Scout Capital on Anheuser-Busch InBev (BUD): Q2 Letter Excerpt ~ market folly

Thursday, September 13, 2012

Scout Capital on Anheuser-Busch InBev (BUD): Q2 Letter Excerpt

Adam Weiss and James Crichton co-founded Scout Capital in 1999 and now manage around $4 billion.  In their second quarter letter to investors, they touched on their new stake in Anheuser-Busch InBev (BUD) that they initiated in the first quarter.

They purchased shares thinking that domestic (US) beer demand was coming back and that the company would turn from paying down debt to share repurchases or dividends.  Scout also felt BUD was cheap at a 7.5% free cash flow yield which was trading at a discount to other consumer franchises.

Their thesis centered on the discount stemming from two disconnects: 1. fundamentals of the industry and 2. capital allocation.

1. On fundamentals, they felt that the Street was "confusing cyclical effects for secular ones" as many investors had modeled the negative trend of beer volume into the future.  Scout went the other way and assumed better employment would help US volumes.

2. On capital allocation, Scout's analysis pointed to Anheuser-Busch InBev being likely to allocate cashflow in a different direction than simply paying low coupon debt in order to keep its investment grade rating.  The hedge fund thought BUD could buyback 7-9% of its shares per year, something that wasn't being priced in.

However, Scout also noted that the company's management is very smart with allocating capital as BUD instead chose to purchase Mexican brewer Grupo Modelo for $20 billion just before the end of the second quarter.

Scout writes,

"Factoring in expected costs savings, we believe the acquisition adds 10%-15% to ABInBev’s 2013 EPS on a full-year, pro forma basis. This doesn’t account for the tremendous international growth opportunity for Modelo’s flagship Corona brand as part of ABInBev’s global distribution network, which we estimate could contribute an additional 2%-4% earnings accretion. While the stock rose 10% on the news of the Modelo deal, our earnings estimates increased even more, and we believe BUD valuation is still too cheap relative to the growth and quality. The current free cash flow yield of 7.5% continues to represent a 20% discount to global consumer staples stocks with similar growth."

As if Anheuser-Busch InBev wasn't already in a dominant position in the beer market, this acquisition further entrenched their status.

Weiss and Crichton then concluded that,

 "With the benefit of an improving U.S. beer market, upside to the cost and revenue synergies from the Modelo acquisition, and redeployment of excess cash flow toward buybacks, we believe ABInBev can compound free cash flow per share at around 15% for the next few years and generate total shareholder returns in the high teens, before any multiple improvement. On our 2014 free cash flow per share estimate of $6.50 and a peer-like cash flow yield of 6%, our two-year price target is $110 or 40% upside (including dividends) from the current level. BUD remains a core position."

Per their most recent 13F filed with the SEC, Scout disclosed over a $365 million position in BUD as of June 30th.  At that time, it was their largest disclosed US equity long.  This isn't the first time we've seen a hedgie's pitch on the brewer as Whitney Tilson's T2 Partners also made a presentation on BUD a few years ago.

For more hedge fund Q2 letters, this week we've also posted up:

- Eminence Capital bullish on Google

- Why Bill Ackman sold Citigroup

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