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Here's how you can hedge against the falling dollar and reap large profits from the fourth largest brewery on earth
by Christian DeHaemer
Sub-Saharan Africa is sinking. In March, Mozambique got hit with a rampaging wall of mud and water over six feet high rolling down the Gaza plain — its biggest flood in 40 years.
Over one million people (out of a population of 17 million) discovered the hardships of displacement and the difficulties of finding safe drinking water. Cholera became epidemic in the tent cities and shantytowns that sprang up on the mud flats.
The economy and infrastructure were devastated. One third of Mozambique's cereal crop was destroyed. So were homes, roads and bridges. South Africa, which sent military helicopters to pluck more than 550 stranded victims from the treetops, suffered some of the same heavy rains and cold weather as its northern neighbor.
Kudu on the rampage
The northern fence of the world famous Kruger National Park was damaged. Wild beasts, including lions and elephants, kudu and buffalo, wandered north. The buffalo were the most destructive, carrying hoof-and-mouth disease and other illnesses that infected cattle herds.
South Africa was spared a major catastrophe, but its crops suffered — mainly maize (what we call corn). Numbers just released for Q1 show that the agricultural portion of South Africa's GDP dropped 17.7%, down from an increase of 12.4% the previous quarter and a 36% increase the one before that.
This dropped the overall Q1 GDP growth number to 0.9%, a far cry from the estimated 2.5% most analysts were expecting — even though agriculture only makes up 4% of South Africa's GDP. The market reacted by selling South African Rand and JSE markets down to historically low levels.
Acts of God — and man
A forty-year flood is freak of nature. An African dictator is a way of life. In Zimbabwe, ruling President Robert Mugabe's ZANU-PF party has decided to try a little land reform — always popular with the peasants.
Some white landowning farmers have been killed, while others have been made to attend "re-education meetings" with workers to force them to renounce the opposition party. They are made to hold hands aloft with ZANU-PF officials and promise to let the party's thugs use their trucks for campaigning. A full 1,100 farmers are scheduled to lose their farms, many of which have been in the same family for more than a century.
Dictators can be decidedly unoriginal. In a page taken out of Malaysian politics, Mugabe arranged for former Zimbabwean president Canaan Banana to start serving a one-year prison term for sodomy and other homosexual offences. (Maybe these guys have a chat room at Dictator.com. Suharto — Indonesia's former President for Life, pulled a Pinochet recently, claiming he was unfit to stand trial due to a stroke.)
 Still playing the colonialist card
The bad harvest and all this upheaval on South Africa's northern border would be bad enough for its financial markets even without South Africa's president Mbeki's apparent sympathy for the democratically elected strongman to the north.
Mbeki's failure to immediately condemn farm invasions and violations of the rule of law and take steps assure South Africans that similar invasions will not be tolerated triggered a fall in the rand over the past six weeks. But you know...
...I love it. It's the best think since sliced biltong.
In investing, as in life, the best strategy is often the most obvious. One I have employed in the past with great success is to buy solid blue chip companies in emerging markets at the nadir of their psychological curve.
Obviously, when you can find a company flush with cash and full of future prospects, with superior management that has a long and proven ability to weather harsh market conditions, you should grab that company during its 52 week low.
When all the sellers have sold and there is no one left but buyers, when nobody wants to own a company and all of the negatives are priced in — the stock has nowhere to go but up. As the dreaded Yankee Yogi Berra once said, "You hit them where they ain't."
SAB story
Many of you remember South African Breweries from two years ago, when the Asian currency crisis took it down to unforeseen levels. If memory serves right, we made some 53% profits from SAB in three months.
I've made similar short-term gains for you with China Telecom (55%), PLD Telekom (162%), Indonesia Telekom (55%) and D&G (102%). I didn't hold any of these companies more than six months. In fact, I'm four for four in bombed-out blue chips recommended in Taipan.
South African Breweries (SAB:London GDR) has gotten crushed recently due to the situation described above, the fall of the rand against the dollar and their pre-announcement of a flat year, which coincided with one of NASDAQ's worst down days.
All this has left SAB's share price bouncing around £400, well off its highs of £645. It is now trading with a market cap of £3.15 billion, just over its annual revenue of £3.04 billion. It has a P/E of 11.87 and a dividend yield of 4.14 %. In terms of volume, South African Breweries is the fourth largest beer company in the world.
Flat beer
The company had a less than stellar year due to the heavy rains and falling currency. Beer sales in South Africa fell by two percent. This was blamed on the fact that beer drinkers had less disposable income, and research shows that a dip of 5 degrees Celsius reduces the tendency to swill — a situation that recurred throughout the summer. That said, none of these conditions are set to repeat this year.
In circumstances the company can control, such as operating margins and overseas growth, SAB did remarkably well. As a result of a number of productivity and cost containment initiatives, operating margins increased 1.7% to 25.3%. Compare that to Coca-Cola (KO:NYSE), with an operating margin of 14% and a P/E of 79 — even after falling 40% from its highs. Anheuser-Busch (BUD:NYSE) has a P/E of 24 and an operating margin of 19%.
 International assets
Worldwide demographics tell us that emerging markets from Southeast Asia to Eastern Europe are "youth heavy" — in direct contrast to the industrialized nations. This is largely because their wars ended 10-30 years later than World War II, so their baby booms happened in the 60s and 70s instead of the 40s and 50s. As this burgeoning young adult population becomes more urban and prosperous, the beer drinking culture expands.
SAB's strategy is to invest in brewing businesses ahead of market and consumer demands. They aim to achieve critical market share early and exploit economies of scale and productivity gains by building modern plants before the market is fully developed. It's a strategy that appears to be working, though it does include risk and they have met with restructuring loses and plant closures in Russia. But they appear to have put this behind them.
Some 25% of SAB's operations are now outside South Africa. SAB reports in U.S. dollars but it generates revenue in a basket of currencies. In spite of the strong and rising dollar over the past few years, SAB has shown excellent growth in many of these emerging markets. A number of them did quite well, including Poland, Botswana, Russia and China, where revenues grew 40%.
A better company — the same price
SAB has sold off a number of its other ventures over the past in order to focus on what it does best, using the proceeds to expand as well as buy back its own shares. It plans on spinning off its gaming and hotel division later this year by listing them on the Johannesburg Stock Exchange. This is expected to generate US$500 million. That's catalyst one for buying this company.
Not to bore you with the minutiae, I will just hit on the highlights. Total beer volume was up 10% to 53 million hectoliters last year. Profit before tax was US$764 million. It was US$712 million before one-time gains on the sale of a subsidiary. That was up from 1999, when profits were up US$680 after one-time charges and gains.
Adjusted earnings were up 8% to US$426 million. If you allow for currency fluctuation earnings rose 14%. That's great when you consider a declining volume in its main territory. Underlying margins in all divisions climbed 1.7% to 25.3%.
Beer me, Kemo SABI
The best and fastest growing division is SAB International or SABI. SABI is based in Amsterdam and has operations throughout the world, with the notable exception of South America.
The trend in Poland among young people is away from vodka and toward beer. The annual compound growth rate of beer consumption over the past five years has been 9%. Volume in Poland was up 33%. SABI has dominant market share, rising 15% last year to 69%. It is forecast to grow more than 3%. Sales should improve as well.
In Botswana, where GDP grew by more than 10% and employment rose by 5.3%, SABI grew both margins and productivity in its plants.
Sales in China rose by 38%. Volume grew from 6.1 million hectoliters last year to 8.4 million hectoliters this year. Capacity rose to meet demand. SABI purchased three new facilities at Tianjin, Sanshan and Wang Hua. China is growing GDP 6-7% a year and the outlook is positive going forward. SABI is positioned to expand sales in current regions as well as adjacent areas.
As Russia turned around, so did SABI's division there. It has developed a strong brand portfolio. Demand has outstripped supply.
Purchase of Pilsner Urquell
In the Czech Republic, SABI recently purchased Pilsner Urquell, the premium brand in that country with a 44% market share. Pilsner Urquell is already exported to 50 countries and has excellent potential for further growth.
As the Czech Republic enters the European Union you should see growth in premium beer volumes based on
rising disposable income. The same can be said of Hungry, where SABI is also well positioned. The Czechs drink more beer per person than any other nationality.
Momentum in Europe is well established, with good underlying business performance that Pilsner Urquell should enhance.
A few months ago SABI obtained permission from the Indian government to enter the beer market in India through a joint venture with local partners. SABI will own 60% of the new company, with a brewery in Nawabganj, Uttar Pradesh, that will be modernized and upgraded.
Emerging market vs. the almighty dollar
Despite all the strong bullish factors in SAB's favor, my recommendation has nothing to do with the fundamental organic growth of this company — though current world trends appear increasingly beneficial. SAB is a market psychology play based on the undue fears of its neighbors.
I was in South Africa last September with the Taipan group tour. Everywhere I went, people showed an inordinate amount of respect for Nelson Mandela. His ideals of compassion and reconciliation were shared equally by the Afrikaner gold mine owners and staff at the game hotels. Such admiration for a public figure probably hasn't been seen in the U.S. since George Washington.
In my opinion, this type of legacy, as well as the ingrained adherence to constitutional law, won't be swayed by a two-bit dictator in Zimbabwe. And anyway the situation in Zimbabwe is likely to calm down, or at least head to the back page, after the upcoming July elections.
Running rand
The hit to the rand will likely dissipate. The dollar has peaked out against the Euro. As the U.S. economy slows and its foreign balance of trade continues to grow, the dollar will come down against a basket of currencies. There is no doubt that SAB had a bad year with a marginal 8% earnings growth due to currency problems (14% growth if you assume a stable currency). But this trend is likely to reverse itself over the coming year. Currency fluctuations could well overstate its growth going forward.
The heavy rains and 40-year flood that slowed beer consumption are unlikely to happen two years in a row. In fact, agriculture in South Africa is headed for a bumper crop, which should increase disposable income as well as return GDP to more than 3% growth.
I think the bad news is priced in. SABI is now trading some 23% below book value. SAB has higher organic growth than its competitors, trades at less than half their value and is gaining market share in the fastest growing beer markets worldwide.
Hedge hog
As a hedge against a declining U.S. economy, a falling dollar and a still richly valued tech market I recommend that you buy South African Breweries below £410. SAB trades in London as a GDR.
A return to its 2000 highs will give you a 58% yield. Thanks to the future economic outlook, I believe this company will likely trade much higher than that with a spin off of its hotel and gaming division. Buy SAB under £410 with a medium-term price target of £645.
Contact: 25 Grosvenor Street, London, W1X 9FE. Tel: (020) 7659 0100, Fax: (020) 7659 0111, www.sabplc.com.
Look, a penguin!
As I said, I went on the Taipan tour to South Africa last September. The trip couldn't have been better, as I'm sure others in the group will attest. There is nowhere else on earth where you can see wild lions in a park bigger than Massachusetts one day, and the next take a boat ride to see penguins at the end of the earth. We descended a mile below ground in a working gold mine and haggled with diamond wholesalers.
The accommodations were equal to the best in the world, and Michelle was there to make sure the travel arrangements ran smoothly. If you have time when you are in Cape Town, check out a local rugby bar, the Springbok, where beers are cheap and the conversation is flavorful. Just don't tell them you support the New Zealand All Blacks. If you'd like to go on this year's trip, you had better act fast. Siu-Yee tells me it's filling up fast. Read more about the conference here and then give her a call at 800-926-6575.
| Year ended 31 March |
1998 |
1999 |
2000 |
| Turnover Mill. £ |
2,832.00 |
2,860.00 |
3,050.00 |
| Pre tax profit Mill. £ |
3930 |
369 |
372 |
| Norm earn per share p |
31.3 |
32.9 |
13.4 |
| FRS3 earn per share p |
31.6 |
30.1 |
27.1 |
| Intangibles Mill. £ |
0.4 |
0.6 |
203 |
| Fixed assets Mill. £ |
1,093.00 |
1,081.00 |
1,170.00 |
| Fixed investments Mill. £ |
225 |
235 |
238 |
| Stocks Mill. £ |
228 |
231 |
212 |
| Debtors Mill. £ |
408 |
370 |
354 |
| Cash, securities Mill. £ |
333 |
359 |
464 |
| Creditors short Mill. £ |
715 |
857 |
765 |
| Creditors long Mill. £ |
411 |
729 |
720 |
| Prefs, minorities Mill. £ |
191 |
34.6 |
99.7 |
| Ord cap, reserves Mill. £ |
970 |
656 |
1,055.00 |
| Mkt capitalization Mill. £ |
4,213.00 |
In addition to his duties at Taipan, Chris DeHaemer is the editor of The Hammer.
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