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Big Beer: An AB InBev – SABMiller Merger Is Not Going to Happen

Heineken (HEINY)—the world’s third-largest brewer— made news over the weekend by rejecting a merger offer from rival SABMiller (SBMRY)—the world’s second-largest brewer.  Apart from creating a global beer-brewing juggernaut, SABMiller’s offer was an attempt to fend off a potential bid by Anheuser-Busch InBev (BUD), the world’s largest brewer, according to Bloomberg.

I’ve got news for you: A mega beer merger isn’t happening.

Consider the trouble Anheuser-Busch InBev had in getting its 2013 acquisition of Mexican brewing group Grupo Modelo approved.  BUD had to sell its American distribution rights to Corona and Negra Modelo to Constellation Brands (STZ) in order to keep the regulators happy, but they didn’t get it right the first time.  The U.S. Department of Justice initially torpedoed the deal on anti-competitive grounds.

If BUD had a hard time sealing the deal with Modelo—a medium-sized player at most among global brewers—then it’s hard to see the regulators allowing a merger between two of the big three.  Anheuser-Busch InBev, SAB Miller, and Heineken have global market shares of 20.0%, 9.6% and 9.3%, respectively.

Drilling down into specific markets, the numbers get a lot bigger.  Anheuser-Busch InBev reports market shares of 47.2% of the American market, 58.4% of the Mexican market and 56.0% of the Belgian market.  Were BUD to make a serious offer for SABMiller, it would have to divest so much of the combined company as to make the deal unworkable.

Yet it appears that BUD’s interest is legitimate. What’s going on here, and why the sudden interest by Big Beer in getting even bigger?

In a word, “growth,” or the distinct lack of it in the developed world.  U.S. beer sales fell 1.9% last year, even while craft beers enjoyed an impressive 17.2% pop.

Craft beers—which include everything from the larger independent brands like Boston Beer’s (SAM) Samuel Adams and the Spoetzl Brewery’s  Shiner Bock (a favorite of mine)to the new  upstart brewpub down the street—now account for 7.8% of all American beer sales, with no sign of slowing down.  This is bad news for the likes of Bud, Miller and Coors, but it actually gets worse.  Even the large, mainstream imports—which have been a major source of growth in recent decades—saw declining sales last year of nearly 1%.  Americans are drinking less beer overall and being a lot more choosy about the beer they do drink.

It’s not just Americans who are sobering up; European beer sales have been disappointing for the better part of the past decade.  Even Germany—the mecca for beer—is seeing declines in drinking.  Germans have been drinking less beer every year for seven years running.

The one bright spot for Big Beer is its exposure to emerging markets and particularly to frontier markets like Africa.  As I noted in “SABMiller: Right Now, the King of Stocks,” AB InBev gets about 52% of its earnings from Latin America, including Mexico. But its exposure to Africa is close to nil.  Meanwhile, SABMiller’s African operations are responsible for 31% of profits, about 17% of which is from South Africa.

This is the real story behind all of the Big Beer merger talk: BUD’s management is salivating at the prospect of getting access to Africa’s up-and-coming consumers.  African per capita GDP has more than doubled in the past decade, and according to Deloitte, seven of the 10 fastest-growing countries in the world are in Africa. As African living standards rise, so do the standards of African drinkers.  But today, only about 20% of the beer consumed in Africa is branded or bottled. The remaining 80% is essentially glorified moonshine.

Is there a trade here?

Maybe.  As I wrote in July, SABMiller is a stock worth buying on any pullbacks.  The stock had a pullback in July and early August, dropping about 10% peak to trough.  But the weekend’s merger talk sent shares sharply higher on Monday, to fresh 52-week highs.

At 28 times trailing earnings, SABMiller stock is pricey.  Don’t buy at these levels.  But if we get another pullback following a failed acquisition attempt by AB InBev, then I would recommend seizing the opportunity.

This post first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Russia Risk to Western Companies (Mostly) Overblown

Russia made news last week but shutting down four Moscow McDonald’s restaurants, ostensibly for health code violations.  But the move is widely viewed as Russia’s latest “countersanction” against the West in retaliation for Western sanctions against Russia for its involvement in Ukraine.  McDonald’s first Russian restaurant—opened in 1990 when Russia was still the communist Soviet Union—is the most-visited McDonald’s location in the world.

While Russia is one of the company’s biggest markets outside of North America, the closures are expected to be temporary and are not expected to inflict major long-term damage on McDonald’s Corp (MCD).

Other Western companies may indeed feel the pinch, and not just from sanctions or official bullying.  Russia’s economy is also contracting, potentially taking consumer spending with it.

Let’s take a look at Western companies with strong ties to Russia and assess their potential Russia risk.

I’ll start with German luxury automaker Daimler (DDAIF), maker of the iconic Mercedes Benz.  Daimler has been steadily increasing its presence in Russia, and as recently as July the company planned to start manufacturing Mercedes cars in Russia.

Daimler’s sales in Russia have also, up until very recently, been growing at a blistering pace.  In the first half of 2014, Daimler sales in Russia were up about 20% after rising about 19% in 2013.  But with Germany now leading the sanctions charge, its companies are now at risk.  And Western automakers are a likely candidate in the event that there is another round of countersanctions.

Daimler’s Russia sales could come grinding to a halt, and that seems to be the fear driving investors in the stock over the past month.  German stocks, as measured by the iShares MSCI Germany ETF (EWG), were down about 13% from the June peak to the early August trough, though they have recovered modestly since then.  Over the same period, Daimler was hit harder, down about 18% before recovering slightly.

Should Daimler investors be worried?

No.  Though Russia was a promising market for Daimler—and may be again once Ukraine fades from memory—Russia is not one of Daimler’s biggest markets.  Daimler sold 1.5 million cars globally last year.  Only 44,376 were sold in Russia, or less than 3% of the total.  Were that amount to fall to zero—which is unlikely—it would not be catastrophic to Daimler’s business.

Taking a bigger picture, while Russia is a promising export market for Germany, Germany’s exposure to Russia is overstated.  Russia accounts for only about 3% of total German imports, making Daimler pretty typical as far as German companies go.

Meanwhile, Daimler sells for a very reasonable 10 times earnings and sports a 3.6% dividend yield.

Moving on, let’s take a look at European brewers.   Heineken (HEINY) recently warned that its sales volumes were down more than 10% in Russia, and this was before the effects of any countersanctions.  But as a diversified global brewer, the slowdown in Russia is not particularly damaging for Heineken.  Heineken’s most promising growth markets are in Africa, Latin America and Asia.  The entire Central and Eastern European region, of which Russia is a part, accounted for only 10.1% of operating profit last year.

I can’t say the same for rival Carlsberg (CABGY).  Carlsberg—which is based in Denmark—is the largest brewer in Russia and generates about a third of its sales by volume in the country.  Carlsberg saw is beer sales volumes  in Eastern Europe fall by 13% in the second quarter, and again, this is before the effects of any countersanctions by Moscow.  Consumer confidence has been sagging for months, and the Russian government has been discouraging beer consumption for months as part of a public health drive.

Carlsberg is not expecting a speedy recovery either; the company indicated it might be closing some of its 10 breweries in Russia.

I’ve been a major Heineken bull for years based on its strong competitive position in Africa, and I do not see any developments in Russia having much of an impact.  But I would probably steer clear of Carlsberg for the time being.

What about oil and gas companies?  Russia is, of course, one of the biggest players in the global energy industry, and virtually every international oil major has some connection to the country.

One U.S. company potentially at risk is Exxon Mobil (XOM).  Exxon partnered with Russian energy giant Rosneft (OJSCY) in 2011 to develop Russia’s massive artic reserves in a deal that could eventually  be worth as much as $500 billion.  Exxon had negotiated a very favorable tax deal in exchange for its investment and expertise, and by Russian estimates the Artic region in question has as much oil and gas resources as Saudi Arabia.

As a visible symbol of American industry, you might think that Exxon would be a very easy target for Russian reprisal.  Though thus far, Putin has made no indication that he intends to punish Exxon, and in fact, as recently as mid August Putin praised Exxon as an “old and reliable partner.”   While Putin is no doubt itching to thumb his nose at the West, his relationship with the oil majors is simply too important to blow up over a political row.

The bigger risk to Exxon is not punishment from Russia, but rather the reality that it might not be able to invest as much as originally planned due to Western sanctions that limit the export of oil production equipment to Russia.

What about Exxon stock?

Despite being near its 52-week high, XOM is not particularly expensive, particularly by the standards of today’s market valuations.  XOM trades for less than 13 times forward earnings and yields a respectable 2.8% in dividends.  A deepfreeze in Exxon’s Russia operations would take a bite out of growth.  But at current prices, you’re not exactly paying a premium.

XOM is a decent buy at today’s prices.  Should it sell off on any escalation in tensions with Russia, I would consider it a strong buy.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 


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Big Beer: How Does SABMiller Stack Up?

After two years of flat trading, “Big Beer” stocks have enjoyed a raucous keg party since the first quarter.  Anheuser-Busch InBev (BUD) and Heineken (HEINY) are both up around 20% since the beginning of February, but the real standout has been SABMiller (SBMRY): up more than 30%.  The S&P 500 is up about 10% over the same period.

After the recent run-up—which has not been accompanied by a proportionate surge in earnings—all three megabrewers now fetch relatively high earnings multiples: AB InBev, Heinekenand SABMiller trade for 19 times, 18 times and 22 times forward earnings, respectively.

Of course, when you consider that the S&P 500 trades for 20 times earnings, those valuations look a lot more reasonable.  Outside of an elite handful of companies—think Coca-Cola (KO) or Disney (DIS)—big beer names have the most recognizable brands in the world.  With branding power comes premium pricing and higher returns on equity.  Add to this financial strength and the recession-resistant nature of beer demand, and you have a recipe for a premium stock valuation.  All else equal, the Big 3 megabrewers should trade at a significant premium to the S&P 500.

But the single biggest reason why I love Big Beer is a long-term holding is its prime placement in the developing world.  Big Beer went on a two-decade acquisition spree that left each of the Big 3 with outsized exposure to emerging markets.  This explains why beer stocks get hit particularly hard in January, when it looked as if emerging markets might be heading for a currency crisis, and why they have rallied hard in the months that followed.  As investors have regained confidence in emerging markets, they’ve regained confidence in Big Beer.

How does this shake out geographically?  Let’s take a look.  AB InBev gets about 52% of its earnings from Latin America, including Mexico.  North America takes another 38%, and Europe and Asia make up most of the remainder. AB InBev has very little presence in Africa. While we think of BUD as an American company, it’s actually a Latin American company with its headquarters across the Atlantic in Belgium.

Heineken breaks out its numbers a little differently.  “The Americas,” which lumps the United States and Canada in with developing Latin America, accounts for about 26% of profits.  “Asia-Pacific” accounts for about 18% of profits.  Western and Central/Eastern Europe bring in 27% and 10% of profits, respectively.  But the real story is its exposure to fast-growing Africa: the Africa/Mideast region accounts for 21% of profits, a proportion I expect to see massively grow in the years ahead.  (Figures add up to more than 100% due to rounding and adjustments; all data from Heineken 2013 annual report.)

But if I like Heineken’s geographic mix, I love SABMiller’s.  SABMiller has the highest exposure of the three to Africa.  SABMiller’s African operations are responsible for 31% of profits, about 17% of which is from South Africa.  But not to be neglected, SABMiller also gets 33% of its profits from Latin America, 13% from Asia Pacific and 11% and 12% from Europe and North America, respectively.

Why am I so bullish on Africa’s prospects?  Because frankly, it is it the last real investment frontier.  Per capita GDP has more than doubled in the past decade, and according to Deloitte, 7 of the 10 fastest-growing countries in the world are in Africa.   As African living standards rise, so do the standards of African drinkers.

What is most attractive about a frontier market like Africa is that the competition is not other beer brands; it’s home brew. Only about 20% of the beer consumed in Africa is branded or bottled. The remaining 80% is brewed at home or by small commercial establishments.

I’m not talking about trendy craft brews here; I’m talking about moonshine.  As incomes continue to rise in Africa, so will consumption of bottled beer.

So, what does all of this mean for SABMiller’s stock?

I wouldn’t expect a repeat of the 30% returns enjoyed over the past five months.  And for that matter, I’m not expecting much from the broader market either given today’s prices.

But I would highly recommend picking up shares of SABMiller on any pullbacks.  Among Western multinationals, SABMiller is uniquely well-positioned to profit from the rise of Africa’s middle classes.  This is one of the most powerful macro trends of the next decade, and you want your portfolio to be on the right side of it.

This article first appeared on MarketWatch.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Yum Brands Expanding in the Wrong Country

Yum Brands (YUM), the parent company of KFC, Pizza Hut and Taco Bell, is on the offensive: Its Taco Bell chain will be adding 2,000 new domestic locations in the next 10 years.

To put that in perspective, there are currently about 6,000 Taco Bell restaurants scattered across America. This means that the chain will be increasing its presence by fully one-third in a country that already has no shortage of fast-food taco joints.

Most of these new units will be franchises (as opposed to company-owned), and Yum Brands is specifically targeting women and minority franchisees in an effort to attract “new blood.”

I’ve been known to frequent Taco Bell a little more often than my doctor might like; it seems I have a weakness for tacos that sell for less than a dollar. But my own (admittedly awful) dining preferences aside, Yum’s massive domestic expansion raises a few questions.

I’m a big fan of the franchise restaurant model as opposed to the company-owned restaurant model. It turns a gritty, hypercompetitive and low-margin business into a higher-margin brand-management company.

But strong brands don’t need to go out looking for franchisees; they normally have would-be franchisees knocking on their doors. Yum brands’ aggressive recruiting efforts may be creating major headaches for YUM stock down the line if some of these inexperienced new franchisees find themselves in over their heads.

But more fundamentally, why the sudden domestic push? Yum Brands jumped into emerging markets with both feet decades ago, primarily through expansion of KFC, and emerging markets have long been the company’s primary engine of growth. In fact, I would go so far as to say that Yum is first and foremost an emerging-market company. YUM stock gets 60% of its revenues from emerging markets and has more than 13,000 emerging market locations — nearly double that of McDonald’s (MCD).

The sudden emphasis on the American market raises questions about management focus. Sure, China’s growth is slowing, and 2013 has been a rough year for emerging markets in general. But refocusing on the American market seems like a major distraction in what has otherwise been a remarkably successful expansion strategy.

Furthermore, its Taco Bell restaurants have major competition from Chipotle Mexican Grill (CMG) and its imitators, and that’s a battle the company will have a hard time winning. Chipotle is wildly popular among younger and more health-conscious Americans for its use of organic ingredients.

Taco Bell has responded by taking its menu upmarket and in a healthier direction. For example, its Fresco Menu and Cantina Bell Menu are both massive steps up from its traditional low-budget options.

It’s tempting to dismiss this as putting lipstick on a pig, but the quality of Taco Bell’s food really has improved in recent years. Whether it has improved enough to realistically compete with Chipotle is another story, however.

So, what about YUM stock? Is it a short?

No — or at least, not yet. YUM stock trades at 21 times expected 2014 earnings, which is a little on the expensive side. But at 2.6 times sales, the company is considerably cheaper than MCD stock (3.43 times sales), CMG stock (5.27 times sales) or Burger King stock (BKW) (5.82 times sales).

And as I mentioned before, Yum Brands’ strong presence in China and other emerging markets is a major plus.

So, I’m not shorting YUM stock any time soon. But I’m not buying it either — not until I see management refocus its efforts where they are likely to bear the most fruit.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.

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Want Emerging Markets Exposure? Go for Global Beer

From the news, you would think that Brazilians had stopped drinking beer.  Ambev (ABV), the Brazilian brewing giant, is expected to see mildly negative volume growth this year, as slower economic growth and rising inflation appear to have dampened the party spirits.

Ambev—which trades as a separate ADR despite being controlled by global brewer Anheuser-Busch InBev (BUD)—has followed the Brazilian market lower this year.  In dollar terms, Ambev is down about 17% from its February high vs. a loss of 15% on the popular iShares MSCI Brazil ETF (EWZ).

So, after its recent spill, is Ambev a buy?

At current prices, Ambev is not a compelling buy.  True enough, the brewer is one of the purest plays on the rise of Latin American living standards.  This is a durable macro trend and, in my view, one of the most  attractive investment themes of the next decade.  But trading at 23 times expected 2013 earnings and yielding only 2.3% in dividends, it can’t be considered a screaming bargain.

What about its behemoth international partner, Anheuser-Busch InBev?

BUD is the largest brewer in the world and one of the most diversified.  It counts over 200 beers in its product portfolio, claims 6 of the 10 most valuable beer brands in the world, and it sells over half of its beer by volume in emerging markets.

BUD isn’t “cheap” trading at 20 times earnings, but for a high-quality, defensive dividend grower with unparalleled international reach, I wouldn’t consider it expensive.

Earlier this week, I wrote about my favorite way to invest in emerging markets: Western-domiciled multinationals with an oversized presence in the developing world, or what I like to call “Emerging Markets Lite.”  Anheuser-Busch InBev would certainly make the cut here.

But as attractive as BUD is, it’s not my favorite.  That distinction belongs to Dutch-based megabrewer Heineken (HEINY).

Heineken depends on Western Europe for a larger chunk of its revenues than Anheuser-Busch InBev, which has muted investor enthusiasm.  But Heineken gets about half of its revenues and more than 60% of its sales by volume from emerging-market countries, and it has excellent positioning in Africa, the last real investing frontier of any size.

Africa already accounts for 22% of Heineken’s sales by volume, and this percentage will only increase with time as African consumer trade-up from home brews to branded beer.

Heineken trades for a reasonable 17 times earnings and pays a modest 1.8% dividend.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long HEINY. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”  This article first appeared on InvestorPlace.

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