BUD - Anheuser-Busch InBev: Bud Light Scandal Aside The Stock Is A Sell

2023-07-19 10:16:37 ET

Summary

• AB InBev's lack of a solid competitive advantage or 'moat' and the recent Bud Light controversy has led to declining profitability.
• Despite geographic diversification, AB InBev faces intense competition and has no oligopoly like Coca-Cola or Pepsi.
• Financially, the company is struggling due to rising costs and changing consumer preferences, with COVID-19 significantly impacting gross margins.

Introduction

A wise man once said that there are things one should not talk about a party, politics, religion, and money. I agree with that saying, in fact, I'll go further and argue that companies and writers on this site (myself included) would be wise to do the same… well maybe excluding the money part. I suppose that point cannot be avoided on an investment-focused site.

Remaining unbiased is essential for investors.

It's easy to forget that as the US has found itself in the middle of a culture war. No matter what side you find yourself on in that debate I'm sure you can feel the tension, I know I can. Debate has always been a fundamental part of the American experience, and that free debate is one of the greatest features of our great democracy.

But what makes our democracy great, and America great, may not necessarily be what makes a company or an investor great, especially when the debate is over something immaterial to the company.

Applying politics to investing can lead us to be less curious about different fields, or industries, that may be a no-go based on our belief systems but lucrative investments.

No company, of recent memory, has been so central in the zeitgeist as AB InBev's ( BUD ) Bud Light.

That is why, within today's article, I wanted to take a step back. Yes, AB InBev has taken a ton of flack and lost significant market share when it's Bud Light promotion sparked an unintended boycott. But at the same time, it is still a company, and it is still producing cash flow. In this article I'll give you my sober assessment of AB InBev's business, politics aside, and why I believe, that the stock is a Sell.

The Basics of Beer

As a preface, I am of the belief that many investors naturally overcomplicate things, they break down a company's business down to the smallest identifiable parts and then spend precious time obsessing over the small details.

That is the exact opposite of my investment philosophy.

Over the long term, what makes a company a worthwhile investment are its sustainable competitive advantages, or as others call it, a moat. A moat can come from many places, network effects, innovation, branding, and real estate are just some of the inputs which can lead to a moat. Ultimately it is this "moat" which provides for predictable cash flow.

Companies without a moat must compete against peers with their similar products until profits are taken down close to zero, that's capitalism. On the other hand, companies with a moat are able to be price-setters as their product often has few if any, quality replacements.

Think about successful brands within the consumer packaged industry, consider Coca-Cola ( KO ), Doritos ( PEP ), and Monster Energy ( MNST ) as examples. These are all examples of companies with a moat based around the strength of their brands, brands that have been built over many decades.

As a result of that great investment, these companies usually compete with just one or two other products in their category creating an oligopoly of sorts.

Now think about beer brands and which ones are your favorites… I'd bet you can name quite a few, I know I can. Now ask yourself whether you like trying new beers or sticking with just one brand. I know personally, I like to try new beers, especially at breweries when I travel. I bet many of you will feel the same as I do.

How many people think similarly about Cola and chips? How many people venture out to discover new chip brands and cola every time they are out about? Not many. That's why brands like Doritos and Coca-Cola are so valuable, many view them as irreplaceable in a way that beer brands are not.

To better understand just how diverse the beer industry is you may be interested in reading this article which, though somewhat outdated, shows you just how many popular beer brands there are and which companies own those brands. AB In Bev has some good representation on the list with Michelob Ultra, Bud Light, Stella, and Busch but it is far from the duopoly of Coke and Pepsi.

Due to the relatively high fungibility of these products, I believe companies in the beer industry, generally, have a very low moat. The Bud Light controversy may have damaged the bud light brand, but I would argue, it wasn't so strong in the first place.

Geographic Diversification

Luckily for AB InBev, they are diversified geographically meaning the Bud Light controversy is unlikely to impact sales of their goods in other markets. So sure, Bud Light may have suffered permanent brand damage, but for AB InBev it's just one of many brands in one region of many. That's why I believe that even if that damage were to extend to other US brands owned by AB InBev I doubt it would have a significant long-term impact.

While alcohol consumption in the US, is on the decline, this geographic diversification can help to shield them from shifting consumer tastes. For context, AB InBev is reported to operate in over 100 different countries with over 500 beer brands.

But geographic diversification can only do so much, at the end of the day AB InBev still does not have an oligopoly like Coke or Pepsi, they are still subject to brutal, profit-killing competition.

Now that I've addressed my long-term strategic concerns with the business let's examine its financials.

Financials

AB InBev's value, as all companies ought to be valued, is simply the function of its future cash flows discounted back to today. So, let's see what is driving those cash flows.

Revenue and Gross Margins

Beer companies can make money in two ways, selling more cases of beer, and increasing the profitability of those cases. They can increase the profitability by reducing the cost per case, or increase the selling price.

In the case of AB InBev, we see that they have been successful in increasing their revenues but it has come at the cost of margins. Looking at the chart above we can see that COVID-era has radically reduced the profitability of AB InBev as gross margins are off more than 10% from their high.

Increased materials costs, combined with increased labor costs and transportation costs alongside changing consumer preferences have harmed the company financially. Brands suffering from scandals typically lack pricing power so that lever for growth is currently on ice too.

Assembly and transportation are largely a function of labor and there are simply too few blue-collar workers in developed countries, especially the US. The brands are not as strong as many think, and due to the scandal, they are weaker than ever.

That's why I believe earnings are likely to stall out around current levels.

International expansion may wind up being AB InBev's savior in all of this, but international expansion is very expensive and far from a sure bet. Entering a new market requires extensive investment in advertising, establishment of a local distribution network, and compliance with foreign governments.

Growth regions must excel for AB InBev to make up for its troubles in the US.

Valuation and Conclusion

On some metrics AB InBev looks cheap, it trades for less than 20x earnings and 2x sales, but compared to peers, especially Molson Coors ( TAP ) AB InBev's valuation might actually be steep. Molson Coors trades at 14.5x forward earnings while AB InBev trades at 18.5x which translates to an earnings yield of 5.4% for AB InBev.

Interestingly, the 3-Month T-Bill yields 5.4% risk-free but the T-bill is risk-free.

In conclusion, AB InBev's low moat and vulnerability in the beer industry, highlighted by the recent Bud Light controversy, present challenges for the company. Financially, AB InBev has seen declining profitability due to rising costs and changing consumer preferences. Despite geographic diversification, intense competition limits its pricing power.

For those reasons, I rate AB InBev a " Sell ".

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