SABMiller Not Quite Fizzing on Emerging-Market Growth

The world's third-largest brewer by sales and the second-largest by volume, SABMiller (NASDAQOTH: SBMRY  ) offers investors an uncommon level of exposure to emerging markets. Approximately 70% of the company's profits come from emerging markets like Latin America, Africa, and Asia, where SABMiller goes head-to-head with the likes of Anheuser-Busch InBev (NYSE: BUD  ) , Carlsberg, and Heineken, while the company has largely unprioritized the more developed European and North American markets.

SABMiller is not a cheap stock on current multiples, but beer consumption in many of the company's markets is still well below developed-world standards. As disposable incomes rise, SABMiller will look to leverage that volume growth for better margins while also upselling customers to more premium brands.

Third-quarter update mostly OK
SABMiller provided the market with a business update Tuesday morning, consisting just of updated revenue growth figures. Overall organic revenue growth came in at 4%, just shy of sell-side expectations for 5% growth. Volume was up 2%, with 7% growth in soft drinks offset by 1% growth in lager volume. Growth was led by Africa and Asia-Pacific, where volumes are still growing at a mid-single-digit rate. Europe and North America remain weak, with low-single-digit volume declines.

Looking to leverage past investments
One of the key components to the SABMiller story in the coming years is the extent to which the company can leverage growth-oriented capital investments made in recent years. SABMiller acquired numerous beer brands around the world in the 2000s and then backed those acquisitions by investing in modern brewery and distribution facilities. Now the challenge for the company is to drive greater consumption and market share to maximize the value of those investments.

In China, for instance, beer is still very much a regional market. SABMiller's joint venture with China Resources Enterprise, CR Snow, holds the largest share in the country at 22%, while Tsingtao is around 16% and Anheuser-Busch InBev trails at 11%. In many cases, leading brands in one province are all but ignored in neighboring provinces, and that makes it more challenging for SABMiller and A-B InBev to establish and build national brands.

Fragmented markets are less problematic for SABMiller in Africa, where the company has greater than 50% share in many countries. The problem in Africa has considerably more to do with incomes, where SABMiller's products have to compete with sorghum and millet beers brewed locally and outside of local tax oversight (making them much, much cheaper). With South Africans drinking about six times more beer than the rest of Africa, but with beer about four times more expensive (relative to local earnings) outside of South Africa, there's a sizable long-term opportunity for consumption growth as incomes improve.

M&A rumors seem off-target
SABMiller is a relatively popular subject in M&A rumors, but I attribute this more to reporter and analyst boredom than any real substance. Anheuser-Busch InBev has reportedly considered making a bid for SABMiller, and while this would represent enormous global consolidation of the beer industry (putting about 40% of the global market in one company's hands), the companies don't actually overlap all that much outside of the U.S. and China.

SABMiller has also been named as a potential buyer of Constellation Brands, Molson Coors, Heineken, and Carlsberg. Neither Constellation nor Molson Coors would make that much sense to me, given the weaker organic growth prospects in North America and the strong existing market share for Anheuser-Busch InBev. Likewise with Heineken and Carlsberg, which would add exposure in the less-desirable European markets and not really improve the company's position in Latin America (though Carlsberg has a large position in the Russian beer market).

If SABMiller does a larger M&A transaction, and I consider that to be a large "if," I would expect either a deal for Castel Group (the second-largest brewer in Africa) or a deal for a large Coca-Cola bottler in a developing/emerging region. SABMiller is already one of the largest Coca-Cola bottlers in the world, and Coca-Cola has shown an interest in having its bottling operators held by large, well-established companies.

The bottom line
With the company's greater than 20% share in China, India, Russia, and most of Africa, I am bullish on SABMiller's emerging market growth potential. Looking at the early results from the company's acquisition of Foster's in Australia, though, I have to acknowledge that it has shown some skill at driving better results from brewing operations in developed markets as well.

I'm looking for mid-single-digit long-term revenue growth from SABMiller, coupled with significant margin and free cash flow leverage as the company runs more volume through existing infrastructure. That works out to a fair value in the high $40s today, suggesting that the shares have gone too far for the time being. While SABMiller still looks priced to generate an annual return in the neighborhood of 6% to 9%, investors considering these shares today have to have a long-term horizon to find much appeal.

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