FOCUS InBev H2 harbours optimism, but profit trends, management strategy linger

BRUSSELS (Thomson Financial) - InBev S.A. should reverse disappointing first-quarter earnings and falling profit margins by showing a better second half of the year, but questions still linger for investors over the blue chip's earnings trends and management strategy, analysts said.

Yesterday, the stock slumped over 5.0 percent after the Leuven-based brewer - maker of global beer brands Beck's, Brahma and Stella Artois - posted an unexpected fall in first-quarter profit, blaming tough comparables, poor weather in Brazil, Russian supply trends, commodity costs and inflation. At 5:06 p.m.

today, InBev was up 0.47 euro or 0.94 percent at 50.36 euros, while the Bel 20 was down 47.70 points or 1.23 percent at 3,825.46.

The numbers prompted a raft of brokers to lower their forecasts for the group.

Gerard Rijk, analyst at ING with a 'buy' rating on the share, said: "The trough in the first-quarter results was deeper than we anticipated. Owing to disappointing volumes, operational leverage was negative and the phasing of cost and price increases was still unfavourable." "In our view, the status quo at InBev, the recent disappointing earnings releases and management credibility issues turn it from a growth/yield stock into a trading stock".

Rijk also said the group's management face tough challenges ahead to boost operational performance.

"The big cost-cutting programmes are nearly finished. Now the more difficult part of sales synergies and premiumisation needs to be done. The brands are there and the process is supported by remuneration changes towards top-line growth instead of cost-cutting/EBITDA margin targets. The question is whether the consistency and organisation in marketing know-how are sufficient to make this essential change. Also, the lack of add-on acquisitions does limit the roll-out potential of the global premium brands". "We do not see a quick change here, as recent opportunities in Central and Eastern Europe and other parts of the world were taken not by InBev but by its competitors".

Damien Caucheteux, analyst at Petercam with a 'hold' rating, agreed that costs going forward would be key to the group's fortunes: "The shortfall is to be attributed to poor volume performance in Brazil, Russia and importantly the strong growth of cost of good sold. The softness in consumer goods in Brazil is also not reassuring as this issue is probably there to stay and we will certainly revise down our volume growth assumption in Brazil for the full year." "Growth in cost of goods sold should decelerate in the following quarters and the higher than anticipated inflation will be compensated by additional cost savings. However, programs are already tight and are mature in most of InBev's important geographic zones. Extracting further savings could prove more difficult in our view". Earlier, UBS downgraded its recommendation on InBev to 'hold' from 'buy' and cut its target price to 57.00 euros from 70.00 euros. UBS concluded that other brewers such as Carlsberg A.S., SABMiller and Heineken N.V. offer better sales growth and cost savings potential.

However, analysts remained bullish regarding the group's prospects for the second half.

Rijk at ING said: "In the course of 2008, the driving factors for earnings momentum should normalise. Brazil was already back into growth in April with 3.1 percent beer volume growth. The cost of sales per hectolitre should decelerate towards an average 2008 increase of 4 percent." "The weather comparisons are easier and even positive in the second half.

InBev's Russian sales, which were hurt by de-stocking, should benefit from the fact that the pipeline is empty. Overall, a return to volume growth brings back the operational leverage in the results, which is essential for brewers." Rijk added: "Mainly because of cost of sales issues, the second-quarter EBITDA margin might remain under pressure, but in the second half it should improve year-on-year. We see this as a logical development." "The full implementation of price increases and the easier year-on-year comparisons in input prices, added to comparisons with weak temperatures, pave the way for higher margins. The return of operational leverage should give additional momentum here".

Yesterday, Chief Financial Officer Felipe Dutra said the company is "not proud" of the results, but reiterated the group's commitment for profit margins to return to growth in the second half. KBC Securities, with an 'accumulate' rating, lowered its target price to 60.00 euros from 62.00.

Analysts said that although the market was forewarned about weak results on publication of the group's full-year results and at its annual shareholders meeting, the numbers were still worse than anticipated.

Net for the Leuven-based brewer came to 249.0 million euros from 280 million. Analysts forecast a rise to between 320.0 million euros and 330.0 million.

EBITDA came to 982.0 million euros, up from 962.0 million, but below the 1.04 billion to 1.09 billion euro estimates. The EBITDA margin fell to 30.7 percent from 31.5 percent. Analysts forecast a rise of between 31.9 percent and 33.3 percent.

Sales rose to 3.20 billion euros from 3.05 billion, and below the 3.25 billion to 3.33 billion euros estimates. Total beer and soft drink volumes rose marginally to 59.04 million hectolitres from 59.03 million. By region, first-quarter sales in North America, Latin America North and Latin America South rose 3.9 percent, 4.2 percent and 25.2 percent respectively.

Western Europe sales rose 0.7 percent, and Central and Eastern Europe sales rose 1.9 percent. Asia Pacific sales rose 2.6 percent. Global export and holding companies sales rose 3.8 percent.

It said in Latin America North, volumes fell 1.5 percent, volumes in Brazil were down 1.9 percent as a result of poor weather and a very early Carnival, which reduced the summer holiday period. The group added that there is some "softness" in the Brazilian consumer goods sector, hit by food inflation over 11 percent, ahead of 4.7 percent country inflation. However, it remains "confident" that the Brazilian beer market will return to growth over the rest of the year.

It said that Central and Eastern Europe volumes dipped 5.7 percent, impacted by an 11.4 percent drop in Russia following wholesale stockpiling in December 2007 in anticipation of a price increase in January.

In terms of its global flagship brands, volumes rose 4.4 percent. Beck's volumes rose 0.7 pct and Stella Artois volumes rose 7.2 pct, boosted by sales in the UK, U.S. and Argentina.

InBev called the first quarter a "difficult" start to the year.

The group said the tough comparables will continue into the second quarter but added that it will deliver EBITDA margin expansion in the second half. It reiterated last week and Thursday that in 2008 there will be "greater challenges" to overcome than there have been over the past three years.

Chief executive Carlos Brito said: "As highlighted in our 2007 full-year announcement, we benefited from strong growth in the first half of 2007, which would lead to challenging comparables for the first half of 2008, especially in the first quarter with respect to both volume and EBITDA performance." "However, we believe that we have the right programs in place to deliver stronger results in the following quarters, allowing us to resume EBITDA margin expansion in the second half of this year".

The group said it remains committed to continuing to deliver EBITDA margin expansion through a combination of "top line growth and disciplined cost management".

"Top line growth will remain our priority, and in addition to the further roll-out of our proven sales execution programs, we will continue to provide the right brands with sufficient resources to grow," it said.

It added that operating efficiency also remains high on the agenda, with cost of sales per first-half growth decelerating over the remainder of the year.

On costs, the group said cost of sales per hectolitre rose 9.9 percent on higher commodity input costs. Consolidated cost of sales rose 119.0 million euros or 9.5 percent. Operating expenses came to 1.12 billion euros. Net debt rose to 5.70 billion euros as of March this year from 5.09 billion as of December 2007.

The group also said that recent developments are indicating that the weighted average inflation in its markets is moving towards the range of 5.0 percent to 6.0 percent - higher than the 4.0 percent it anticipated.

It said, however, that it has "already mapped" additional cost-saving opportunities to fully offset the gap versus its full-year cost of sales per hectolitre target of 4.0 percent.

Last week, at its annual shareholders meeting, the group raised the possibility of increasing its prices as commodity costs and inflationary pressures bite. Previously, the group committed to keeping price hikes below or in line with inflation. CFO Dutra said the price increases across its zones are "local" and made "per channel, per brand (and) per package".

InBev was created in September 2004 via the merger of Interbrew and Companhia de Bebidas das Americas (AmBev). It has operations spanning Europe, North and Latin America, and Asia Pacific, with an estimated global market share of 15.0 percent. It has a portfolio of over 200 brands.

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