Both the Belgium-traded ordinary shares and the ADRs of Anheuser-Busch InBev (BUD) have fallen by over 20% over the past two months, underperforming the derating consumer staples sector, which has declined 6% over the same period, as measured by the S&P Consumer Staples Index. During that time, we have seen nothing that changes our opinion of the power of the business to earn economic profits in the long term, and we are reiterating our $126 fair value estimate for the ADRs, but raising our valuation of the ordinary shares to EUR 118 from EUR 112 to account for the recent strength of the U.S. dollar against the euro. We still believe AB InBev represents one of the strongest franchises in global consumer staples, with a wide economic moat, and we believe there is compelling value in the shares for long-term investors.
We see three reasons for the relative underperformance of AB InBev: severe weakness in Brazil, a risk of a dividend cut, and an historically high multiple. All three are legitimate concerns, but we think all are overblown. Brazil is currently going through a turbulent economic period, and industry volumes are pressured. However, AB InBev’s 68% volume share gives it a cost advantage and greater financial flexibility over competitors, which should position it well in this premiumizing market for the long term. Fears over a dividend cut are not without foundation, but we believe the dividend can be sustained and increased at a low-single-digit rate until the firm reaches its optimal leverage ratio of 2 times debt/EBITDA by 2020. The high level of acquisition debt not only provides a risk to the dividend, but also distorts the near-term earnings power of the business. When debt has been paid down, we expect the SABMiller acquisition to be accretive to earnings, and the stock trades at just 14.6 times our 2019 estimate of EPS.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.
Philip Gorham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.