Durig Capital Fixed Income Review
Most fixed income investors are knowledgeable of the difficulty to finding and acquiring yields that are high enough to provide enough cash flow they need or desire without being accompanied by very significant and unacceptable risk, either in loss of principal or in long term wealth losses related to inflation. Consequently, we continually search the globe to find debt instruments with higher yields relative to the risks that we can identify. This week we take a fresh look at short 39 month, A rated, Brazilian real linked notes from AmBev, now a part of Anheuser-Busch InBev (BUD), which appear to be trading several points below par and offering about a 10.6% yield to maturity.
Corporate Bonds linked to the Brazilian Real
For the past three years, Brazil has grown less than the previous decade’s average. Gross domestic product expanded only by 2.3% last year and is forecast to grow even less in 2014. High interest rates are seen as a hurdle for economic growth, and a combination of worrisome inflation and low growth could also become a liability for President Dilma Rousseff, who is likely to seek a second term in the October general elections. However, the central bank of Brazil has a mandate to keep annual inflation at around 4.5%, with a tolerance margin of two points up or down. While most economists say Brazil should get more serious about bringing down inflation, the government says it is doing what it can without suffocating the economy.
Brazil began raising borrowing costs last April as a response to persistently high consumer prices, when the Selic was at a historic low of 7.25%. Just last week, the central bank itself raised its forecast for inflation this year to 6.1%, from 5.6% previously, largely the result of an unexpected surge in food prices. The central bank therefore raised its Selic benchmark rate to 11% from 10.75%, the ninth consecutive increase. This in turn appears to have effected a strengthening of the Brazilian real relative to the dollar. While the real currency lost value last year as global markets braced for the end of the U.S. Federal Reserve easy-money policy, it has recovered in the past few weeks and some Industry analysts say that high interest rates are helping to keep the Brazilian real from depreciating against the dollar.
From another perspective within our own country, the dollar slumped to one-month lows against a basket of major currencies this week after the minutes of the Federal Reserve’s March meeting indicated that rates are likely to remain on hold for some time. In our ongoing effort to address the concerns of our clients in protecting their existing wealth from a persistent currency devaluation, we believe these short to medium term Brazilian real linked Bank Bonds represent this week’s best opportunity to gain exposure to one the world’s better emerging economies at a historically reasonable exchange rate. Therefore, we see the high cash flow of these 9.5% couponed bonds, linked to the Brazilian real, as a sound addition to our Fixed-Income2.com and Fixed-Income3.com portfolios.
The Beer Industry
Beer is the world’s most widely consumed alcoholic beverage, and overall is the third-most popular drink after water and tea. Beer is one of the world’s oldest beverages, dating back to possibly as early as c.9500 B.C. in the recorded histories of Egypt and Mesopotamia when cereal was first farmed. Archaeologists have argued that beer was instrumental in the formation of civilizations because of the fact that the process of making it involved boiling, which helped save the populace of many European cities from contaminated and often toxic water supplies during the middle ages. Other analysts speculate that beer consumption increases during recessions and hard times, and can become quite addictive.
Anheuser-Busch InBev SA/NV is a Belgian-Brazilian multinational brewing company headquartered in Belgium. In 2004 Interbrew and AmBev merged creating the world’s largest brewer, InBev. Then, in November 2008, InBev merged with Anheuser-Busch, creating Anheuser–Busch InBev. In 2013, Anheuser-Busch InBev and Grupo Modelo.A.B. de C.V., Mexico’s leading brewer and owner of the global Corona brand, finalized an agreement under which Anheuser-Busch InBev acquired the remaining stake in Grupo Modelo that it didn’t already own, a deal estimated at $20.1 Billion. More recently, Anheuser-Busch InBev NV agreed to pay $5.8 billion for South Korea’s Oriental Brewery Co. Ltd., regaining control of a company that became the Asian nation’s biggest brewer under KKR (KKR) & Co. and Affinity Equity Partners Ltd.
AB InBev is the world’s largest brewer and one of the world’s top five consumer product companies by market capitalization value. Engaged in producing, distributing and selling a strong portfolio of well over 200 beer brands, the company employs more than 150,000 people based in more than 24 countries worldwide.
We like companies that are profitable
AB InBev’s total revenues for 2013 were $43.2 Billion earnings, while normalized EBITDA was reported at $17.2 Billion, an increase of 8.6% and 10.7% respectively when compared to the previous year (2012.) This indicates very healthy operating margins, which helps to significantly minimize the default risk of any short term bonds.
Interest Coverage Ratios
AB InBev’s net finance cost for 2013 was $2.486 Billion, compared to $2.348 Billion in 2012. Relative to it’s EBITDA, the resulting interest coverage ratio is nearly 7x’s, which appears to be more than adequate even with its planned acquisition of Oriental Brewery.
We like companies with lower debt to cash ratio
End of year cash was reported at $9.839 Billion, and the total debt $38.831 Billion. Considering the company’s excellent cash flow and profit margins, we think its impressive cash and balance sheet flexibility significantly outweighing its slightly higher debt to cash ratio.
We like companies that have sound balance sheets
Sporting a current market capitalization of about $170 Billion and an enterprise value of nearly $212 Billion, the company has a modest debt to equity ratio of only about 18%. Therefore, we see Ab InBev as having excellent balance sheet flexibility.
We like higher yields
The yields currently being offered with many more commonly known short term investment grade bonds appear to be only marginally better than the paltry 0.80% yields found in three year US Treasuries. Considering that Brazilian real appears that it may have stopped or even reversed a three year decline against the US dollar, we find the nearly 10% greater yields of this high quality, A rated issuer to be very attractive.
The default risk is AB InBev’s ability to perform. Considering its dominance within an industry that appears prone to be more recession proof than most, its high profit margin, its excellent cash flow as well as its flexible balance sheet, it is our opinion that the default risk for this short term bond is minimal.
We believe the largest risk in this issue is the currency risk. Since about July 2013, the Brazilian real has traded in a range between about .41 and .46. It was May of 2012 that President Rousseff and her administration claimed that any significant strengthening of the Brazilian real against the U.S. dollar would hurt exporters and manufacturers, and it was widely believed the administration targeted the real to trade at half the value of one US dollar. Prior to the 2012, the real was considered one of the world’s strongest currencies. With that said, it is our opinion that proper diversification into many other countries, currencies, and industries often serves to reduce one’s overall portfolio risk.
The geopolitical risk with AB InBev may be one of the lowest we have found, as this is truly a global company with largest concentration of sales being about 45% in North America.
Although AB InBev is an industry heavyweight, it may face increasing competition from substantially smaller and leaner companies such as Molson Coors Brewing Company (TAP) attempting to gain market share within a historically lucrative market. What makes this industry very hard to enter is the massive logistics and the costs of transportation of global supplies, which is very capital intensive and difficult to build out. The alcoholic beverage sector also includes other sizeable global competitors, such as SABMiller plc (SBMRY) that captures about 30 % of the US market with its Miller Beer brands, and Heineken NV (HINKF) at a distant third with its flagship Heineken brands. Hard liquors powerhouse Diageo plc (DEO) also competes globally, having Guinness among its beer lines, but AB InBev also owns distribution rights to the Bacardi, which competes amongst the liquors. All of these brands compete in variegated global markets, with different leading products and brands in different cultures and languages.
The profits from AB InBev may be directly affected by prices in the properly prepared cereal grains of rice, barley, corn, and of course, hops.
We believe that these InBev bonds have similar risks and other global multinational companies linked to the Brazil real such as Morgan Stanley Brazilian Real Linked Notes , 12.50% Yield Brazilian Real, Bank of America , or 10.00% Yield, Brazilian Real: Lloyds Bank Group selected from some of our previous reviews.
Summary and Conclusion
Given its dominant global branding and its impressive logistical infrastructure, the highly profitable AB InBev appears to be well situated for the future as a key player within the global economy. It has a fair cash position, excellent good cash flow, solid bottom line growth, a healthy balance sheet and appears to have recession resiliency. Therefore, we believe these short term AB InBev Brazil real based bonds offer superior cash flow and yield relative to the very minimal financial risks that we can identify, and see them as an excellent addition to our Fixed-Income2.com and Fixed-Income3.com portfolios.
Issuer: AmBev/Anheuser-Busch Inbev SA/NV
Yield to Maturity: ~10.6%
Disclosure: Durig Capital and certain clients may have positions in AmBev 2017 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail client.