The BMW Method
BUD, my Final Analysis...

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By tman77
July 1, 2005

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[Ed's Note: The evaluation method used here is from the book by Robert Hagstrom, The Warren Buffett Way.]

Anheuser Busch, why would Buffet have bought?

S&P 500 CAGR over the past 5 years for comparison. As everyone on this board knows, this will vary depending on the starting price you select, but it is roughly -2.50%.

1. Does the company sell brand name products that are likely to endure?
Yes. The core product is Alcoholic Beverages under the Budweiser name brand. It is sold worldwide and is recognized as a leading brand for beer around the world.

2. Is the business of the company easily understood?
I think so. Its core operations involve the production and distribution of beer.

3. Does the company invest in and operate businesses within its area of expertise?
Principally the company acts as a worldwide production and distribution network for its beverages. Anheuser has been in operation for over 100 years. In addition, the company also operates several theme-parks under the Busch Gardens name.

4. Does the company have the ability to maintain/increase profitability by raising prices?
I believe so. I believe the market for premium alcoholic beverages (beer, wine & spirits) is always supporting higher price levels. There is some concern that there has been a major shift in America/World away from beer towards Wine/Spirits. While of somewhat concern, I believe this is both a short term trend. Even in a declining use market, I believe Anheuser could continue to raise prices on its product, similar to market conditions faced by cigarette manufacturers, minus the tremendous legal issues.

5. Is the company, looking at both long-term debt, and the current position, conservatively financed?
At year end 2004, the company had $8.278 Billion in total debt on the balance sheet, while only having $228 Million in cash and cash equivalents. While this debt to cash level seems quite high, I believe the company is effectively using leverage (debt) to help increase its returns on equity. Free cash flow for the last year was $1.85 Billion, indicating the company could pay off all debt within 5 years. This is a long time period, but the company has been spending nearly all of its free cash flow on share repurchases for the past few years. This indicates management believes the company is significantly undervalued and is acting rationally to increase shareholder value.

The current ratio is .92. On a pure ratio evaluation it should be above 1.0.

Long term debt to shareholders equity is 3.08. This is a fairly high level of debt to equity, but the company has done an excellent job of using debt wisely while maintaining excellent credit ratings, thereby enjoying the benefits of low interest charges on its debt.

6. Does the company show consistently high returns on equity and capital?

       ROE     ROIC   ROCE
2000   37%            15.6%
2001   41%     16%    15.3%
2002   54%     17%    17.5%
2003   72%     21%    18.4%   
2004   83%     24%    18.4%
Wow! The ROE numbers are eye-popping. However, this is to be expected with a highly leveraged company as the use of debt will inflate ROE. Looking at Return on Capital gives a better view of a leveraged company.

The Return on Invested Capital percentages shows the company is making market beating returns as compared to its cost of capital, and ROIC has been increasing over the past few years.

To calculate ROIC (2001-2004) I used NOPAT/Invested Capital as defined in

Of all the calculations I made, I have the least confidence in this one as this is my first time calculating ROIC, and there exists several different definitions for ROIC.
(It took me as long to read about, and run through the ROIC numbers as it did for me to compile the rest of this report.)

Since my confidence level in my ROIC calculations wasn't sky high, I added in the Return on Capital Employed as reported in Anheuser's annual report.

7. Have the earnings per share and sales per share of the company shown consistent growth above market averages over a period of at least five years?

        EPS       SPS
1999   1.47     12.16
2000   1.69     13.21
2001   1.89     14.33
2002   2.20     15.27
2003   2.48     16.50
2004   2.77     18.14
So EPS has grown at a CAGR of 13.51% while Sales per Share have grown at a CAGR of 8.33%. The company has increased profitability in excess of the % increase in sales. An investor should try and understand what is causing this. Regardless, both earnings and sales have outpaced the S&P 500 over this time period.

8. Has the company been buying back its shares, and if so, has it bought them responsibly?
Yes, over the past 5 years the company has reduced the number of shares outstanding from just under 1 Billion to 755 million, or a CAGR of -3.10%, (negative is a positive in this sense). It has used the bulk of free cash flow to repurchase shares when management could have paid off debt. This is insightful, as it points to the fact that management believes share repurchases are a better alternative to paying off debt. This is likely due to the fact that the company enjoys low interest rates on its debt. Management is also sending shareholders a message that buying back shares is a better use of cash than returning it to them via dividend payments. Ultimately due to share repurchases, owner earnings have grown at a CAGR of above 16.67% a year for the past 5 years, yet the stock price has increased by a CAGR of only 3% per year over that same time period. This indicates the company's value is outpacing its share price by a wide margin.

9. Has management wisely used retained earnings to increase the rate of return to shareholders?

         EPS      DPS
2000   1.69     .634
2001   1.89     .692
2002   2.20     .758
2003   2.48     .833
2004   2.77     .937
Total: 11.03    3.85
Using the approach of Mary Buffett and David Clark in "The New Buffettology", we could calculate the percentage increase in earnings per share resulting from the retained profits. EPS in 2000 were $1.69 and in 2004 were 2.77. Thus from the total retained earnings of $7.18 (Retained Earnings minus Dividends paid) earnings have increased a total of $1.08, or a percentage increase of 15.04%; market beating returns over this period. This meats Buffet's requirement to show an increase in market value for every dollar retained.

10. Is the company likely to require large capital sums to ensure continuing profitability?
Not Likely. Currently capital expenditures are roughly equivalent to depreciation. Should the company need to invest large amounts of capital to open a new brewery or distribution centers, it will be from direct demand from the market.

At this point, I feel pretty good about investing in BUD. A valuation would tie it all together. In this instance, discounted cash flow is a good approach. This method works well for companies that do not require large recurring investments of capital. It does not work well for companies such as manufacturing firms which have large fixed assets that are constantly in need of replenishment.

Owner earnings currently at 1.85 Billion have grown at a CAGR of 16.67% over the past 9 years... Will grow Owner Earnings/Free Cash flow at 15% a year for 5 years, 7% for 5 more years, than terminal growth of 4% a year thereafter. Discount rate of 10%... Market Cap. Value in today's dollars of $72 Billion, current Market Cap is just shy of $36 Billion, so a 50% margin of safety, without dividend yield.

I posted the above valuation a few days ago, but Ceberon suggested my assumptions might be a bit high, so I reposted using a growth rate of 7% a year for 10 years, followed by a terminal growth rate of 3% with a 9% discount rate. This produced a Market Cap value of $48 Billion, or a 25% margin of safety, without dividend yield.

For the second valuation scenario, one could say, "Yes but if you back out the $8.5 Billion in debt, you are essentially left with the current fair value of the company." True, but as the above analysis has shown, BUD management is doing a superb job of using leverage effectively. Should the share prices rise to what management believes is a full or overvalued level, based on their recent actions they could be expected to both pay off debt and increase the dividend payout. The point here is to recognize management has been rationally and competently managing capital allocation for the best interests of the shareholders.

As always, comments, corrections, questions, criticisms are all welcome. Most/all of this financial information is available via ValueLine Reports, but I didn't have access to that service. I used Morningstar, Yahoo, and the Anheuser Annual Reports as my sources, as well as various articles from the

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