BUD-WEIS-ER, Frogs & Fuss Aren’t Enough for Me to Drink

Summary

  • After its merger with SAB Miller, Anheuser-Busch InBev has proven to the world that it will “own the beer market” across the world.
  • The company is dominant in many countries with 50%+ market share in Brazil, Latin America and Belgium.
  • Unfortunately, the dividend perspectives don’t justify the current price.

Investment Thesis

Do you remember those BUD-WEIS-ER frogs in the company’s commercial a long time ago? I’m not sure I was old enough to drink beer back then but I surely enjoyed the frogs. In fact, Anheuser-Busch InBev (BUD) always had this magic touch to create viral ads. Over the years, the beer maker has expanded its brand portfolio to the limit of the world.

BUD is a leader in a stable market that is not ready to decrease. The company is producing over 500 million of hectolitres (as compared to 204 million for Heineken) and enjoys economy of scale. The brewer will continue to grow through acquisitions and will also increase its presence in emerging market, notably in China. BUD is a solid dividend payer with a 3.50% yield offering income seeking investors the opportunity to invest in a well-diversified company. Unfortunately, BUD seems overvalued at this time.

Image source

Understanding the Business

If you like beer, chances are you have drunk something coming from the world largest brewer. BUD dominates much of the market with 18 brands selling over $1 billion per year. Brand such as Budweiser (BUD shows 48% of US market share), Stella Artois (Belgium) and Corona are well known across the world. For the record, my own favorite beer is Hoegaarden.

With a production of over 500 hectolitres of beer per year, Budweiser sells more than twice the amount of beer Heineken sells. BUD is everywhere in the world:

Source: BUD 2017 Q3 investor presentation

Revenues

Source: Ycharts

BUD shows a strong history of growth by acquisition. Their latest one propelled the whole business to new heights. With such a large operation, BUD obviously benefits from large economy of scale. It is also the first brewer to be able to acquire another brewer (such as SAB Miller in 2016 in a +$100 billion deal). Through acquisition, BUD increases its leadership position, boosts new brands through its well-developed network and enjoys additional synergies. Through its 62% stake in Ambev, BUD is a leader in many Latin American countries such as Brazil (64% market share) and Argentina (77% market share).

Earnings

Source: Ycharts

The key for BUD in the upcoming year will be to develop premium beers such as Michelob Ultra and Stella Artois and focus on craft & imports. Unfortunately, there is a very limited growth potential for brands such as Budweiser & Bud light as they literally own the market in the U.S. Therefore, profitability will be found across premium pricing on “sophisticated beers”. This is not only a way to ensure profit growth, but also to protect BUD’s market share. There is a definite growing interest for craft and import beers as consumers enhance their taste for beer.

Another growth vector for the upcoming years will definitely be Latin America. While BUD is already the leader in those countries, the recent economic rebound should invite more consumers to celebrate and have a “cold one”. Both revenue and profit were up in those countries during Q3 by +8.9% and +13.1% (West), +8% and +16+.7% (North), +22.1% and +17.3% (South) respectively. BUD will need to work on its margin expansion in the upcoming years as the SAB Miller merger has already generated over $1 billion in synergy.

Source: Ycharts

Dividend Growth Perspectives

The fact that the BUD dividend is paid in euroes generates additional variations. According to Divdiend.com, BUD shows 8 consecutive years with a dividend increase. Considering the latest acquisitions and the current debt level, I don’t think we will see much dividend increase in the upcoming years. BUD shows a strong business model, but its tastes for acquisitions doesn’t give it the perfect dividend growth profile.

Source: BUD 2017 Q3 investor presentation

Source: Ychart

That is unfortunate as BUD was very close to becoming a Dividend Achiever. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

At this point, I still consider BUD as a dividend paying stock, but I don’t put too much fate into future dividend growth perspectives.

Potential Downsides

First, it is hard to grow when you are that big. One problem with BUD is that many of its brands have nowhere to go in terms of market share. It is hard to imagine Budweiser increasing its market share. In fact, it’s having a hard time against other imported beer and smaller or local microbreweries.  While the company generated synergies with SAB Miller, it is still a big pill to swallow. Its long term debt totals over $120 billion at the moment. Finally, as the company makes about 50% of its revenue offshore and has a strong presence in Latin America, BUD is subject to additional volatility (from both currency and unstable Latin America markets).

Valuation

It is hard to determine the real valuation of BUD at the moment. With the important acquisitions, all numbers are a little bit skewed, starting with the EPS. At the moment, BUD has never been that highly valued in the past decade:

Source: Ycharts

I also tried to use the Dividend Discount Model to determine a fair value for BUD. The problem is that I’m not sure there will be much dividend growth in the upcoming years. I’ve used a 5% growth rate as I felt generous. The immediate dividend growth may not happen, but management showed the ability of doing major dividend hikes in the past. This could very be the case in a few years from now.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $4.07
Enter Expected Dividend Growth Rate Years 1-10: 5.00%
Enter Expected Terminal Dividend Growth Rate: 5.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $170.94 $128.21 $102.56
10% Premium $156.70 $117.52 $94.02
Intrinsic Value $142.45 $106.84 $85.47
10% Discount $128.21 $96.15 $76.92
20% Discount $113.96 $85.47 $68.38

Please read the Dividend Discount Model limitations to fully understand my calculations.

Unfortunately, even with generous numbers, BUD is still overvalued. Keeping this in mind, I don’t think it’s a good candidate for my dividend growth portfolio.

Final Thought

When I started this analysis, I was relatively optimistic about BUD. It’s global presence and leadership in many markets made me like the company… a lot. BUD benefits from strong economy of scale and a wide distribution network. That makes it easier for it to acquire other brewers and push new products through its lines of business. Unfortunately, BUD just swallowed a big piece and will need some time to recover. I don’t think we can call it a hangover just yet, but when you have a few beers, this is certainly not the right time to start sprinting. I will leave BUD on the side for now.

Disclaimer: I do not hold BUD in my DividendStocksRock portfolios.

 

Consolidated Edison – Great Utility, Very Bad Price

Summary

#1 Consolidated Edison is a classic play in the utility sector with growth vectors in the natural gas distribution business.

#2 ED shows 43 consecutive years with a dividend increase making it a dividend aristocrat.

#3 While the company and its dividend are solid, the stock is definitely overvalued.

Over the past 30 days, Consolidated Edison’s (ED) stock has been evolving in red territories. The utility company shows a loss in value of about 10% between December 2017 and January 15th 2018. After a fabulous run in the current bull market, most utilities are slowing down. I think it’s time to take a look at Consolidated Edison to see if the current stock drop is a buy opportunity.

Understanding the Business

Consolidated Edison is a classic utility company operating in the New York State. It operates under 4 different segments:

Electric (71% of revenue)

Gas (14% of revenue)

Steam (5% of revenue)

Non-Utility (10% of revenue)

November ED presentation

While the chart above shows a whole segment for clean energy, the company generates only 4% of its revenue from this business segment. The core business remains it regulated utilities activities with 93% of its revenues.

Revenues

Source: Ycharts

Utility stocks aren’t the fastest growing companies on earth. They are more of a “hold & get paid steady” type of holdings. Revenue usually grows with regulations pushing energy prices higher. Besides that, ED has little growth vector. Management expects its utility revenues (gas and electric) to increase at a CAGR of 5.5% through 2019.

However, it has a 12.5% stake in a 303-mile pipeline called the Mountain Valley Pipeline. The MVP is a joint venture of EQT Midstream Partners (EQM), NextEra Energy (NEE), Con Edison, WGL Midstream and RGC Midstream.

Source: MVP

This natural gas pipeline is expected to start working toward the end of 2018. ED is also another participant in another natural gas pipeline named Stagecoach Gas Service.

Earnings

Source: Ycharts

The company has show steady earnings with a small uptrend since 2012. That is because ED is investing in its energy transmission and clean business in order to generate additional growth in the future. As you can see in the next chart, both are yet to become important contributors.

Management looks at the future with a smile as both segments are expected to support ED’s growth for many years. I agree pipeline projects are promising as they are never built without a strong economic demand behind it. Therefore, once they are operational, pipelines translate into a steady cash flow stream.

Dividend Growth Perspective

Consolidated Edison shows a stellar dividend growth sheet. With 43 consecutive years with an increase, ED is part of elite Dividend Aristocrats and Dividend Achievers lists. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

Unfortunately for income seeking investors, ED doesn’t pay a juicy 5%+ yield anymore. After all, ED’s stock price has jumped by 44% over the past 5 years. During the same period, the company increased its payout by 12%… and I’m not writing CAGR… just 12% total.

Source: Ycharts

The problem is that the company’s projects require lots of money and ED can’t afford to share too much wealth with investors. A 3.50% yield is appreciated, but don’t expect much growth in the upcoming years.

Potential Downsides

In my view, the company shows two important downsides. The first one is based on the current valuation. As you will see in the final section of this analysis, ED is clearly overvalued. The latest stock price run has made it vulnerable for additional volatility. The beginning of the year has been particularly painful for ED and I expect more potential losses.

ED has been raising lots of debt in the past 5 years and it may catch up to it now that the interest rates are increasing.

Source: Ychart

This situation will not put the dividend payment in jeopardy, but that’s just another reason to not expecting much growth in the upcoming years.

Finally, the rise of interest rates will also convince parts of income seeking investors to cash their juicy profit in this industry and move back to bonds eventually. This should slow down the hype around this sector and potentially slow down their stock potential for a few years.

Valuation

As previously mentioned, ED seems overvalued on all sides. First, the company has never traded at such high multiple:

Source: Ycharts

I know that using the PE ratio for a utility stock could be tricky. After all, the nature of their business requires lots of adjustments to get the real picture of their earnings. However, if you use the same metric for the past 10 years and get the highest points now; it’s a sign of an overhyped stock.

Digging deeper, I used the dividend discount model. I couldn’t use more than a 3% dividend growth rate in this case. After all, ED has increased its dividend by a CAGR of 2.29% over the past 5 years. Therefore, even 3% is a generous figure.

As for the discount rate, I never use under 9%. In this case, even if I use an 8% discount rate, I will get a stock that is highly overvalued.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $2.76
Enter Expected Dividend Growth Rate Years 1-10: 3.00%
Enter Expected Terminal Dividend Growth Rate: 3.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $68.23 $56.86 $48.73
10% Premium $62.54 $52.12 $44.67
Intrinsic Value $56.86 $47.38 $40.61
10% Discount $51.17 $42.64 $36.55
20% Discount $45.48 $37.90 $32.49

Please read the Dividend Discount Model limitations to fully understand my calculations.

I’m not saying ED’s stock price will drop like a rock. However, I don’t think this is the type of company that fits my 7 dividend growth investing rules.

Final Thought

I understand the need for utility stocks in one’s portfolio. They are steady income generators with some decent yield. However, the fact that the price for most utility stocks jumped along with the current bull market makes them unattractive for new investors at this time. ED is definitely a good example of this situation.

 

Disclaimer: I do hold NEE in my DividendStocksRock portfolios.

 

T. Rowe Price: a Performing Assets Manager for a Bullish Market

Summary

#1 I believe financials will continue to be strong in 2018 and TROW will be part of the party.

#2 TROW is a dividend aristocrat with 31 years of dividend increase under its belt.

#3 In 2018, TROW will reach 1 trillion dollars in assets under management.

I must admit, I rarely let one fly under my radar. But this time, I feel that T. Rowe Price (TROW) did the trick. While the stock has remained dormant for about 4 years, 2017 was a big wake-up for investors. Between January 2013 and January 2017, TROW lagged the S&P 500 by about 40% (15.58% vs 56.98%). However, TROW jumped by 40% in 2017. It seems the asset manager is unlocking value after being ignored by the market for a while. Is it the result of an overheating bullish market looking for new preys or is it really because TROW has shown some impressive results since the very beginning but we just didn’t see it? After all, TROW has been a model of performance since its IPO back in 1986:

Understanding the Business

T. Rowe Price is one of the world largest asset managers with $991 billion in assets under management (as at November 30th 2017). What really matters for assets managers is obviously how much they manage (Assets Under Management, AUM) as they are making fees on investors nest egg. By comparison, Blackrock (BLK), the world largest asset manager, shows 5.7 trillion.

T.Rowe Price shows a classic model with a wide variety of investing products going from fixed income to equity. The bulk of its business is done through financial intermediaries (third parties such as financial institutions selling its products) and institutional investors.

2017 Investor day presentation

Revenues

Source: Ycharts

TROW has been quick in focusing on retirement products and started defined contribution plans back in 1982. Now that most employers shifted retirement planning in the hand of their employees, TROW is well positioned to surf on this tailwind. As population ages and the need to plan for retirement have become crucial, TROW will definitely be an active player in the upcoming years.

Another growth vector comes from TROW past performances. WE all know that past performance is not a guarantee of future returns, but if you have to invest $2 on a pony, you will take one that already won a few races, right? As at its latest quarter (Sept 30th, 2017) TROW shows a remarkable performance:

Finally, TROW benefits from a large interest for its target-date fund. As retirement planning is taking importance, TROW offers a mutual fund that modifies its asset allocation going toward a target date. In other words, the fund adapts automatically its strategy to stay in line with the client’s age.

Earnings

Source: Ycharts

TROW success comes from a long history of performance and partnerships with third parties. Since 2009, TROW surfed on the strongest tailwind any asset managers can hope for: a never-ending bullish market.

Since TROW makes money based on how much money it manages (AUM), an ever-growing market naturally pushes revenue and earnings higher year after year. By building a strong brand through its financial intermediaries and institutional clients, TROW has one of the stickiest investing brand products around. After all, which institutions would drop highly performing asset managers? You don’t trow history in the trash can that easily.

Dividend Growth Perspective

What I like about TROW is that it is not its first bull ride. The company has successfully gone through many cycles and maintained its dividend increase streak alive. Today, TROW shows 31 consecutive years with a dividend raise. This makes it part of the elite Dividend Aristocrats and Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

While the stock stagnated prior to 2017, we can see that T. Rowe kept increasing its dividend which pushed its yield to 3%. Now that the stock has surged, TROW offers a 2% dividend yield to investors. While this is not an astronomic distribution rate, TROW meets my 7 dividend growth investing principles.

Source: Ycharts

TROW has been an example among dividend payers for the past 30 years. Over the past 5 years, TROW has increased its dividend by 50% or 8.45% CAGR. Besides the special dividend paid, TROW has maintained a low payout ratio. There is no doubt the company will push its dividend increase streak to 32 this year.

Potential Downsides

One must remain cautious when looking at TROW numbers. While the company has gone through other market crashes, it doesn’t mean TROW won’t suffer during the next one. As the market goes up year after year, this pushes AUM higher. Then, revenues and earnings are rising naturally without any efforts. For example, TROW Q3 AUM increased by $44.3 billion. Out of this number, only $5.9 billion were net cash inflows. This means that as soon as the market enters in correction mode, the AUM will follow accordingly. As about 80% of TROW revenue comes from management fees, there will be an immediate effect on the stock price. Keep in mind the stock surged by 40% in 2017.

The company also started to reduce fees charged on some mutual funds. While this type of investment vehicle is still popular, the major trend is toward ETF investing. In order to remain competitive, TROW has no other choices but to modify its fee structure. This could hurt its profitability.

Valuation

I was quite curious about TROW’s latest run on the market. When I looked at its PE history,  I noticed the market simply brought back its previous multiple:

Source: Ycharts

I guess the market shares the same fear as I do when I think of TROW. While the company is very strong right now, the bulk of its business model is not geared toward ETF investing. The mutual fund industry is slowly dying, this is not a secret for anybody. However, TROW has successfully found a way out of this issue with target-fund and strong performances.

In order to have a better idea, I’ve used a double-stage dividend discount model. I used a 8% dividend growth rate for the first 10 years and reduced it to 6% afterward.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $2.28
Enter Expected Dividend Growth Rate Years 1-10: 8.00%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $172.37 $114.18 $85.12
10% Premium $158.00 $104.66 $78.02
Intrinsic Value $143.64 $95.15 $70.93
10% Discount $129.28 $85.63 $63.84
20% Discount $114.91 $76.12 $56.74

Please read the Dividend Discount Model limitations to fully understand my calculations.

I’m now surprised to see TROW being overvalued right now. At the same time, I hardly see how I could give TROW a strong dividend growth rate. As for the discount rate, I never go under 9%. As I often say, there is a price to pay for quality.

Final Thought

While TROW shows some real strengths and good numbers, I’ll have to pass on this one. I don’t think TROW will continue to do that well in the upcoming years. Its business model is still heavily geared toward fees charged on mutual funds. The current bull market shows everybody under their best day. I think TROW’s star will pale upon the next market correction.

Disclaimer: I do not hold TROW in my DividendStocksRock portfolios.