason.

Beer has been enjoyed for thousands of years (and many prior recessions and economic slowdowns.) It is even possible, though not likely, that a slower economy could help blue-collar beer regain some of the share it has lost to highbrow wines and spirits in recent years.

It’s not something that I would rely on as an investment thesis, but it does give me greater comfort.

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