Brewing South American Consolidation
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High volume growth and strong pricing power have been the main characteristics that South American beverage businesses have been working with for years. That was the environment the three brewers ruling the different countries in the region enjoyed and knew how to profit from. Here I will make a case for two of those three and analyze the case for a potential merger between them. We will review market giant Companhia de Bebidas das Americas (NYSE: ABV) and Chilean champion Compania Cervecerias Unidas (NYSE: CCU).
In our story, the acquisitions king is ABV, also known as AmBev. The company is 62% owned by Ab InBev (NYSE: BUD), but it is actually ABV that has been consolidating the brewing industry for more than 20 years. Its management bought Antartica in Brazil, and later on they acquired Quilmes in Argentina; and after those deals they conquered European Interbrew to finally bid for BUD in 2008.
ABV rules the brewing market in Brazil, Peru, the Dominican Republic, Argentina, Bolivia, Uruguay and Paraguay. ABV sells 155 million hectoliters of beer a year and produces revenues of over $14 billion, with an over 40% EBIT margin. Just a few day ago, ABV reported robust 3Q 2012 results, with EBITDA jumping 19.2% organically and a consolidated EBITDA margin expansion of 170 basis points, arriving at 47.3%.
ABV knows better than anyone how strong barriers to entry can be when you are not the market leader in the beer business, and that’s the reason for its market share obsession (in most countries where it operates, market share for ABV in the beer business is well over 75%). ABV knows how margins improve as you reduce your fixed costs per hectoliters by gaining market share. Only in Chile, where CCU controls 85% of the market in the beer business, does ABV has a low margin business. I will soon post an article on WarrenTrades about fixed costs and competitive advantages.
Meanwhile, CCU is expected to sell 18.5 million hectoliters in 2012 and 19 million by 2013. The company, with a 23% EBITDA margin, is considerably less profitable than ABV. That said, its over 5% free cash flow yield and reasonable valuation, at x9 EV/EBITDA and a x16 P/E, makes it a good long. Above all, the company has the characteristics that bigger, cash rich competitors have.
As we stated before, right now there are three players in South America's beer business: ABV, CCU and SAB Miller. I am sure that, in time, there are going to be left only two players in the field. ABV, with its $122.9 billion market capitalization and its very strong tradition of buying good business and turning them into even better, more profitable businesses, could be a suitable buyer for much smaller CCU (market capitalization of $4.6 billion). CCU owns great brands and an impossible to replicate market position in Chile. Besides, ABV will have a lot of room to improve CCU' s margins through cutting costs and finding synergies if it reaches to acquire it. I would make a bet on CCU being acquired, so go long on CCU!
martinzaldua has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Compania Cervecerias Unidas S.A. (ADR). 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.If you have questions about this post or the Fool’s blog network, click here for information.