by Ivan Martchev | May 17, 2013 9:00 am
Overwhelming evidence shows us that as emerging markets develop, local consumers find creative ways to spend that newly found cash on Western lifestyles. Regrettably, this notably increases consumption of branded tobacco and alcohol products.
Those unburdened by socially responsible investing, though, can invest in such long-term trends in a fairly straightforward way.
For extended periods of time in 2011 and 2012, Latin America’s largest brewer, Companhia de Bebidas Das Americas (ABV), or AmBev, had a market capitalization substantially higher than that of Anheuser-Busch InBev (BUD). Typically, I don’t mind seeing one beer company out-competing another, but the situation here was peculiar as AmBev was a majority-owned subsidiary of InBev.
This was the stock market saying that the developed market assets of InBev were worth much less as they were capitalized at a monstrous discount to the valuation of the emerging-market assets of the same company.
InBev owns 61.9% of AmBev and the Zerrenner Foundation owns 9.6%, while 28.5% is free-floating stock. Part of AmBev’s steep valuation was due to the small float. Still, there was much more to this story.
AmBev consistently showed better profitability with an operating margin of 42.39% at last count, while InBev delivers 31.66% on the same metric. (According to GAAP, a majority-owned subsidiary gets its financial performance consolidated with those of the parent, so InBev’s remaining assets were even less profitable than 31.66% — the average of all BUD assets — considering the large operating profit that came from AmBev.)
I believe those AmBev margins will remain high as total beer consumption (as well as premium beer consumption as percentage of total) tends to improve with rising GDP per capita. Since premium beer carries higher margins for the producer, AmBev has years to get to developed-market penetration rates in the emerging markets it operates in. No developed market is the same — they consume much more beer per capita in the Czech Republic than in France, for instance — but the long-term trend in AmBev’s markets is decidedly up.
It is no wonder that many investors chose to invest in the “crown jewel” directly, as those emerging markets’ beer operations are not only more profitable, but they also grow faster. This is why ABV shares trade at 9.4 times book and 8.2 times sales with no net debt on the balance sheet, while BUD shares trade at 3.8 times book and 3.9 times sales. Even though it has shrunk somewhat over the past year, a sizable valuation gap is likely to remain because of the more dynamic nature of the beer business in emerging markets.
The situation in tobacco is similar, where emerging markets consumers’ trade up to Marlboro or Camel, while ditching local cheaper brands.
In this case, we can compare a purer international and emerging-markets play in the face of Philip Morris International (PM) and a totally U.S.-centered Altria (MO).
Tobacco sales for global-branded products typically see volumes grow internationally, while in the U.S. the market has been registering a slow decline since 1981. Still, even though U.S. cigarette volumes might decline 2% to 3% a year, in many cases price hikes make up for the volume decline. Clearly, this trend will run into serious trouble at some point, but given how long this has been managed well and given how many smokers still remain in the U.S., this might last for much longer than nonsmokers would like.
Altria shows five-year sales growth of 1.93% using the aforementioned price-hike strategy. Altria earnings are meaningless as the company has regular charges for constant ongoing restructuring, which are aimed to maximize cash flow and maintain and increase a juicy 4.8% dividend. Philip Morris International shows 4.36% five-year sales growth and consistent volume growth over the same period.
Clearly, Philip Morris International has more room to grow volumes and sales — and dividends, for that matter — as its point of volume declines is at an unknowable point in the future, likely many years from now.
Still, this company derives all of its sales outside of the U.S. While investors are facing a healthy volume growth environment with PM, they are also facing a rallying dollar at present. It used to be that multinationals in the S&P 500 tended to see a sales and earnings boost from currency translation, but in 2013 they have been experiencing a headwind.
I am not a dollar bull, but am a euro and a yen bear, which simply means that if those major currencies are declining against the dollar, the dollar — as much as it is fashionable to hate it — is rising. Since I do not believe the declines in the yen and euro are over, I think the currency headwind with PM is a valid issue for 2013, particularly because we do not know how much of (and how, if at all) its currency exposure it has hedged. That said, it is the purest major emerging-markets tobacco play.
Finally, what we observe with cigarettes and beer, we see with spirits.
Diageo (DEO) is the world’s largest spirits producer, with a major exposure to beer to boot. I have the same currency concerns I have with Philip Morris International, but if currency exposure is well-managed, rising volumes will make it worth considering the shares over the long haul. The company owns the legendary Johnnie Walker brand along with many other famous spirits.
Over the past five years, it has stressed innovation to expand sales in growth markets. So while JW fans have long been familiar with Red, Black, Green and Blue labels, they have recently seen Double Black, Gold Reserve and Platinum as well.
I am sure we will see many more “labels” from Diageo not only with Johnnie Walker, but also with its other beer and spirits brands, which will boost sales and volumes for this premier global spirits producer.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds positions in MO, BUD, ABV, DEO and PM for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities. Investing in non-U.S. securities including ADRs involves significant risks, such as fluctuation of exchange rates, that may have adverse effects on the value of the security. Securities of some foreign companies may be less liquid and prices more volatile. Information regarding securities of non-U.S. issuers may be limited.
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