Bid For Anheuser-Busch Really Hits Home

After being born and raised in Baltimore, I traveled out to St. Louis for college and subsequently spent a decade there. The long rumored InBev hostile merger offer for American icon Anheuser-Busch (BUD) came true on Wednesday, as the maker of Budweiser confirmed they had received an unsolicited $65 cash bid.

InBev has a reputation for buying up competitors and slashing costs (read: jobs) to boost efficiencies, profit margins, and as a result, its stock price. As a result, news of this bid really hits home and comes with very mixed emotions. My company owns shares of BUD for some of its clients, so that is good from an investment standpoint, but that about the only positive I can see from my perch.

I have friends who work at the A-B (as it’s known locally) global headquarters in St. Louis so their job security is in question all of the sudden. Whether it be Busch Stadium (home of the Cardinals), Grant’s Farm, or the St. Louis Zoo (free to the public thanks to subsidies from BUD), the city really would take a hit if an InBev/A-B combination resulted in dramatic change.

Upon seeing the press release yesterday afternoon, I quickly sent off an email to a client and close friend working there, to which he replied with a single line:

“Top 5 worst news I’ve received in my life.”

This hostile battle is going to get ugly. BUD will have shareholders who want to take the deal and employees, supporters, and customers who will be firmly against it. After seeing another company with very little leverage turn down an excellent bid (Yahoo), it is certainly possible that A-B could rebuff InBev, although doing so will draw lots of commotion within the investment community.

As you can see from the chart below, BUD shareholders have not had much to smile about this decade, and this deal certainly would boost earnings and the combination’s share price.

The question is, at what cost? Would the brand be tarnished in any way if InBev’s cost cutting managers arrived on the St. Louis campus? It is hard to know.

Normally, as an investment manager I would be jumping for joy at the possibility of getting $65 for shares that not too long ago traded in the high 40’s. But this is far from a normal situation for many of us with direct or indirect ties to the company.

For non St. Louisans, the key question is what to do with the stock (now trading at 63 and change in pre-market trading). Given the local disapproval of a deal, coupled with it being an election year and oversea buyouts/job loss being a hot button political issue, I would say the odds of a consummated deal are no better than 50/50 at this point.

Given that the stock was hovering around $50 before InBev rumors started, and an eventual deal could range between $65 and $70 (if they are forced to sweeten the offer to secure BUD), an expected value on the stock sits in the $58-$60 range. With a current price in the $63 area, it seems reasonable to consider selling a portion to lock in gains and guard against a blocked deal, which could certainly happen.

Full Disclosure: Long shares of BUD at the time of writing

Are All Consumers in the Same Boat?

Last weekend I attended some festivities for a friend’s birthday that included dinner at the Landmark Buffet at the Ameristar Casino and Hotel (ASCA) in St. Charles, Missouri. Along with spending some time with good friends, I was also especially interested to see how busy the casino was on a Friday night. If you simply looked at the stock prices of the major casino companies in the United States, you would have predicted the place would be empty. Gaming stocks have been crushed lately on consumer spending worries. ASCA stock, for example, is down about 45%, from a high of $38 to the current quote of $21 per share.

Such large drops are fairly surprising given that gaming stocks are widely believed to be fairly recession-proof. Rather than take lavish vacations, or even hop on a plane heading to Vegas, people tend to scale back and just drive to a local riverboat casino instead. Despite the typical feeling that gaming holds up okay in recession, the casino stocks this time around have really taken it on the chin, so investors are clearly betting that this time is different.

Surprisingly, the Ameristar Casino was as crowded last Friday as I have ever seen it. At the buffet, for example, people are still standing in line for at least an hour for a $21.99 crab leg, steak, and shrimp dinner. After seeing such a large crowd, I came to the conclusion that the health of the consumer likely depends largely on where the person lives. Here in the Midwest, the housing market downturn has been less severe because it never really got crazy to start with. Compared with hot areas like California, Nevada, Arizona, and Florida, states like Missouri had much more subdued housing speculation.

The result of that is that things aren’t that bad here. You don’t hear about huge numbers of foreclosures or see evidence that the consumer is largely tapped out. The main problem here with respect to housing is simply a supply-demand imbalance. There is still a decent amount of building going on, in the face of high levels of for-sale signs out already, so houses aren’t selling. However, people are simply sitting on them, reluctant to lower prices to motivate buyers, much like other places across the country. But without extreme speculative activity, the negative impact on consumer spending does not appear to be as drastic as other places across the nation.

How can we make investment decisions based on this? Well, my opinion is that many consumer related stocks have been beaten down way too much. Companies focused on the roughest housing markets will likely see the brunt of the negative impact. Other areas such as the Midwest will likely hold up well on a relative basis. For a company like Ameristar, which owns properties in Missouri, Nebraska, and Mississippi, things might wind up being okay.

Additionally, the upscale consumer sector should still do relatively well. Sure, things will slow down, but the high end of the market will drop off less than the lower end, and likely will rebound faster once things turn around. After all, rich people probably aren’t scaling back too much due to elevated inflation levels.

One other area I think is poised to hold up well is the restaurant sector. Wall Street is bracing for people to stop eating out during the current economic downturn, but I would argue that eating out is due more to a secular shift in behavior than a bi-product of easy credit. People nowadays work longer hours than they used to and have less time to make dinner every night. I’m not saying dining spending won’t drop when things get tough, but I think if you look at the hits the stocks have taken and what that implies about business expectations, things won’t be nearly as bad as investors are pricing into the stock prices of restaurant chains.

All in all, I think investors should differentiate between the varying degrees of consumer stocks. A lower end company operating in California or Florida is going to fare differently than a high end company in the Midwest. A Vegas casino might not do as well as one based in St. Charles, MO in uncertain economic times. Traffic declines at a clothing retailer will likely be more dramatic than at a restaurant chain, if indeed eating out is a decision made for convenience more than monetary reasons. A new wardrobe is much easier to postpone than making time to prepare dinner at home.

As we allocate money to the consumer discretionary sector, it might serve us well to think about these things.

Full Disclosure: No position in ASCA at the time of writing

Kraft Shares Still Not Overly Attractive, Even After Altria Spin-Off Selling Pressure

With the Altria (MO) spin-off of Kraft Foods (KFT) completed on Monday, there has been renewed selling pressure on Kraft shares as investors shed their newly claimed small position in the company. Such negative price action will likely be a short term phenomenon, at least as far as it’s relation to the spin-off, so a contrarian investor should be asking, “Is this near-term weakness an opportunity?”¬†However, despite the poor performance, Kraft shares are not cheap.

At the recent price quote of $30 and change, they trade at 17 times 2007 profit forecasts. For a company that is growing sales at a low single digit rate annually, and whose earnings are projected to be flat between 2006 and 2008, the stock doesn’t at all look like much of a value play, despite what the yield and the five year chart might have you believe.

The way I see it, not really. The one thing Kraft does have going for it is a fat 3.2% dividend yield, but other than that, there really isn’t much to like. Buying a stock just for its dividend doesn’t really make much sense when you can earn more in a savings account. As you can see from the five year chart below, Kraft shares have been underperforming the market for a long time, so bargain hunters may be drawn to the name.

Full Disclosure: No position in KFT at time of writing

The Power of Multiple Expansion

Stock prices go up for one of two reasons; earnings growth or multiple expansion. If you really want to hit the jackpot with your investments, try and find stocks that can give you both. The combination of the two, as I will illustrate in a moment, is really powerful in terms of shareholder returns.

This is one of the many reasons why value investing has proven to be so successful over time. By buying stocks that have meager valuations, there is always the potential for multiple expansion. Getting earnings growth is even easier because most economies grow over time, so as long as management teams do a good job, earnings growth is inevitable over the long term.

Last year a friend of mine emailed me about a stock he was looking at, beverage giant Diageo (DEO). Diageo is one of the biggest wine, spirits, and beer suppliers in the world, known for brands such as Smirnoff, Guinness, Baileys, Captain Morgan, and Tanqueray. At the time (perhaps about a year ago or so) DEO shares were trading in the low sixties and the company was expected to earn about $4 per share in the coming year. At about fifteen times forward earnings the stock looked pretty fairly valued to me. Given DEO’s size and an organic revenue growth rate of about 6 percent, earnings growth would likely average mid to high single digits, so a fifteen multiple seemed reasonable.

I can’t remember exactly what my response to him was, but I suspect my feelings on the stock were something like “yeah, it’s a solid defensive play with a nice dividend yield, but it looks fairly priced, so I would expect the stock to pretty much track earnings growth.” Well, that assessment turned out to be quite wrong. The stock has risen by more than 30 percent since then, to the low 80’s.

So what the heck happened? Simply put, most of the gain came from multiple expansion. Beverage stocks have had a great run lately as they offer fairly predictable profits and nice dividend yields (just look at the charts for BUD, KO, and TAP). Defensive investors have placed a higher value on these stocks lately, and their stocks, which used to fetch market multiple of 14-16 times earnings are now getting 17-19 times earnings. Sales growth is still mid single digits, with earnings ranging from the high single digits to low double digits, but the stocks are seen as safe, and as markets rise, some investors look to put money in less aggressive places.

How much of DEO’s gain was due to multiple expansion? Well, they earned $4 per share in 2006 and the stock went from a 15 P/E to an 18 P/E, so that is $12 per share in appreciation due to a higher multiple. That amounts to about a 20 percent share price jump (given that the stock was around $60 per share). Add in another 10 percent or so for earnings growth and you get a stock that is up 30 percent in the last year.

I might have been wrong about Diageo, but this should help to explain why valuation is so important when investing in the stock market. Diageo’s business hasn’t really changed much at all in the last year, but investors’ willingness to pay up for the stock has, quite meaningfully in fact. And that, you see, is the power of multiple expansion.

Full Disclosure: No position in DEO at the time of writing

Altria to Spin Off Kraft… Shocking!

It’s amazing how many people have been quoted saying the Altria (MO) spin-off of its 89% ownership of Kraft Foods (KFT) will send the shares of MO to between $100 and $110 each. If we’ve known about the spin-off forever (we have, even though the exact date was just announced) why has the stock been trading in the mid 80’s? I guess I’m just not convinced that something like a spin-off, that surprised absolutely no one, will result in a 20% move in the shares of a company that, let’s face it, makes cigarettes.

Altria shares, ex-Kraft, trade at about 15 times 2007 earnings. Is this a bargain for the leading maker of so-called “cancer sticks?” Doesn’t seem to be. How much will investors be willing to pay for a company that sells a product that kills people and is hardly a rapidly growing market opportunity? Although the decline won’t be as rapid as many of us would like, I have to think that over the long term the number of people who smoke will go down, not up.

For this reason, shares of cigarette firms, including MO, traditionally have traded at a discount to the market. With shares of Altria trading at about a market multiple, it’s hard for me to understand why the actual spin-off of Kraft will cause a huge stock price spike. Such a move would require either 1) investors paying an above-average multiple for a business with a below-average growth rate, or 2) a dramatic increase in future earnings due to the financials flexibility that the spin-off provides.

The latter seems more likely than the former, but I still think Altria shares are fairly valued at current prices. In fact, it’s interesting to note that MO stock has actually dropped from above $87 to $85 since the company announced the details of the Kraft spin-off. The stock remains an excellent dividend play, but investors expecting an immediate move up to $100 or more might have to wait a little longer than some are predicting.

Full Disclosure: No position in MO

A Wildly Bullish Quarter for Buffalo Wild Wings

Sports bar/restaurant chain Buffalo Wild Wings (BWLD) posted an excellent third quarter Tuesday evening, prompting a five point rise in its stock in extended hours trading. Sales jumped 32 percent to $68.3 million, ahead of estimates of $64.9 million, as company-owned same-store sales soared an astounding 11.8 percent. Earnings hit $0.40 per share, nearly 30% above estimates of $0.31 for the period.

The company’s conference call was very bullish, as management laid out growth plans for the next three years. BWLD expects annual unit growth of 15 percent, sales growth of at least 20 percent, and earnings growth of at least 25 percent.

Also worth mentioning was the lack of fourth quarter guidance. The company announced that it has decided to abandon giving quarterly financial projections, due mostly to the fact that they have been quite unsuccessful at the task in the past, and with fewer than nine million shares outstanding, a miss or beat of a mere penny per share equates to only a $44,000 difference.

The bears on the stock (and there are plenty of them, as seen by the 18% short interest in the name) will point to the lack of guidance for the fourth quarter as evidence that management expects poor results relative to the market’s expectations. However, such a conclusion isn’t very likely. Management mentioned on the conference call that Q4 same-store sales are already tracking up 11 percent year-over-year, well above even the most bullish estimates on the Street. Even if fourth quarter results get no bump up from current analyst projections of $0.46 per share, the company will report $1.54 in EPS for 2006. A twenty-five percent jump in 2007 puts EPS for next year at $1.93 per share.

As I have written before, I don’t care much at all for quarterly sales and earnings guidance. In the case of BWLD, the company has a growth plan in place that will take form over the next three to five years and beyond. Whether they open a new store in Q3 or Q4 should be irrelevant for long term investors. Investors in the stock, myself and my clients included, will be served quite well if the company hits its growth targets, regardless of how volatile the quarterly fluctuations in financial results turn out to be.

Full Disclosure: I own shares of Buffalo Wild Wings (BWLD) personally, as do my clients.

 

Lampert/Anheuser Busch Rumors Insane

Have a flat-lined stock like Gap Stores (GPS) or Home Depot (HD)? Why not start a rumor that Eddie Lampert, Chairman of Sears Holdings and general partner of ESL Investments, a Connecticut based hedge fund, is interested in your stock? That seems to be a recurring idea on Wall Street lately.

The latest rumor sent shares of St. Louis based beer brewer Anheuser Busch (BUD) up 2 percent on Tuesday, on reports that Lampert could launch a $56 per share takeover bid. This has to be one of the silliest rumors I’ve ever heard. At least GPS or HD made a little sense given Lampert’s taste for retailers, even though Home Depot is far too big for an outright acquisition.

How exactly could Lampert pay $44 billion for BUD? And even if he did have the money, why would he do such a thing? Maybe those starting these rumors just want the Warren Buffett/Eddie Lampert comparison to ring true. After all, Berkshire Hathaway (BRKA) has a fairly large position in BUD. Regardless of who is responsible for the rumors, please do not buy BUD shares on hopes of this news materializing. There is no way Lampert buys out Anheuser Busch.

Grocery Shopping At Walmart

The large grocery store chains used to have virtual monopolies on food shoppers’ wallets. However, over the last five years their fortunes have changed, and their stock prices have lagged. The pressure has come from a two-pronged attack, discounters and healthier food stores. Walmart mostly and Target to some degree in the former group, and the likes of Whole Foods and Trader Joe’s in the latter group.

Some of the traditional grocery stores have seen the light and are attempting to shift their store offerings to be more like a Whole Foods. Safeway, for instance, has begun a remodeling campaign under the “Lifestyle” concept to regain some of the market share it has lost in recent years. Time will tell if the move works, but at least they are trying, so their odds are far better than those simply muddling along with razor thin margins and no plan to at least maintain the business they have.

This weekend I shopped at Walmart for groceries for the first time. That was a big step for me. I hate shopping at Walmart. I find their stores a miserable experience. While the prices are low, the departments aren’t well organized and much of the shelves look like they haven’t been restocked in weeks. More times than with any other store, I can wander around for 5 or 10 minutes looking for the aisle I need. This is a sharp contrast to Target stores, which I find to be fully stocked and very easy to navigate.

Anyway, back to Walmart and groceries. I usually visit the local grocery store, more out of convenience than anything else. However, I finally bit the bullet and realized I could save some decent money in Walmart’s grocery aisles. After a successful trip, I came home and compared Walmart’s prices to those I paid during my last trip to the local grocery chain. I wanted to know how much the savings really amounted to. Turns out, Walmart’s regular prices are 30% below my neighborhood grocery store. Even when you factor in the local grocer’s sale prices, Walmart still saved me 20%.

While I still prefer to go elsewhere, I will be making more trips to Walmart for staple items that I know I can save a good amount of money on. For me, that seems to be groceries and toiletries. With Walmart continuing to expand their food selection and Whole Foods and Trader Joe’s growing their store bases at 20% annual rates, the traditional grocery chains better adjust, as Safeway is attempting to do, or else they will become extinct fairly quickly.

Whole Foods Reacts Poorly To Results

I feel for shareholders of Whole Foods Markets (WFMI). Yesterday the company reported 20% growth for yet another quarter and boosted its 2010 revenue goal to $12 billion from $10 billion. In a bid to please shareholders, the company also announced a $4 special dividend, a regular dividend increase of 30%, a two-for-one stock split, and a $200 million stock buyback plan.

Getting all four of those surely sounds like a good thing, but WFMI shares are down $9 in pre-market trading. The reason is quite simple. Whole Foods is a very high multiple stock and Q3 earnings didn’t come in ahead of estimates, which many were banking on. Despite a growth forecast of 20% annual growth through 2010, the stock is under pressure.

This is undoubtedly due to the stock’s high P/E. The company should earn about $3 next year, but that equates to a price-to-earnings ratio of 48 before today’s drop. You’ll be hard-pressed to find many investors who are willing to pay more than that for a stock, even if WFMI’s outlook is very bright and the company can deliver on its growth goals.

What Happened To Buffett’s Budweiser Stake?

Berkshire Hathaway (BRKA) filed with the SEC on August 15th and listed its current public stock holdings as of June 30th. Interestingly, there was a notable name absent from the list; Anheiser Busch (BUD).

Now, you may recall BUD came out in late April and said it had learned that Berkshire, Buffett’s holding company, had taken a meaningful stake in it. The stock reacted by jumping $3 to $48 on the news, and many investors bought BUD shares simply because Buffett did.

The question I have is, how come recent SEC filings show no such stake in the beer giant?