Markets & Finance

It's Good to Be the King of Beers


By Howard Choe With about 49% of the U.S. beer market, Anheuser-Busch (BUD), the name behind Budweiser, Michelob, and Busch, is truly the "king of beers." As the dominant domestic and global brewer (measured by barrels shipped), Anheuser enjoys many benefits, principally favorable brewing industry trends, that should help sustain its lead.

A stock with these qualities is quite appealing in an uncertain market environment (see BW Online, 01/15/03, "Beer Beats Bullets"). S&P has assigned this reliable consumer staple (it has delivered 16 consecutive quarters of double-digit earnings-per-share growth) its highest investment ranking of 5 STARS (buy).

Thanks to its dominance of the large U.S. market -- its closest competitor holds only a 19% share -- Anheuser was also the world's top brewer at the end of 2001 (latest available figure), with about 11% of global volume. It operates 12 breweries in the U.S. and two overseas, and competes internationally in Britain, Spain, Canada, Japan, Ireland, China, and Latin America.

PRICE PUSHER. To make matters worse for its competitors, Anheuser continues to gain market share by perennially outperforming the industry. In 2002, its U.S. shipment volume increased 2.1%, to 102.5 million barrels, compared to growth of 1.3% for the overall industry. (This is a marked improvement from Anheuser's 1.2% volume growth in 2001, vs. 0.6% for the industry.) The focus on growth is exemplified by its investment in China, the world's second-largest -- and fastest-growing -- beer market. Anheuser has a 4.5% equity stake in Tsingtao, China's leading brewer, but will increase that to 27% in the first quarter of 2003.

The "king" calls the tune when it comes to pricing in the U.S. Anheuser usually implements increases in two stages annually. It initiated the first stage of its 2003 increase this past October, raising prices by about 3% on products that account for nearly 45% of its volume. Its main competitors, Miller (SBMQY) and Coors (RKY), soon followed suit.

The price hikes appear to have worked well, as volume trends remained solid in the December quarter. This bodes well for the next round of increases (on 20% of volume), which should come in the first quarter of 2003.

MARKETING MUSCLE. The benefits of Anheuser's leading market share are evident in the substantial economies of scale it realizes in distribution, product breadth, and marketing. Its distribution strength is without equal, and its exclusive wholesaler network, which sells 63% of its total volume, is a significant competitive advantage. Anheuser's wholesalers have leading shares in most markets and are able to provide customers with the top brands in nearly every beer category.

While Anheuser also tops the industry in terms of marketing outlays, it does so at the lowest cost per barrel vs. its rivals. Due to its ability to leverage its size and efficiencies, Anheuser can utilize more resources (as a percentage of sales) to market its products. For the nine months ended September 30, 2002, it increased media spending by 46%, to nearly $300 million. This is a stark contrast to Miller, which boosted spending by 23%, to nearly $200 million, and Coors, which actually cut its marketing budget by 2%, to $151 million.

The beer industry overall shares Anheuser's strong fundamentals. The pricing environment remains favorable. Unlike most industries in this weak economy, brewers have been able to hike prices without impairing volume growth. We believe this is a result of the moderate level of increases, and we point out that the real (inflation-adjusted) price of beer is lower today than it was 10 years ago.

SUDS VS. VINO. Favorable demographics, particularly the trend toward premium beers and the growing population of 21- to 29-year-olds, also contribute to the industry's health. Beer-drinkers in this age group are vitally important because their loyalties are still unformed -- and they tend to consume a disproportionate amount of beer relative to wine and spirits.

Based on historical growth rates and the current operating environment, we at S&P project beer volume to increase at 1% to 1.5% over the next five years, which should help to bolster revenue growth.

Anheuser should continue to benefit as it realizes stronger net revenues per barrel, reflecting increased consumption of higher-margin premium products (Budweiser, Michelob, Killarney's, and Tequiza) and successful price hikes. Margins should also get help from continued productivity improvements. We expect shipments to increase 2% in 2003, with a 2% to 2.5% rise in revenue per barrel.

SOME CAVEATS. That should flow through to Anheuser's bottom line. We expect 12% EPS growth in 2003, to $2.47. On an S&P Core Earnings basis, stock-option and pension-related expenses would have collectively lowered 2001 reported EPS by nearly 12%. For 2002 and 2003, we project these expenses to collectively lower Core EPS by 10% and 5%, respectively.

A few caveats are worth mentioning. At S&P, we consider the key investment risks for Anheuser to be:

The potential that a deteriorating economy could induce consumers to increase consumption of subpremium beers, thus impairing profit margins.

A negative consumer reaction to price increases, causing reduced consumption.

A possible significant increase in excise taxes, which could trim sales.

But we remain bullish on Anheuser, whose shares recently traded at 20 times our 2003 EPS estimate, a modest premium to the p-e multiple for the S&P 500-stock index. The stock is attractive in light of Anheuser's dominant and growing market position, accelerating free cash flows, and consistent and dependable earnings growth. Our

discounted cash-flow model arrives at a value of $65, well above the recent price of $49 and our 12-month target price of $58. Our target price assumes that the market can support the shares at a p-e of 23.5, which is at the high end of Anheuser's historic p-e range. Analyst Choe follows food and beverage stocks for Standard & Poor's


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