Enrique Abeyta on BUD; Gabriel Grego takes down Bio-On; Bond Ratings Firms Go Easy on Some Heavily Indebted Companies
1) At my first shorting conference on May 3, 2018, my colleague Enrique Abeyta made a compelling short case for the shares of beer giant Anheuser-Busch InBev (BUD) (see video here and slides here).
The stock soon fell by more than 30%, but later recovered, so Enrique shared an update in my August 28 e-mail.
On Friday, the company reported ugly earnings... and the stock fell 11%. So naturally, I asked Enrique for his thoughts. Here's his reply:
Before diving into what happened, it's important to look at the big picture...
As I have said before, I'm impressed with management, led by 3G and Jorge Paulo Lemann. They are doing everything they can to address the secular pressures facing this business. That said, there is little they can do in the long-run and the growth pressures will only get worse from here.
In the first half of this year, however, BUD shares had a great run, rallying more than 50% to above $100 in mid-July. A strong recovery in volumes in the first half of the year led analysts to raise their estimates for the first time in four years. In addition, the company began asset sales to pare debt, which is smart.
As Enrique explained, the long-term issues that concerned him came back big time in the third-quarter earnings report. He continued:
Let's start with the U.S., where volumes declined by 3.1% (versus a 1.7% decline in the first half), leading to a loss in market share of 0.9%.
Ostensibly, the culprit here is the hard-seltzer craze, where BUD currently has zero exposure. Some might look at this as a temporary phenomenon or fad – and maybe it is with hard seltzer in particular – but it speaks to the weakness of these large, tired brands with big market share. Even if hard seltzer fades, some new fad (or group of fads) will emerge and continue to erode BUD's market share.
The company also had a big miss in China (70% of the Asian business), where volumes were down a huge 5.9% (versus only -0.5% in the first half). It noted weakness in the high-margin "nightlife" channel (i.e., bars).
I think what we're seeing is the impact of the ongoing trade war. What is more American than Budweiser? I can only imagine that highly nationalistic Chinese folks sitting at the bar may not be jumping out of their seats to order the beer of their global rival. It's hard to see when this gets better...
Latin America and Korea also were weak, as BUD's global competitors didn't match its attempts to raise prices.
While a few markets did OK, and Anheuser-Busch InBev continues to pay down debt, the company's fundamental operational outlook is poor.
To be clear, BUD is a profitable business that generates large cash flows, so it isn't going away. But it has a huge market cap ($161 billion) and a massive debt load (more than $100 billion). Combine that with a continually declining market share, which is leading to negative earnings revisions, and this looks like a classic "melting ice cube" value trap.
The stock is super oversold right now, with a relative strength index of 22 – the lowest in the entire S&P 500 – so it's not a great short right now, but it will be on any strength.
I hope you saw the e-mail I sent you yesterday with the special offer we're making for Enrique's brand-new research service, Empire Elite Trader.
Though it's a long-only newsletter – and therefore, won't include short ideas like BUD – Enrique closed his first two trades for annualized returns of 163% and 199% on Netflix (NFLX) and Altria (MO), respectively.
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2) Kudos to my friend and former student, Gabriel Grego of Quintessential Capital Management, who exposed yet another totally fraudulent company in July, Bio-On (BIT: ON).
The Italian company – which I covered in my July 24 e-mail – claims to engage in the "production of new 100% ecological and sustainable materials." At the time, its market cap exceeded $1 billion.
When Gabriel first published his research, the company sued him for defamation and cried market manipulation, which led investigators to open a probe. Big mistake! In response, Gabriel hired a top criminal lawyer and two respected business school professors and filed a 120-page official complaint for market manipulation and fraud with the regulators.
Less than three months later, Gabriel was proven correct. Last week, Italian tax police raided the company and arrested most of senior management, as well as certain board members. It also launched an investigation into six other individuals plus the auditor, Ernst & Young, and its primary bank, Banca Finnat Euramerica. If only the SEC, when presented with overwhelming evidence of fraud, acted so decisively!
The investigators released transcripts of private phone calls that the police intercepted. One has the CEO speaking to the auditor, saying: "Make up that income statement as I would like to justify €300 million of market cap."
As Gabriel noted: "It really gives you a window into the thinking behind the perpetrator of a fraud and his motives and pressures. It also shows how colluded and corrupted auditors can be."
You can read more of this sordid story here:
- Italy's Unicorn Stumbles as Fund Report Leads to Founder Arrest, Bloomberg
- Italy's Bio-on CEO arrested in 'Plastic Bubbles' probe, Reuters
Also, here's a one-minute news report video (it's in Italian, but you can get the drift).
The stock has been halted (and will likely never trade again).
3) Gee, what a shocker out of the Wall Street Journal: the bond-ratings firms are totally corrupt! Bond Ratings Firms Go Easy on Some Heavily Indebted Companies. Excerpt:
Amid an epic corporate borrowing spree, ratings firms have given leeway to other big borrowers like Kraft Heinz and Campbell Soup, allowing their balance sheets to swell.
"It's pretty eye-popping if you've been doing this for 20-plus years, to see how much more leverage a number of these companies can incur with the same credit rating," said Greg Haendel, a portfolio manager at Tortoise in Los Angeles overseeing about $1 billion in corporate bonds. "There's definitely some ratings inflation."
Years of rock-bottom interest rates have fueled a boom in borrowing, driving debt owed by U.S. companies excluding banks and other financial institutions to nearly $10 trillion – up about 60% from precrisis levels. Leverage – how much debt a company owes relative to its earnings – hit a high in the second quarter of this year, according to JPMorgan Chase & Co. data on investment-grade bonds going back to 2004, which also excludes financial companies.
The buildup has fueled one of the most divisive debates on Wall Street: Will higher debt loads cause big losses when the economy turns? Or have low interest rates made the borrowing more manageable?
Best regards,
Whitney