Does Another Round of Beer Mergers Make Sense?

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Scott Reeves

Mass-produced beer is a slow-growth industry, and major brewers have merged in an effort to cut costs and grab market share. But consolidation may be little more than a short-term fix.

The best known deal: InBev snapped up Anheuser-Busch, once an American icon, in 2008 for about $52 billion to create Anheuser-Busch InBev (BUD), the world’s largest brewer with operations in about 30 countries around the world.

InBev’s third-quarter profit increased 11.9% to $1.55 billion by reducing expenses, including jobs and advertising expenses. But revenue dropped 10% to $9.76 billion as beer volume fell 3.1%.

Bloomberg reports that InBev may attempt to repeat its successful cost-cutting formula by acquiring the 50% of Mexico’s Grupo Modelo it doesn’t own. If completed, the acquisition would add Corona to In Bev’s Stella Artois, Budweiser, and Beck’s brands.

Fremsa, Modelo’s rival in Mexico, is reportedly in talks with SABMiller and Heineken, an apparent move to counter InBev’s possible deal with Grupo Modelo.

Cost-cutting is the smart thing to do during a recession, but InBev, which controls about 25% of the world’s beer sales, has yet to show that it can significantly increase market share.

"InBev paid a high price for A-B and is now highly leveraged, with debt standing at more than 70% of total capital," Ann Gilpin, an analyst at Morningstar, said in a research report. Gilpin continues:

With bonuses for the next five years tied to net debt/earnings before interest, taxes, depreciation, and amortization ratios, management is wasting no time in getting out their machetes to slash costs. However, if InBev does not proceed delicately, we think it could do more harm than good. The InBev/A-B combination has already led to a serious clash of cultures, and several key marketing and distribution executives have bailed since the merger. A-B knows the complex US market much better than InBev, and we fear that any change in the firm's marketing strategy in the US could lead to a deterioration in sales.

Long term, Morningstar expects the company’s net sales to increase 3% to 4% on growth in Latin America and Eastern Europe, where growth outpaces more the mature markets in the US and Western Europe.

In mid-day trading Friday, Anheuser-Busch InBev gained $1.73, or 3.58%, to $50. The 52-week range is $36.95 to $52.54.

SABMiller, InBev’s chief rival, said sales fell 1% for the six months ending September 30. US brewer Molson Coors (TAP) said worldwide sales fell 2.9% in the third quarter.

Investors interested in the beer sector might want to go upscale and take a look at Boston Beer Company (SAM), the leader in craft beer. Despite the recession, the upper end of the market, including craft beer and imports, grew about 5.5% in 2008 and now represents about 20% of the US beer market.

"In the long term, we think that the category has further room to grow as we expect consumers to drink less mass-produced beer and switch to higher-priced, better-quality products," Philip Gorham, an analyst for Morningstar, says in a research report. "Furthermore, its positioning at the premium end of the market means that Boston Beer's products offer a higher-margin alternative to mass domestic beer for both distributors and retailers, so gaining distribution and shelf space should be an achievable objective."

Still, Boston Beer is tiny and holds about 1% of the US market. The company also produces a range of seasonal beers in an effort to differentiate its products, but this increases cost. Nevertheless, Boston beer said third-quarter revenue increased $7.6 million, or 8%, to $108.7 million compared with the same period a year ago. Net income totaled $10.4 million. Last year, the company reported a loss of $295,000 on taxes, production shifts, and a product recall.

In mid-day trading Friday, Boston Beer fell $0.03, or 0.07%, to $40.78. The 52-week range is $17.50 to $42.25.

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