General Electric's (NYSE:GE) Jack Welch had a principle: Either a company should be in the No. 1 or No. 2 spot in every business line where it competed, have a plan to get there, or get out of those operations entirely. The reason is simple. Most large product lines can take advantage of the economies of scale. The bigger a company, the better advantage it can take of its size. In practice, this scale effect works out so that the largest two companies in an industry can ruthlessly cut their costs, gain market share through aggressive pricing, and yet still turn decent profits. Anyone smaller than No. 2 usually ends up either just limping along as a mediocre player or destroyed by larger rivals.
Thanks to recent industry consolidation, Inside Value recommendation Anheuser-Busch (NYSE:BUD) now finds itself the world's third-largest brewer by volume, behind Britain's SABMiller and the Belgian/Brazilian giant InBev/AmBev (NYSE:ABV). Even its smaller rivals understand the advantages of size and scale, and that's why Molson Coors (NYSE:TAP) now exists, from the merger of Molson and Coors. Budweiser and Bud Light may still be the best-selling beers in America, but in our ever-smaller world, the king of beers has been dethroned. Unless and until Anheuser-Busch either starts aggressively growing its market share or acquiring its way back to the top, it finds itself in the unenviable position of trying to prove the legendary Jack Welch wrong.
In addition to being left out of the consolidation race, Anheuser-Busch is struggling against titanic demographic shifts. An aging global population no longer identifies with the party-hearty image that Anheuser-Busch and the other brewers had tried to cultivate for decades. To add insult to injury, the growing trend for universities to crack down against keg parties and other beer-soaked pastimes has seriously dented beer's market share of folks in their earliest drinking years. Thanks to these relentless market shifts, beer has been slowly losing market share to hard liquor, distilled spirits, and wine. Spirit makers Constellation Brands (NYSE:STZ) and Diageo (NYSE:DEO) have profited from this trend, and their shares have easily outperformed Anheuser's over the past five years.
Thanks to the shifting market preferences, owners of Anheuser-Busch's stock hold shares in the third-largest company in a shrinking industry. That's not exactly a platform of strength from which the company can springboard to profits and shareholder gains. Don't just take my word for it; take a gander at the company's recently reported data from the Securities and Exchange Commission. Anheuser-Busch's financials are showing signs of the strains from being in such an ugly position. Here's some key data from this past year.
| 2004 | 2005 | Y/Y % Change | |
|---|---|---|---|
| Q1: SAE | $3,477,000,000 | $3,563,700,000 | 2.49% |
| Q2: SAE | $4,010,000,000 | $4,018,100,000 | 0.20% |
| Q3: SAE | $4,080,100,000 | $4,088,500,000 | 0.21% |
| Q1: OCF | $593,200,000 | $536,200,000 | -9.61% |
| Q2: OCF | $963,000,000 | $812,900,000 | -15.59% |
| Q3: OCF | $835,200,000 | $819,100,000 | -1.93% |
| Q1: NI | $549,900,000 | $512,800,000 | -6.75% |
| Q2: NI | $673,500,000 | $607,000,000 | -9.87% |
| Q3: NI | $684,400,000 | $518,200,000 | -24.28% |
Sales have stagnated, and both operating cash flows and net income have turned in a decidedly negative direction. Yet for some inexplicable reason, Anheuser-Busch's board of directors still decided to increase the company's dividend by some 10% this summer, in an amazing defiance of the company's poor financial showing. You'll find no bigger fan of strong and rising dividends than me. Even so, I'm scratching my head over the decision to hike that payment during a prolonged period of financial weakness. It's almost like watching Emperor Nero fiddling while Rome burned. When photography titan Eastman Kodak faced similar demographic-driven issues, thanks to the onslaught of digital pictures, it at least had the decency to cut its dividend while it retooled its business for the world of the future.
The Foolish bottom line
As the third-largest company in a shrinking line of business, Anheuser-Busch has some serious work to do if it wants to remain globally competitive for the long run. Until I see either concrete execution of a turnaround or other successful plans to grow the business, my money is staying away.
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At the time of publication, Fool contributor andInside Valueteam member Chuck Saletta owned shares of General Electric. The Fool has a disclosure policy.
