Is This Brewer Biting Off More Than It Can Chew?

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For Belgians, beer it's not just a frothy drink. There's a whole culture that lies behind the nearly 500 different types of brew – many of which are served in their own, personalized glass – and the hundreds of breweries that date back centuries.

No wonder Anheuser-Busch InBev's (NYSE: BUD) roots can be traced back to Den Horen, one of the oldest breweries in Belgium. Yet, despite its long heritage and its prominent position in most of the world's top beer markets, over the last couple of years, its revenue growth has gone into a steady freefall.

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BUD Revenue 5 Year Growth data by YCharts

Looking ahead, what does the future hold for this world-class brewer?

A quick glance at the latest numbers

The maker of Beck's and Stella Artois reported its latest numbers on July 31. AB InBev wrapped up a rather bumpy, yet better-than-expected, second quarter. It chalked up revenue of roughly $10.6 billion, while net profit rolled in at almost $7.50 billion.

On an organic basis, revenue was up nearly 4% year-over-year as higher-margin premium beers somehow covered up lower volumes. For instance, in North America, volumes were down roughly 2% as the cooler-than-normal weather didn't really whet consumers' appetite for a cold one. However, a pick-up in prices, as well as distribution cost savings, gave its U.S. EBITDA margin a 0.8% boost.

On the other hand, its bottom line was by $6.31 billion from an accounting adjustment on the initial investment held in Mexican brewer Grupo Modelo, the maker of Corona. Normalized profit – profit free of unusual or one-time influences – came in at $1.50 billion or $0.93 a share, taking a nearly 22% nosedive on a year-over-year basis. The brewer blamed the higher income taxes and the lofty financing costs for this decline.

Next destination: China

Since 1998, AB InBev has been working its way into the Chinese market either by acquisitions or by forming partnerships with leading Chinese brewers. Over the past two years, though, it focused on regional investments  aiming at getting a firm grip on the world's biggest beer market in terms of volumes. Just recently, it acquired four breweries in China with a total capacity of approximately 9 million hectoliters.

Needless to say, its investments have already started bearing fruit. Throughout 2012, the company saw its Focus Brands in China, including Budweiser and Harbin, grow 8%, while Budweiser came out on top among premium beer brands. Today, AB InBev is a major industry player in the country behind domestic rivals Tsingtao Brewery and CR Snow – a joint-venture between China Resources Enterprise and UK-based SABMiller (NASDAQOTH: SBMRY).

Looking ahead, the company plans to beef up investments in the country in an effort to make Budweiser, its flagship brand, the world's first global beer. Carlos Britos – the man holding the reins of the brew juggernaut – told the Wall Street Journal that the global beer industry is on the verge of rapid changes. “American culture is something that travels. Budweiser is traveling with it.”

Going global or staying local?

With slack volumes in the U.S. and anemic sales in Europe, emerging markets seem like a lucrative alternative. Especially in China, a young and growing middle class coupled with a mega population that's already keen on drinking beer, as well as an ongoing policy shift toward a consumer-led growth model, make this country an attractive place for selling beer.

But could Budweiser ever become the No 1 beer in China, knocking local brands over?

In general, to make it in this business you need an effective distribution channel that will enable you to clamp down on expenses. You need to bring the product to the consumer, and you need to do it cheaply. AB InBev is going in the right direction expanding its regional network outside big cities. Since 2011, it has increased the number of its plants to around 40.

But that's not much to write home about. SABMiller has twice as many plants as AB InBev has. Moreover, recently, it took control of the Kingway Brewery in China, outbidding Ab InBev and domestic Beijing Yanjing Brewer. SABMiller claims an around 22% share in the Chinese beer market, backed by Snow beer's popularity. Yet, despite the immense growth potential, the brewer says that unit pricing and margins are extremely low. Local, low-end brands could sell for as cheap as $0.30, making it hard for foreigners to compete.

That's why Ab InBev is betting on Budweiser, and Heineken (NASDAQOTH: HEINY) is focusing only on the premium end of the Chinese beer market. Over the past two years, the Dutch brewer has been unloading operations pulling out of China's mainstream sector while turning to more prestigious brands. Last year, it took full control of Asia Pacific Breweries, the maker of Tiger, which is a comparably pricey beer. Heineken, which reports earnings on August 21, expects that direct ownership of Tiger - on top of Asia Pacific operating as a regional hub for its namesake brand - could bring it one step closer to becoming a leading premium beer maker.

Yet just playing the devil's advocate – some analysts argue that globalizing beers actually misses the point. Local brands have long dominated major beer markets across the world. Chinese consumers' appetite for international brands is steadily increasing, but still, the most popular brands are local ones. Yanjing, Tsingtao, and Snow beers are some brands that a housewife could handily pick out from a supermarket shelf in Beijing. 

Final thoughts

Formed by two game-changing mergers in the previous decade, and recently swelled by the $20.1 billion takeover of Grupo Modelo, AB InBev is almost twice the size of its nearest competitor. If someone in this business can turn its flagship brand into a truly global brand by wowing the world's largest market, then this is definitely Ab InBev.

Yet, brand positioning is a bit tricky. You might spend money like water on promoting and marketing your product, but, at the end of the day, it's the consumer who decides its fate.

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Fani Kelesidou has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong

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