Case Studies

Update on ABI’s Global Markets

Anheuser-Busch InBev (ABI), whose stock rose 28% during the period and is now the biggest investment of the Fund, contributed the most to returns in the first quarter.  ABI’s stock price declined in the last few months of 2018 due to concerns over the company’s reported results for the third quarter of 2018.  Our research efforts at the end of last year — including in-person meetings with AmBev (ABI Brazilian unit), Coca-Cola FEMSA, and Coca-Cola Andina during a trip to Brazil and subsequent calls with management at ABI and Heineken — suggested that this operating performance weakness was temporary rather than indicative of a new, lower trendline for the business.  Of perhaps greatest concern to the market, ABI third quarter revenue and profits reflected a slowdown in Brazil, which is the company’s second largest market after the United States.  ABI materially increased its prices in July, which Heineken did not follow until September.  The impact to both companies’ volumes from this two-month price differential was interpreted as a possible enduring change in the relative positioning of their respective brands in Brazil.  Instead, our findings indicate that this shift was transient.  Further clouding the picture, while ABI sells 64% of all beers sold in Brazil, Heineken has higher market share in the lower-priced value segment.  A weak Brazilian economy has led consumers to trade down from the mainstream segment where ABI sells most of its beer, but we expect ABI to retake market share when the economy strengthens.

Relatedly, Heineken volumes in Brazil were (and still likely are) flattered by a near-term push from the Coca-Cola bottling system to grow short-term sales to enhance its bargaining position during an ongoing arbitration process between the two.  Heineken is trying to break its Brazilian distribution contract with local Coke bottlers, which is not scheduled to expire until 2022. Following its purchase of Kirin in Brazil, Heineken would like to pull its brands from the Coke system and add them to the existing Kirin distribution network, which would let Heineken retain a much higher percentage of the profits from its sales in the country[1].  Interestingly, we believe this decoupling of Heineken from the Coke system would increase profits for both Heineken and ABI.  With the loss of access to the Coke distribution network, Heineken will lose half of its points of sale and therefore lose volume; ABI is best positioned to pick up most of these volume losses.  Beyond Brazil, ABI’s commencement of high-inflation accounting in Argentina in the third quarter seemed to spook other market participants.  This change essentially accounted for a year’s worth of devaluation in the Argentine peso all in one quarter and thus was more noise than signal.  Encouraged by our research, we took advantage of ABI stock price weakness in the fourth quarter of last year and early in the first quarter of this year to add to the Fund investment in the company.

We also have been focusing our research efforts on improving our understanding of the craft beer space.  We recently joined the Brewers Association and attended their Craft Brewers Conference in Denver.  In the U.S. market, craft brewers have taken substantial market share from ABI and other mainline brewers in the last fifteen years, and we want to appreciate better the changing competitive landscape within the craft sector and what it means for ABI in the future.  Craft sales in the U.S. are stagnating, and the sector is becoming increasingly fragmented as consumers are demanding local beers with many trying a new beer on every occasion.  Because of this overall softness in the segment and the flood of new craft brewers over the last decade, distributors have regained the upper hand in negotiations with these small brewers, which has pinched their margins and endangered their viability.  Accordingly, the promise of breakout successes like those previously enjoyed by The Boston Beer Company and Sierra Nevada seems less attainable now than in the past.  Because of this lower ceiling and declining margins, new brewers are required to build their business models to succeed as a tap room (capturing higher-margin on-premise sales) rather than as a regional beer company that relies on third party distribution.  Craft beer will remain an important category in the U.S., but we expect this new reality to diminish the headwind that ABI has faced from this category.

The global beer market is oligopolistic with pockets of more intense competition.  Captive distribution precludes small brewers from easily gaining a foothold in emerging markets.  Of the other global brewers, we admire Heineken business in particular.  Last week, the company reported strong volume numbers in several countries where it competes with ABI, while ABI captured share in other markets.  We monitor the competitive balance of these two brewers closely.  Molson Coors, on the other hand, is struggling to keep up both domestically and internationally.  We recently met with its management in Denver, and we have questions about their strategic plan and the cohesiveness of the team in place to execute it.  Some of these weaknesses will likely present themselves as opportunities for ABI to exploit.

Overall, positive ABI fourth quarter numbers, which they reported in February, helped clarify some of the uncertainty surrounding Brazil and validated our previous expectations for ABI future growth.  While we were rewarded during the first quarter, we still believe ABI remains meaningfully undervalued.

[1] This situation is complex, but the short-term pressures from it are important to recent results.  Heineken previously signed a contract with the Coke system, thanks to the latter’s superior distribution in the country, to distribute Heineken brands in Brazil.