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Morningstar | In Line 1Q for AB InBev as Potential IPO Could Signal Change in Strategy in Asia

AB InBev reported first-quarter results broadly in line with our expectations, although organic revenue growth of 5.9% was slightly more skewed to volume growth than we had anticipated. We have tweaked our near-term assumptions marginally, and lowered our revenue forecasts for foreign exchange headwinds, but we are reiterating our $118 fair value estimate for the ADRs as well as our wide moat rating. Management acknowledged rumours it is considering a potential minority stake listing of the Asia Pacific business, which we would regard as a net positive, valuation notwithstanding. Despite a strong run year-to-date, we still see upside to AB InBev.

First-quarter organic revenue growth of 5.9% was a modest sequential acceleration from the fourth quarter of last year, with volume growth of 1.3% and price/mix of 4.6%. Brazil lead the way, with a beverage volume rebound of 12.4%, although this came at the expense of fairly weak price/mix of around 4%, which was insufficient to offset commodity inflation, and led to gross margin contraction of 440 basis points in the region. Stronger pricing elsewhere meant that AB InBev's consolidated gross margin was down just 50 basis points, and we expect gross margin pressure to ease over the course of the year.

There were few surprises across geographies. Argentina remains very weak, while it is disappointing that South Africa has not yet been the driver of growth we expect it to be in a normalized economic environment. Volumes and revenue declined in the mid-single-digit range in the first quarter in South Africa. The U.S. is a closely-watched market by investors following the secular decline in category share to craft beer over the last decade. Volumes declined by 2% at the retail level in the first quarter, although pricing of around 2.5% meant that revenue grew modestly. The source of our wide moat rating is a cost advantage, and we would prefer to see a more gentle volume decline over time to preserve that cost advantage.

AB InBev is still underperforming rivals Heineken and Carlsberg, both of which achieved modestly higher organic growth in the first quarter. This is in no small part due to the respective companies' footprint in Asia. For Carlsberg and Heineken, growth is being driven by exposure to developing markets in southeast Asia such as Myanmar, Vietnam and Cambodia. AB InBev's Asian business is slightly more skewed to developed markets, particularly Australia and Korea, while its large regional emerging market is China, a large but competitive and relatively low-margin market. It is little surprise, therefore, that AB InBev is considering a minority listing of this business on the Hong Kong Stock Exchange. At 14 times to 15 times our estimate of regional 2019 EBITDA, we estimate a potential value of the Asia business of $45 billion to $50 billion. We have seen much higher valuations reported in the media, although these estimates seem to imply aggressive valuation multiples more akin to an emerging markets business.

Depending on the size of the public issue, which is currently unknown, there are two potential uses for the funds. The company's first priority should be to pay down debt. AB InBev's balance sheet leverage has been a considerable concern for investors since the SABMiller acquisition in 2016, and led to the halving of the dividend last year. AB InBev finished the year at 4.8 times net debt/adjusted EBITDA, and management has stated that it can reduce leverage to below 4.0 times net debt/adjusted EBITDA organically by 2020, a claim that we think is accurate. Any capital raised from the Asian IPO and used to deleverage the balance sheet would help shareholders breathe more easily, in our view. A secondary priority may be a strategic rethink in the Asian region. Funds could be used to either acquire small local brewers with high market shares in small but growing markets, or to partner with local players with existing distribution infrastructure. This was a strategy adopted recently by Heineken, when it invested around $3 billion in CR Beer and handed distribution rights to its brands to its new regional partner.