Heineken: Probably Fair Value

by The U.K. Income Investor

I was tempted to cover Heineken (HEIA) stock back in early April. The Dutch brewer traded for around €72 per share at the time, which represented a circa 30% drop on pre-COVID highs of €105 per share. That seemed like a decent enough price considering that FY19 income came in at €4.39 per share. I mean, paying 16.5x normalised earnings for a large-cap alcohol stock will probably work out okay in the long run.

Ultimately, that piece did not make it onto the site. The stock has since rallied to the €89.10 mark, so perhaps it should have! In any case, two other alcohol stocks did receive coverage in that time: Diageo (on this site), and Anheuser-Busch InBev (over on The Compound Investor). It seems apt that this turned out to be the pecking order. In terms of the former, the competitive advantages of spirit maker Diageo strike me as much stronger than the brewers. As for the latter, the scale advantages of Anheuser-Busch InBev make it the top beer industry pick on an earnings quality basis.

With all that said, Heineken is not a bad business at all. Scale is everything in the beer world, and the company has bags of it. It sold just over 240 million hectoliters (mhl) of beer last year, which makes it the number two globally after Anheuser-Busch. Heineken also holds the number one spot in a bunch of markets, including in the likes of France, the UK and China. All-in-all, that amounted to a €2.5B profit machine last year on the back of €23.9B in sales. Given said profit tended to roll in year in, year out, that typically made the stock a solid pick for long-term investors.

COVID-19

That last statement certainly held true in almost any economic environment prior to 2020. I mean, conventional economic cycles don’t typically impact cashflows for brewers like Heineken. Folks buy beer to drink at home; they buy beer to drink in pubs, restaurants and cafes. Who really cares if GDP goes up or down from one year to another?

Of course, the COVID pandemic is rather different. It has materially impacted Heineken’s ‘on-trade’ segment in a way that probably has not happened before. In terms of the numbers, total beer volume clocked in at 165.4mhl over the first nine months of 2020. That represented a drop of just over 8% in organic terms compared to last year. Sales of the namesake Heineken brand clocked in at 31mhl year-to-date, up 1% year-on-year in organic terms. That came on the back of 7% Heineken sales growth in 3Q20 – with double-digit growth in markets including Brazil, China, the USA and the UK. Total volume in 3Q20 clocked in at 62.9mhl, down 1.9% year-on-year in organic terms.

Now, a lot is going on within those headline figures. Check out the impact over in Europe as a good example, where the company generated 35% of profit last year. The on-trade there has dropped by 20% or more in some markets. In the UK, where Heineken owns around 2,500 pubs and is the country’s largest brewer, the fall registered in the “high-twenties” as per management’s commentary. That was partially offset by a contrasting increase in off-trade sales. You will find a similar pattern elsewhere: catastrophic declines in the on-trade, partially offset by folks drinking more at home. Temporary ‘dry laws’ in countries like Mexico and South Africa also had a small negative impact.

As you would expect, profit for the period also looks quite poor. The firm posted reported net profit of just under €0.4B for the 9M20 period. That was down circa 75% on the €1.67B it made in 9M19. Again, I’m not sure it is worth reading too much into this: the year of COVID is not really representative of the underlying earnings power here for obvious reasons. On the plus side, the balance sheet remains in relatively strong health. Net debt stood at €16.7B at last count, equivalent to 2.9x FY19 EBITDA of €5.7B. The firm opted to scrap its interim FY20 dividend earlier in the year to preserve cash.

Valuation

Heineken stock is fair value in my view. The shares closed the week at €89.10 on the Euronext Amsterdam, and remain down around 6% so far this year. That performance would undoubtedly be worse if not for the myriad of positive vaccine news in recent weeks. Indeed, you could pick up the stock for a sub-€80 price as recently as early November. Anyway, the current price works out to just over 20x FY19 net income per share.

In terms of a long-term investment, that strikes me as just about okay. It is possibly slightly expensive, but not by much. The company typically only pays out around 35% of net income as cash dividends, leaving plenty of retained profit to be pumped back into the business. I have cumulative net profit running at €18B over the past decade, with €6.8B paid out in shareholder dividends in that time. The implied retained earnings, in turn, helped to power earnings growth at a 7.5% per annum clip.

This year is clearly a washout, but the business will hopefully recover from COVID relatively quickly. Analysts currently see Heineken getting back to earning €4 per share in net profit by FY22. That implies well over €7B in retained earnings out to the mid-2020s, which is more than enough to deal with scheduled debt maturities of circa €6.4B over the same timeframe.

Assuming volume growth in the low-single digits per annum, the stock probably offers long-term earnings-per-share growth in the 7% per annum area. Some earnings multiple compression may shave a point from that depending on your investment horizon. Coupled with a 1.9% dividend yield – with that figure based on reinstating the FY19 distribution – it gets close to the 10% per annum compounding mark. It may not represent a spectacular outlook, but probably one befitting the firm’s stodgy status.

Note

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