Both the American depositary receipts and the Belgium-traded ordinary shares of Anheuser-Busch InBev (BUD)/(ABI) have fallen more than 20% over the past two months, underperforming the 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. We are reiterating our $126 fair value estimate for the ADRs and 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 a 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 volume is pressured. However, AB InBev’s 68% volume share gives the firm a cost advantage and greater financial flexibility over competitors, which should position it well in this premiumizing market for the long term. Fears of 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 estimate for 2019 earnings per share.
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Philip Gorham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.