COMPANIA CERVECERIAS UNIDAS CCU
December 15, 2018 - 12:24am EST by
eigenvalue
2018 2019
Price: 25.50 EPS 1.55 1.70
Shares Out. (in M): 185 P/E 15.8 14.4
Market Cap (in $M): 4,705 P/FCF 15.8 14.4
Net Debt (in $M): -100 EBIT 409 448
TEV ($): 4,695 TEV/EBIT 11.5 10.48

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Description

I recommend the purchase of Compania Cervecerias Unidas SA (CCU), a US listed Chilean beverage company with zero debt, good corporate governance and capital allocation, trading at 14 times projected 2019 earnings, with excellent growth prospects and several free options on significant future sales growth and margin expansion.  I think that the stock is worth at least twice what it is selling for and my target is $50 per ADR.  [This is a company with a number of analysts following it, including Goldman Sachs.]

 

Description

The company is a beverage manufacturer and distributor in Latin America.  The main business is in Chile, with Argentina being the second most important market. The company had sold 26.0 million hectoliters of beverages in 2017, and reported USD 2.62bn in net sales and USD 504 million in EBITDA.  It will probably report volumes up 8-9% in 2018, net revenues up 3.5-4% and EBITDA up 14% in 2018. 

a)      Chilean business – beer and non-alcoholic spirits.  75% market share of the beer duopoly (gleaned from analysts’ reports) in Chile and 44% of the combined beer and non-alcoholic beverage market.   Main competitor with a 25% market share is Anheuser Busch Inbev. It is a number 1 player in the non-alcoholic beverage segment with a 30% market share.   Brews, and distributes both its own brands and foreign brands such as Heineken.   In 2017, this business accounted for 69% of the company’s volumes, 62% of revenues and 76% of EBITDA.  23.6% EBITDA margin in 2017.  Historically, the company lost some market share in the beer business, and gained quite a bit in the non-beer segment.  In the first nine months of 2018, this segment saw 4.1% increase in volumes, 6.0% in revenues and 10.4% increase in EBITDA and 14.2% in EBIT, measured in Chilean pesos.

b)     Wine business, company both sells wine in Chile and exports it.  In 2017, this segment accounted for 6% of volume, 13% of net sales and 10% of EBITDA.  15.7% EBITDA margin in 2017.  In the first nine months of 2018, this business saw 4.4% decline in volumes, 2.3% decline in sales, 24.3% decrease in EBITDA and 31.8% decrease in EBIT.  Profitability fell due to higher cost of grapes due to weak harvests in 2016 and 2017.

c)      Argentina, Uruguay and Paraguay.  This business sells beer, non-alcoholic beverages, cider and spirits.  Argentina dominates the segment.  The company has a 26% market share of the beer oligopoly in Argentina, the leader is Anheuser Busch Inbev with 70% market share.  The company has been gaining market share in Argentina both organically and due to acquisitions.  The company historically enjoyed 20% operating margins in Argentina, currently closer to 10%.   These three countries accounted 25% of the company’s volumes, 18% of EBITDA and had 13.2% EBITDA margin in 2017.  In the first nine months of 2018, this segment reported 24.6% volume growth, 2.4% increase in sales in Chilean pesos (the increase in revenues lagged increase in sales due to effects of hyperinflationary accounting in Argentina and devaluation of the Argentinian peso against Chilean peso), and 62.4% increase in EBITDA, excluding the gain from the Argentina transaction with Anheuser Busch Inbev.

d)     Columbia – the company entered Columbia, a market with a 98% market share held by Anheuser Busch Inbev several years ago via a joint venture with Postobon.  The joint venture has just finished a USD 400MM plant capable of producing three million hectoliters per year.  Prior to this, all the beer sold by the joint venture was imported.  The joint venture will sell both CCU’s own brands as well as licensed ones, such as Heineken.  Currently, the business sells 500K hectoliters per year, growing at 25% per annum.  The market is roughly 23MM hectoliters in size.

e)     Bolivia, Peru, etc.. – the company operates in via joint ventures.  In Peru, it does NOT sell beer.

f)       Long term prospects – the company thinks that it can grow volumes at low single digit rate per annum for many years to come.

g)      Long term – ten year plan to enter Peru – 98% market share of the beer subsidiary of Anheuser Busch Inbev.  Very attractive market.

 

Financials:

 

I expect the company to earn USD 1.58 per ADR in 2018, excluding the gain on the transaction with Anheuser Busch Inbev in Argentina.  For 2019, I expect the company to earn $1.70 per ADR, this assumes no margin recovery in Argentina, no improvement in profitability in Colombia, and three percent volume growth across the board with zero margin expansion. 

 

Capital structure:

Cash exceeds debt, and I expect excess cash less debt = 1 USD per ADR on 12/31/2018.

There are 369.5MM shares outstanding.  1 ADR = 2 underlying shares.

 

Corporate governance: 60% owned by IRSA, a joint venture that is 50% owned by Heineken and 50% by a Chilean family.   The Chilean family (Luksic) has a decent reputation there, based on the research that I have done. 

Capital allocation: company is committed to paying out 50% of its net income in dividends.

 

Valuation:

The stock is selling at 14x my estimate of 2019 earnings. 

 

Why it is a compelling value?

 

At $25.50, the stock is selling at 14x my estimate of 2019 net income, which is very attractive for a company in the beverage industry that has zero debt, and should be able to grow volumes in low single digits per annum.  However, there are several additional free options that may result in a significant increase in profitability.

a)     a) The company is able to return Argentina to previous levels of profitability, with 20% operating income (EBIT) margin.  There is no reason why the number two player in the beer business with a 26% market share in an oligopoly should not be able to get to those margins.  If that happens, this will result in additional 35bn Chilean Pesos of EBIT or USD 0.2 per ADR increase in profits. 

b)    b)  The wine business returns to the 18.6% EBIT margin it posted in 2016.  If that happens, then EBIT will rise by 18bn in Chilean pesos, or USD 0.1 per ADR increase in profits.

c)      c) Columbia expansion pays off. Columbia is one of the most profitable beer markets in the world, supposedly Anheuser Busch Inbev has 50%+ EBITDA margins and generated USD 1.17bn in EBITDA in 2017 although that includes profits from other beverages as well.  Assuming that the company is targeting at least a 20% return on investment, since joint venture started in 2014, and the beer plant is just becoming operational now, will result in USD 40MM of additional net income to CCU or 0.216 USD per ADR in additional net income. 

d)     d) Entrance into a Peruvian beer market, which is dominated (98% market share) by a subsidiary of Anheuser Busch Inbev. 

 

Summary:

To sum up, one is able to buy a debt free beverage company that should be able to grow its volumes in low single digits per annum at between 14x and 11x EPS, which I think is exceptionally cheap.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Increasing dividends, and possibly sharp increase in profits from Colombia expansion and Argentina turnaround.

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