Investors who have fallen in love with the beer industry should sober up. At current prices, brewery stocks look distinctly tipsy.
That's easy to forget after the sector's monumental advance of the past couple of years. Shares in the world's biggest brewer, Anheuser-Busch InBev NV, are up 44 per cent since this point in 2012, while the stock price of SABMiller PLC, the No. 2 player, has surged 38 per cent.
The stocks advanced further on Monday after reports that InBev is eyeing a bid for SABMiller and that SABMiller, in turn, is angling for a deal with Heineken NV. But betting on the latest round of merger talks to propel brewers even higher rests on the assumption that beer is the golden elixir, no matter what it costs.
That seems a mite optimistic. Beer stocks have enjoyed their epic run because they tick all the boxes for what appeals to investors in the wake of the financial crisis. They deliver respectable dividend yields, they operate in recession-proof businesses and some offer a conservative way to play the rise of the emerging market consumer.
But after several rounds of industry consolidation, brewers are anything but cheap. Leading beer makers trade at lush multiples of their earnings and sales, and takeovers are becoming increasingly expensive. Before 2005, beer companies typically changed hands for about 10 times their earnings before interest, taxes, depreciation and amortization (EBITDA), according to Goldman Sachs. Over the past three years, the average acquisition price has jumped to 15 times.
As prices for beer makers have gone up, actual consumption of the beverage has flattened, or even shrunk, in the developed world. The hopes of the industry rest on China, sub-Saharan Africa and Latin America.
As consumers in these developing economies learn to reach for a Bud or a Peroni, global beer volume could grow by a third between now and 2025, estimates Deutsche Bank. It says Heineken and SABMiller are the best positioned brewers to tap into this growth because of their strong position in emerging economies.
That's encouraging – but it's worthwhile noting that the projected growth works out to only about 3 per cent a year. The growth projections also sidestep the question of whether regulators will put up roadblocks to further consolidation. Four brewers – InBev, SABMiller, Heineken and Carlsberg Group – now control nearly half of global beer sales, according to Bernstein Research. It seems unlikely that they will be allowed to dominate the market without a challenge from authorities.
The other unknown is whether brewers will be able to wring any more savings out of their operations. InBev has been a leader in this regard, but its earnings growth is expected to slow to 8 per cent a year over the next couple of years, about half the pace of the past few years, according to Société Général.
A desire to reignite growth could prompt InBev to make a bid for SABMiller, but a takeover carries significant risks. SABMiller trades for more than 23 times its estimated earnings for next year and any bid would have to offer a premium to its existing price, making it a very expensive acquisition.
For now, investors should be wary. The leading global brewers are well-run companies with entrenched market positions and the capability to deliver streams of dependable dividends.
They are not, however, growth machines. Paying today's lofty prices for them requires faith in the potential of developing markets or conviction that a takeover bid will emerge. If neither comes to pass, a nasty hangover looms ahead.
Ian McGugan