Quick: Name five companies that could be great dividend stocks over the next decade. I would wager that beer conglomerate Anheuser-Busch InBev (BUD 0.13%) did not appear on that list.
But why would it? The stock does pay a dividend, but it yields just 1% at the current share price, and it's been a dog of an investment, down more than 50% over the past five years.
But it's the future that matters, right? So I'm going to show you why Anheuser-Busch will be an outstanding long-term dividend stock over the next decade.
A balance sheet full of problems
Nearly a decade ago, the bigwigs of the alcohol industry -- specifically those running Anheuser-Busch InBev and SABMiller -- decided to see what would happen if they combined their companies to form the world's largest beer maker. More than $100 billion later, the two companies merged.
Image source: Getty Images.
However, a similarly significant merger between Anheuser-Busch and InBev occurred in 2008. The cumulative result of AB-InBev's quest for industry domination was a balance sheet that had a staggering $122 billion in total debt.
BUD Total Long Term Debt (Annual) data by YCharts
Too much debt can suffocate a business; AB-InBev's debt generated billions of dollars in annual interest after the merger, squeezing cash flow and forcing management to aggressively slash its dividend to shareholders.
The company's financial problems largely explain the stock's poor performance over the past five years, and COVID-19 only kicked AB-InBev when it was already down. The pandemic lockdowns hurt its business and forced it to borrow once again.
The underlying business is a diamond
Most investors will look at the current dividend and long-term price action and move right along, missing what they might see on closer inspection.
Water, barley, yeast, and hops make up the beer you drink; it's not rocket science. AB-InBev has among the most extensive operations for making beer globally, and famous brands like Budweiser, Corona, and Stella Artois lead hundreds of others. Brand power and massive breweries to lower costs make AB-InBev a very profitable business.
BUD Free Cash Flow (% of Annual Revenues) data by YCharts
AB-InBev gets almost $0.17 of free cash flow from every revenue dollar, but that's not all. The company is paying all of this interest, which comes out before tallying free cash flow. Cash flow would be higher if it weren't for the roughly $5 billion in interest it's paying each year. In that case, the cash flow conversion rate would be as high as 26%.
Of course, that's not the reality today, but it shows how profitable AB-InBev can be once it gets its balance sheet under control.
The stock could shine over time
COVID-19 slowed AB-InBev's efforts to get financially healthy, but it's making progress. There is about $86 billion on the balance sheet today, down almost 30% from 2016.
Additionally, the company has most of its debt at a fixed rate of 4%, and there's little due before 2024, which removes the immediate risk of refinancing in the face of rising rates. AB-InBev ended the year with a net debt (total debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio of 4, down from 5.5 in 2016.
Investors should look for this to keep coming down over time; eventually, management will position the company to begin dedicating cash to its dividend once again. Shareholders could be in for some fantastic dividend growth once there's no longer so much debt covering up AB-InBev's fantastic business.
