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Morningstar | Currency Headwinds Erode United Breweries' Pricing and Margins in 1Q, but Shares Not a Bargain

While narrow-moat United Breweries' volume trajectory remained solid in the first quarter, exogenous factors (namely currency headwinds) continued to hamper its profitability. Consolidated volume growth of 6.6% was largely offset by a 5.2% decrease in pricing, primarily due to the depreciation of the Argentine peso (management estimates a nearly 97% devaluation relative to the Chilean peso), which compressed the revenue received from its international business (25% of sales). This was compounded by a weak macroeconomic climate (and consequently, promotional pressure from retailers) in Chile (66% of sales, not including the firm's wine business).

Unfavorable foreign exchange rates also compressed profitability, with the depreciation of both the Chilean and Argentine peso relative to the U.S. dollar raising United Breweries' dollar-denominated raw material costs. Consequently, consolidated gross margin contracted by 450 basis points to 51.5% (below our full-year estimate of 53%), and gross margin in the international segment deteriorated to 48.6% (12% below its level in the prior year period). While we may adjust our full-year expectations to incorporate this challenging environment, we aren't anticipating a material change to our $25.50 per ADR fair value estimate or longer-term outlook, which calls for mid-single-digit sales growth and average gross margin around 53% over our forecast.

While these developments suggest significant uncertainty remains over the near term, we're encouraged by management's strategic approach to weathering these challenges. For example, its efforts to extract efficiencies from its operations helped marketing and administrative expenses leverage by 85 basis points in the international segment. Still, we appreciate management's suggestion that these savings have never come at the expense of investments (like marketing) that are required for growth.

We contend management's focus will remain on driving volume growth and thus preserving the economies of scale it enjoys (particularly in its home market of Chile) over the near term. However, management also alluded to strengthening pricing in Chile (up 1.7% in March, versus a 0.9% decline for the first quarter in aggregate), which bolsters our confidence in its ability to curb further margin erosion in the region.