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Accounting&CorporateReporting

Analysis:TeamAssignmentMA05

Group Members:

Maria Zaritskaya, Jimin Qian, David Law, Shreyansh Prasad, Ruitao Mao & Elektra

Papazoglou

Word Count: 2647 (including in-text referencing and titles)

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Objective

This report aims to evaluate an investment

opportunity in the beer brewing industry, by

comparing six companies that operate and

compete in the same market. The objective is to

determine which of the companies would be the

best investment option for ABInBev, the largest

amongst them. In order to achieve this,

statements of financial position, cash flow and

income were comprehensively analyzed and the

appropriate ratios calculated and compared. Each

company’s strategy, corporate social

responsibility, geographical area of operations and

corporate governance were also evaluated in

order to determine the preferred acquisition

target.

Introduction

Strategy

The global beer market is concentrated, evolving

through mergers rather than organic growth – with

all 6 analyzed companies, themselves products of

previous merger activity, including the world’s

largest brewer, ABInBev. Formed from two mergers

in 2008, and swelled by a $20.1 billion takeover of

Mexico's Gruppo Modelo (2013), ABInBev controls

almost a fifth of global beer output.

26%

35%

7%3%

17%

12%

BEER SALES BY VOLUME (%),

TOP 6 INTERNATIONAL

BREWERS, 2013

SABMiller ABInBev

Tsingtao Molson Coors

Heineken Carlsberg

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Globalization has driven merger activity as companies look to expand into larger developing

markets and benefit from increased economies of scale.

Geographically, Heineken is the most international brewer, present in 178 countries around

the world and surpassing sales of 1mhl (million hectoliters) in China (2013). AbInBev

dominates North and South America (the regions accounting for 89.5% of ABInBev's EBITDA

and 71.3% of volume sold, as outlined in the annual report). However, AbInBev has no

exposure to the African market, which is not highlighted in the annual report available to the

public, but becomes evident by cross-analysing sales and volume figures for all regions.

SAB Miller has businesses across Eastern Europe, Asia, Australia and Africa, with nearly 70%

of SAB’s sales in emerging markets. While SAB has showcased growth in the world's

developing markets, it lacks a truly international beer brand. SAB Miller is the only company

out of the 6 without a global brand, but with a strong geographical presence in developing

markets.

Tsingtao is sold in 62 countries around the world and accounts for more than 50% of China’s

beer exports. Tsingtao’s main focus, however, is still on its local market (especially in Northern

China).

Recently, emerging markets have become the main battleground for brewers, as sales

stagnate in developed markets. In this respect, ABInBev’s best option would be to acquire a

company with a strong presence in developing countries and a good distribution network to

maximize cost synergies.

Analysis

Corporate Social Responsibility

Brewers are aiming to improve their Corporate Social Responsibility (CSR); most have a

separate CSR report in addition to their annual reports. The most significant aspects of CSR,

regarding beer brewers, are:

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1) Environment Stewardship:

All 6 companies are on track to achieve their goals on environment protection in terms of

water intensity (hectolitre of water used per hectolitre of beer produced – hl/hl) and CO2

emissions (kg/hl). This data, however, is not included in ABInBev’s and Tsingtao’s

sustainability reports. This information is most likely contained only in internal management

reports, as it may reflect unfavourably on the company’s public image.

Overall, Carlsberg achieved the best performance regarding environmental stewardship in

2013.

2) Alcohol responsibility:

Different policies have been adopted by all 6 brewers to promote responsible drinking and

emphasize the harm of alcohol for underage consumers and pregnant women. For instance,

Heineken launched a “Dance More, Drink Slow” (Heineken Sustainability Report, 2013)

campaign throughout 2013 and SABMiller strictly regulates alcohol advertising, focusing on

marketing ethics.

3) Community:

Brewer are gradually trying to become more involved in local communities. In 2013,

Heineken invested EUR18.9 million towards local community growth, while Molson Coors

donated USD8.9 million to community development, including donations and volunteering.

All 5 potential acquisition targets fit in with ABInBev’s culture of promoting responsible

drinking, reducing negative environmental impact and maintaining close links with

community.

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Corporate Governance

ABInBev’s controlling shareholder is the Stichting foundation with a 41.24 % voting interest

in the company. Heineken’s ownership structure, as outlined in its annual report has been

set-up to ensure “the growth and independence of the company” (Heineken Annual Report,

2013) with 50.005% of Heineken shares still privately owned by the Heineken family.

Carlsberg’s largest shareholder was the Carlsberg Foundation, holding 30% of the share

capital and 75% of the votes. Molson Coors’ shares are owned 19% by insiders and 7% by

institutional investors. Tsingtao is the only company of the 5 where the controlling interest

(58%) belongs to a state enterprise. SAB Miller’s largest shareholder is the tobacco

manufacturer Altria Group (26.7%).

Heineken’s and Carlsberg’s ownerships structures could, therefore, hinder an acquisition

attempt, as was the case when SABMiller made bid for Heineken in September 2014.

Tsingtao, being state owned, could be a risky proposal if the Chinese state is not willing to

attract an external investor.

Molson Coors and SABMiller, in this respect, are considered the best acquisition

opportunities.

Profitability

To establish the best acquisition target for ABInBev in terms of profitability, company

performance was evaluated on 5 ratios:

• Gross profit margin

• Operating profit margin

• Net profit margin

• Return on assets (ROA)

• Return on equity (ROE)

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ABInBev’s gross profit margin and operating profit margin in 2013 (59.27% and 32.88%,

respectively) are significantly above industry average, reflecting the benefits of streamlined

production and distribution and making a strong case for further integration.

Out of the 5 potential acquisition targets SABMiller is the unsurpassed leader, showcasing a

78.28% gross profit margin, an 18.97% operating profit margin and a 15.13% net profit

margin in 2013. There was, however a decrease in the net profit margin from 20.57% in

2012, which is not explained in the annual report and must be the subject of internal

management reports.

Overall, the 5 target companies’ gross profit, operating profit and net profit margins

remained fairly consistent year-on-year, with the exception of Heineken, whose net profit

margin declined by a substantial 8.5%.

ROE and ROA must be evaluated together in order to provide an accurate picture of the

companies’ performance. The big factor that separates ROE and ROA is financial leverage. If

a company takes on debt, ROE would rise above ROA. If ROA is low or the company is

carrying a lot of debt, a high ROE can give investors a false impression about the company's

$43.195

$23.213 $24.580

$11.314

$4.527 $6.000

$16.518

$3.511 $2.031 $1.012 $0.316 $0.760

$-

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

ABInBev SABmiller Heineken Carlsberg Tsingtao Molson Coors

$ I

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ILLI

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BREWERIES

SalesRevenue&NetProfitoftopsix

Brewersin2013Revenues Net Profit

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finances. Therefore, it must be noted that analysing a company on just one of these ratios

may lead to a distorted view of the overall performance and reflects the limitation of using

financial ratios out of context.

As we see, ABInBev’s ROE is rather high at 29.87%, yet the ROA is 11.66%. That means

ABInBev carries substantial debt, amassing capital for a potential acquisition. Of the 5

potential acquisition targets Tsingtao has the highest ROA at 7.22%, followed by SAB Miller

with 6.24% in 2013. However, ROA for SABMiller has fallen from its 2012 level of 8%,

suggesting falling efficiency in asset utilization.

Throughout the industry ROE year-on-year has, as a rule, remained fairly stable, fluctuating

by 0.5% on average. SABMiller is the only company of the 5 potential acquisition targets,

whose ROE has decreased by 3.33%. A possible explanation is that SABMiller has not

reinvested its earnings, retaining capital in an attempt to acquire its rival, Heineken.

Efficiency

Based on the asset turnover ratio, Tsingtao ranked first in 2013, yet its efficiency in utilizing

assets was actually declining. The other four all witnessed progress.

Looking at the ratio changes from 2012 to 2013, Heineken appears to have improved its

efficiency (the ratio increased from 0.51 to 0.58). However, further examining sales and

assets figures separately, it can be deduced that total assets decreased substantially in 2013

due to the disposal of intangible assets and property. Despite the fact that revenue also

increased, we can draw the conclusion that the increase of Heineken’s asset turnover rate

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is not able to illustrate efficiency improvement. This instance fully reveals the limitations of

the asset turnover ratio in reflecting the efficiency of asset utilization. While it helps to

measure the efficiency to some degree, it can never be the only indicator for judgment. Sales

and assets still need to be taken into consideration. The example of Carlsberg is similar but

less evident. Only SABMiller’s and Molson Coors’ increase in asset turnover truly reflect

improvements in efficiency.

In terms of the asset turnover ratio in 2013 acquisition of SABMiller is recommended.

Liquidity

Based on the current ratio, Tsingtao ranked first as the only company with a current ratio

above 1, followed by Molson Coors with a ratio of 0.72 in 2013.

The industry average current ratio was 0.75. Generally, companies with a current ratio

below 1 are likely to encounter problems due to a shortage of available cash, as current

assets are not sufficient to cover short-term liabilities. However, for the brewery industry

this is not the case, as creditors usually provide long-term financing. Hence, a ratio below 1

should not be viewed as worrying. ABInBev’s own current ratio decreased from 1.01 to 0.73

in 2013, reflecting its growing amount of debt to finance acquisitions.

The acid test ratio provides a stricter evaluation of liquidity in comparison with the current

ratio, as it excludes inventory. The two companies with the highest acid test ratios are

Tsingtao and Molson Coors. However, Heineken and Carlsberg both demonstrate an acid

test ratio of 0.5 and 0.45 compared to current ratios of 0.69 and 0.59, respectively. This

indicates that Heineken relies more on inventory as current assets than Carlsberg, and that

the ability to cover current liabilities is not as strong. The example of these two companies

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exposes the limitations of the current ratio and stresses the importance of the acid test ratio

when making decisions.

In terms of overall liquidity, SABMiller and Heineken’s performance in 2013 was the same

as in 2012. Molson Coors shows better liquidity performance, while Tsingtao’s and

Carlsberg’s liquidity ratios decreased from their 2012 levels.

Based on the above analysis Tsingtao and Molson Coors are recommended.

Cash flow

ABInBev’s cash flow ratio remained almost constant at 1.06-1.07 over two financial years

(2012-2013). Despite increased expenses for the Gruppo Modelo acquisition, cash from

issuing securities in 2013 made up for the larger expenditures.

SABMiller increased its cash flow ratio from 0.99 in 2012 to 2.5 in 2013. Given the nature of

the industry and the increased fear of a buyout by ABInBev, the increase in cash inflow may

depict SABMiller’s preparations to acquire another industry player. Indeed, in September

2014 a bid to acquire Heineken was made.

Heineken’s cash flow ratio increased only by little (by 0.04) since 2012. Carlsberg, in contrast,

exhibited a lower cash flow ratio in 2013 compared to 2012. If this ratio remains at a value

lower than 1, Carlsberg may face liquidity problems in the future.

Molson Coors’ cash flow ratio increased 0.92 to 0.97 reflecting the 2012 acquisition of EU-

based StarBev, which resulted in higher profits and beer volumes sold.

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The highest cash flow ratio in 2013 was SABMiller (2.5), followed by Heineken (1.05). This

metric could be used in combination with liquidity measures to estimate which company

would have the most cash at its disposal in 2014. Nevertheless, it must be considered that

even cash flow ratios larger than 1 can dramatically decrease over a single year.

Gearing

ABInBev would be interested in the solvency of its acquisition – the ability to meet long-

term financial obligations. The gearing ratio indicates the proportion of debt the companies

use to finance assets. It quantifies the risk to acquire a specific company, related to how

much debt a company has and its ability to pay off its liabilities and cost of capital.

Four of the six companies have similar ratios (50.0% on average), meaning that these

companies have half as many liabilities as they do assets.

ABInBev and Heineken both have ratios averaging 62.81%. This indicates that the companies

are more leveraged, having taken on more debt. Heineken, with a relatively higher leverage

than its competitors may cause concern as a riskier investment but when one considers the

beer industry it may not be surprising to have increased debt when purchasing capital assets

and buying out smaller competitors to expand company beer portfolios and market share.

In fact, Heineken did indeed complete a takeover of the Asia Pacific Brewery Company in

2012 for approximately $4.1bil, explaining its current higher debt ratio.

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Investment

Investment ratios focus on returns to shareholders, here calculated by the Price/Earnings

ratio (P/E). A high P/E suggests that the investors expect a higher growth in earnings for the

company in the future.

Based on our findings shown in Table.7 we find that AbinBev had a P/E of 22.1 in 2013. In

comparison, Tsingtao had the highest P/E at 33.49 which could indicate either high growth

expectations or inflated share-prices. Therefore, although Tsingtao appears to be the best

investment in this case, it could come with increased risk, as stock may be overpriced.

Conversely SABMiller had a P/E of 15.52 and 25.57 in 2012 and 2013, respectively. Its P/E is

lower than that of Tsingtao. However, SABMiller’s P/E grew by 67% as compared to 33% for

Tsingtao. Since P/E is generally a consideration as to which company has better growth

prospects, SABMiller would be the safer investment opportunity.

Industry-specific

An analysis of industry-specific ratios is essential to provide a complete evaluation of the

best target for acquisition. The following have been chosen:

• Percentage change in volumes sold

• Percentage change of cost of sales (COS)/hl

• Percentage change of revenue/hl

In terms of volumes sold, the only company to have experienced a decline from 2012 was

Carlsberg (-1.56%). Molson Coors showed outstanding sales volume growth of 24%,

followed by Tsingtao with 10.13%, and SAB Miller's 6.99%. Heineken's volume sales

performance was fairly stable with a sales volume increase of 2.79%. The increase of

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ABInBev’s sales volume figures (5.46%) were lower than 3 of its potential acquisition

targets’, reflecting falling beer consumption in developed markets.

Based on volume figures alone, it would be tempting to pronounce Molson Coors the best

acquisition target. Yet, as will be shown, volume growth figures on their own can be

misleading.

COS/hl and revenue/hl must be viewed in combination. Declining revenue will usually result

in falling COS. Ideally, revenue/hl should increase, and COS/hl – decrease. Alternatively,

COS/hl should decrease by a wider margin than revenue/hl. Based on this assumption, SAB

Miller showcases the best performance. Although its revenue/hl marginally declined (-

0.29%) from 2012 levels, its cost of sales/hl decreased substantially (-6.62%), reflecting

efficient use of its distribution network.

An initial look at Molson Coors' decrease of COS/hl (-10.16%) would seem impressive, but,

considering the corresponding revenue/hl decline (-11.28%), the company showed a poor

performance overall.

The only other potential acquisition target with a higher revenue/hl than COS/hl is Heineken.

However, ABInbev's performance reflects a need to reduce COS/hl and utilize an efficient

distribution network, which makes Heineken's acquisition less appealing than SAB Miller's.

Considering the 3 ratios, Molson Coors' volume sales do not appear as impressive, taking

into account plummeting revenue/hl. It can be deduced, therefore, that volume growth for

this company has been achieved primarily because of price cuts in order to gain market

share.

Based on industry specific ratio analysis, the acquisition of SABMiller is recommended.

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Conclusion

On the basis of comprehensive analysis, SABMiller is considered the best investment

opportunity for ABInBev.

SABMiller’s environmental stewardship and alcohol consumption policy are in line with

ABInBev’s culture of promoting responsible drinking and reducing negative environmental

impact. Across the industry SABMiller shows solid financial results, outperforming its

competitors in most respects and exceeding industry average figures.

A merger of ABInBev and SAB Miller would create a brewing giant with exposure to all of the

world’s markets. ABInBev’s existing geographical market spread would be especially

complemented by SAB Miller’s current share of the beer industry in Africa and other

developing markets, enabling ABInBev to enter a growing lucrative market and take

advantage of an existing distribution network, deriving cost synergies from a single

distribution network and providing true value to its shareholders.