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Is Anheuser-Busch InBev's Dividend Safe?

The continued slump in Anheuser-Busch InBev's (BUD) stock price has caused some income investors to worry about the safety of the company's dividend. Fortunately, based on the facts we know today, a dividend cut seems unlikely.

AB InBev primarily produces and distributes beer and other alcoholic beverages. The company generates over $50 billion in revenue each year, derives more than 70% of its volume in emerging markets, has approximately 27% share of the global market, and enjoys excellent profitability with an operating margin north of 30%.

So what's weighing on this non-cyclical, global brewing giant that some investors worry could potentially jeopardize its payout?

Debt. 

Specifically, in 2016 AB InBev acquired SABMiller, a multinational brewer based in England, in a $100 billion-plus deal, sending its leverage metrics shooting higher.  

Meanwhile, in recent years sales of AB InBev's well-known Budweiser brand in the U.S. have struggled as consumers increasingly swap domestic lagers in favor of craft beers and other types of alcoholic beverages such as wine and spirits.

While AB InBev's business is nicely diversified geographically, America is by far its most profitable and largest market. Fortunately, the beverage company continues performing very well in other parts of the world, helping its revenue and EBITDA grow 4.7% and 7%, respectively, in the second quarter of 2018.   

However, the market is growing increasingly impatient with AB InBev's efforts to rejuvenate its top line growth in the U.S. and restore its balance sheet.

Deleveraging Remains in Focus

On October 1, 2018, Moody's placed AB InBev's senior unsecured credit rating on review for a downgrade. The firm's beef was with the company's slower-than-expected pace of deleveraging.

AB InBev's net debt actually increased from $104.4 billion at the end of 2017 to $108.8 billion at the end of the second quarter of 2018. The firm's net debt-to-EBITDA ratio also rose from 4.8 to 4.87 over the same period, driven by its rise in net debt as well as unfavorable currency fluctuations that lowered its reported EBITDA.

Usually such a minor fluctuation would not be cause for concern. However, companies want to avoid credit rating downgrades to keep their financing costs manageable, and the dividend can become an attractive source of cash flow to accelerate debt reduction and appease the ratings agencies. That's especially true given the sheer size of AB InBev's debt load.

The good news is that Moody's has assigned AB InBev a rating of A3 rating, which is positioned four rungs above junk ratings (see below). In other words, should Moody's reduce the firm's credit rating by a notch, the effect seems unlikely to be as severe as a downgrade from investment grade to non-investment grade debt.
Source: Moody's

Furthermore, the slower pace of deleveraging that has disappointed Moody's is at least partially due to non-recurring issues. For example, AB InBev has historically generated 65% to 75% of its annual cash flow from operating activities in the second half of the year.
Source: AB InBev Investor Presentation

Due to the timing of certain tax payments thus far in 2018, which have reduced operating cash flow by more than $1 billion compared to 2017, management expects second-half cash flow generation to be toward the high end of the range in 2018:

"However, as EBITDA accelerates and as you have seen that historically second half cash flow generation accounts for 65% to 75% of total full-year cash flow generation, we do expect second half cash flow generation to be much stronger on the high end of this range also due to some technical issues that caused cash taxes in the first half of this year payments of the higher than prior years."

Regardless, what do the financial figures show regarding AB InBev's dividend safety? In 2017, the company generated $15.4 billion in cash flow from operations and spent $4.7 billion on capital expenditures, leaving $10.7 billion of free cash flow.

The brewer's dividend consumed $9.3 billion last year, leaving only around $1.4 billion of excess free cash flow that could be used to reduce debt.

AB InBev's goal is to reduce its net debt-to-EBITDA ratio from 4.87 to around 2 in the years ahead. If you do the math and hold the company's current EBITDA level constant, that means AB InBev's net debt needs to decrease by around $60 billion.

With less than $2 billion of free cash flow remaining after dividend payments, the company would be waiting a very long time to hit its leverage target.

Cutting into the $9+ billion dividend payment would certainly accelerate the deleveraging timetable, but that is a last resort action that management would prefer to avoid at almost all costs.

Instead, there are a number of levers AB InBev can pull to continue paying its dividend while shoring up its balance sheet.

For one thing, the beverage maker's substantial acquisition of SABMiller is still expected to generate more savings. AB InBev continues estimating incremental pre-tax synergies of $3.2 billion per year by October 2020, of which $2.5 billion have already been captured.

Freeing up more than $500 million in additional savings will help with deleveraging, and that target does not include any top line or working capital synergies which could further lift cash flow available for debt reduction.

Management could also look to divest more non-core brands to raise cash, evaluate paying a scrip dividend (shareholders could elect to receive their dividend in the form of cash or shares), or seek other creative forms of equity financing. Any of these actions would likely be better for the firm's cost of capital than cutting its dividend.

It's also worth repeating that the company's business is performing very well outside of the U.S. (global brands up 10.1% in the second quarter), helping grow its overall EBITDA at a healthy pace.
Source: AB InBev Investor Presentation

Finally, AB InBev has done its best to reduce risk with its large pile of debt. Approximately 92% of its debt portfolio holds a fixed interest rate and only $2 billion comes due during 2018 and 2019 (average duration of over 12 years), reducing refinancing risk and keeping higher interest rate costs to a minimum.

Around 42% of AB InBev's debt portfolio is also held in currencies other than the U.S. dollar, partially hedging the company from unfavorable currency fluctuations. With more than $7 billion of cash on hand, liquidity should not be an issue for the foreseeable future.

Overall, management believes the firm is on track to deleverage approximately half a turn (0.5 reduction of its net debt-to-EBITDA ratio) per year as EBITDA grows and debt is reduced.

Perhaps most importantly, the company's capital allocation priorities remain unchanged. AB InBev's official statement makes it clear that while debt repayment is a key priority, dividends are still expected to be a "growing flow over time", even if the pace of growth is modest. 

"Our first priority for the use of cash will always be to invest behind our brands and to take full advantage of the organic growth opportunities in our business.

Our optimal capital structure remains a net debt to EBITDA ratio of around 2 times. Deleveraging to around 2x remains our commitment, and we will prioritize debt repayment in order to meet this objective.

Mergers and Acquisitions remain a core competency and we will always be ready to look at opportunities when and if they arise, subject to our strict financial discipline and deleveraging commitment.

Our goal is for dividends to be a growing flow over time, consistent with the non-cyclical nature of our business. However, given our emphasis on deleveraging, dividend growth is expected to be modest."

Simply put, management also seems committed to maintaining the current payout based on the information we know today. Investors just shouldn't expect much, if any, dividend growth for the next couple of years.

Closing Thoughts on AB InBev's Dividend Safety

Debt-laden businesses can be hairy investments. From deteriorating cash flow to the threat of credit rating downgrades, there are real risks that can put these companies' dividends on shaky ground. And even if everything works out in the end, their steep liabilities can result in uncomfortable stock price volatility along the way, even for non-cyclicals such as AB InBev

Considering AB InBev's stable operations, continued EBITDA growth, strong credit rating, expected improvement in second-half cash flow generation, multiple levers to free up additional cash (divestitures, scrip dividend, etc.), and management's commitment to continuing the firm's existing capital allocation framework, the dividend appears to remain secure for now.

However, management needs to do its part to execute. The firm's U.S. operations need to eventually improve, SABMiller synergies need to be delivered, and AB InBev's balance sheet needs to become safer. There's time to achieve success in these areas, but there is not much margin for error if any unwanted surprises crop up. 

American investors considering the stock also need to be aware that AB InBev pays dividends on a semi-annual basis, and exchange-rate fluctuations will affect the actual amount of U.S. dollars you receive since the firm's dividends are declared in euros. And since AB InBev is a Belgian company, U.S. and Canadian residents are subject to a 15% withholding tax (contact your broker for more information). 

Those aren't necessarily reasons to avoid the stock, but conservative income investors looking for fewer headaches and more predictability may want to look elsewhere. 

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