Carlsberg: Probably not the Best Investment in the World
"I'm not a gambler, I'm an investor. I just happen to be losing money."
In the heat of the Euro Cup 2024 and the hottest summer on record, let's take a look at one of the iconic beer companies in the region.
Founded in 1847 by J. C. Jacobsen on a hilltop location with flowing water just outside Copenhagen, Carlsberg is a Danish giant with rich history and global presence. Despite a devastating fire in 1867, Jacobsen rebuilt the brewery using fire-proof materials and installed a cooling system, improving product quality and boosting sales.
The first chemically confirmed barley beer dates back to the 5th millennium BCE in Mesopotamia (modern-day Iraq). This fact didn't discourage Jacobsen, who being a logical Danish guy, believed strongly that scientific knowledge could help him enhance brewing. In 1883, Emil Hansen, head of the physiology department of the Carlsberg Research Laboratory, made a ground-breaking discovery:
Hansen discovered that "bad beer" was not only a result of bacterial infection, as world famous scientist Louis Pasteur had otherwise assumed. Instead, Emil found that a certain amount of wild yeast in the pitching yeast made the 'beer sickness' break forth.
Emil Chr. Hansen's method on how to purify yeast made it possible to make quality beer from every brew and the new ‘Saccharomyces Carlsbergensis’ was used for the first time, and with great success, on a production scale in November 1883.
As beer sickness was a widespread problem back then, Jacobsen gave the pure yeast away for free to other brewers.
Talk about a beer pioneer.
But this was not all the world would see from the Carlsberg Research Laboratory. I bet you didn't know that pH, the scale specifying the level of acidity or alkalinity of a solution made popular by soap commercials, was invented there by S.P.L. Sørensen. He demonstrated the significance of pH for brewing, among other biochemical reactions. This invention would ensure the consistent quality of every Carlsberg beer.
As the Carlsberg company grew so did its distribution network. By 1925, Carlsberg's stables had nearly 200 horses, used to move product from the bottling plant to the merchants.
Carlsberg began exporting its beer in 1868, but it was not until the mid 20th century that exports started making a significant chunk of sales. The big breakthrough came in 1970 when Carlsberg merged with Tuborg, Denmark's second major brewery.
Despite facing strong competition from countries with established beer traditions like England, Belgium, France, and Germany, Carlsberg managed to become a major presence in Europe through a combination of strategic M&A and international expansion. However, it is worth noting that it accomplished this in a focused way, avoiding the costly mistakes that often come with empire building.
Carlsberg does not expand at any cost. The art is to handpick breweries that not only supplement Carlsberg’s competences and markets, but also share its values. Breweries where the beer culture is strong and Carlsberg can learn from specialists who have a passion for beer and quality.
The company's focus on quality, technological proficiency, and strategic partnerships allowed it to compete effectively across the world.
In the 1990s, Carlsberg significantly expanded its international presence by increasing ownership or acquiring new shareholdings in breweries across Europe, including Portugal, Sweden, Italy, Poland, Latvia, and Croatia.
Today, Carlsberg holds a number 1 or 2 position in more than 20 markets globally, with approximately 70% of the company's volumes sold in these markets where they have a leading position.
Carlsberg's global market share is just 5.4% by volume, which puts it in 4th place.
Failed Acquisition of Britvic
Carlsberg recently made two unsuccessful attempts to acquire British soft drinks maker Britvic. Carlsberg's pursuit of Britvic began on June 6, 2024, with an initial offer of £12 per share, valuing the company at approximately £2.99 billion. When this was rejected, Carlsberg came back with an improved offer of £12.50 per share on June 11, raising the valuation to £3.1 billion. Despite representing a 29% premium over Britvic's closing share price before the news broke, Britvic's board firmly rejected both proposals, stating they "significantly undervalue" the company and its future prospects.
Britvic is an attractive target for Carlsberg for several reasons. Founded in the 1930s, Britvic has grown into a global soft drinks powerhouse with a portfolio of 40 brands sold in over 100 countries. The company's lineup includes popular brands such as Robinsons, J2O, Fruit Shoot, Tango, Aqua Libra, Ballygowan mineral water, and R White's lemonade. It is also the bottler for PepsiCo in the UK.
Britvic's strong market position and diverse product range align perfectly with Carlsberg's "Beyond Beer" strategy, announced in February 2024 as part of its Accelerate SAIL growth plan. This strategy aims to expand Carlsberg's presence in the broader beverage market, particularly in non-alcoholic categories, to drive long-term growth.
Acquiring Britvic would have given Carlsberg immediate scale and expertise in the soft drinks market, complementing its existing portfolio and potentially opening up new growth avenues. With Britvic's strong presence in key markets like the UK, Ireland, and Brazil, the acquisition would have significantly expanded Carlsberg's geographical footprint in the non-alcoholic beverage sector. This is why Carlsberg's shares dropped 9% last Friday when the second offer was rejected.
Furthermore, Britvic's track record of innovation and its established distribution networks could have provided Carlsberg with valuable capabilities to accelerate its "Beyond Beer" ambitions. The soft drinks market, with its diverse range of products and constant innovation, offers attractive growth prospects compared to the more mature beer market.
While Carlsberg's initial bids for Britvic have been unsuccessful, the Danish brewer still has until July 19 to make a firm offer or walk away. The company's statement that it is "considering its position" suggests that a third, potentially higher bid is not off the table.
Carlsberg's Russian Exit
Carlsberg acquired full control of Baltika, Russia's biggest brewing company, in the March 2008 £7.8B deal, together with Heineken, to acquire British brewer Scottish & Newcastle. It was a great deal back then, giving Carlsberg access to the infinite Russian market. Look at the chart below to get into the mindframe of the decision-makers back in March 2008. Over the past decade, Russian beer consumption per capita had grown 3 times, roughly 12% per year.
As it often happens, the deal didn't work out as expected. First, beer consumption declined in the year of the acquisition for the first time in a decade, and what is worse, it continued down from there. It was down 35% by 2019, and you can bet it is even lower today. As if this was not bad enough, last year Russia took Baltika's assets back.
Carlsberg's tumultuous exit from the Russian market serves as a stark reminder of the geopolitical risks facing multinational corporations operating in volatile regions, especially Russia. This saga offers valuable lessons for investors considering exposure to companies with significant operations in politically unstable countries.
In April 2022, Carlsberg announced its decision to exit the Russian market following the invasion of Ukraine. The company projected a substantial write-down of assets, totaling approximately 9.5B Danish kroner ($1.4B). This move, while ethically sound, came at a significant cost to shareholders.
Fast forward to July 2023, and the situation took a dramatic turn. The Russian government seized control of Carlsberg's stake in Baltika Breweries. This action was part of a broader trend of expropriating foreign company assets as a retaliation for the frozen Russian assets abroad.
Carlsberg's response to this seizure has been resolute. In October 2023, the company canceled all license agreements for producing and selling its brands in Russia. CEO Jacob Aarup-Andersen's statement that "they have stolen our business in Russia, and we are not going to help them make that look legitimate" underscores the company's stance.
The Danish brewer has chosen to write down the entire value of its Russian business, all DKK 48B in 2023 on top of the DKK 8B in 2022, rather than accept what it deems "unacceptable terms" that would legitimize the takeover. This decision, while potentially costly in the short term, demonstrates a commitment to corporate ethics and long-term brand integrity.
The saga has now entered a complex legal phase. Carlsberg is embroiled in court battles to retain rights to the Baltika brand in several markets. The company's Kazakhstan unit has filed an appeal against a Russian court decision revoking its intellectual property rights in multiple countries.
While such extreme cases are rare, investors must carefully evaluate the geopolitical risks associated with companies operating in politically volatile regions. The Carlsberg case illustrates how quickly assets can be seized and value destroyed.
Financials
Carlsberg's Q1 2024, as of March 31 2024, volume growth was stuttering. Organic growth was a glacial 2%, coming from Asia (3.1%) and Central & Eastern Europe and India (2.2%). By product category, only premium beer delivered adequate growth of 8%. The alternative products under "Beyond Beer" (mostly Somersby) (-1%) and alcohol-free brews (2%) had mediocre performance.
Higher prices partially compensated for this, with organic revenue per hectoliter of 4%, bringing total organic revenue growth to 6.4%: Asia +7.6%, CEEI +7.3%, and Western Europe +5.1%. The best markets in Q1 were Vietnam, China, Poland, Ukraine, and Serbia.
As of Q1 2024, Carlsberg sold 29.2M hectoliters of beer:
9.1 in Western Europe
7.4 in CEEI
12.7 in Asia
Overall, growth has been elusive for beer companies. Carlsberg was hit particularly hard by the Russia debacle.
There are several contributing factors.
Market saturation: Overall, the craft beer market is highly saturated.
Craft beer boom: Craft beers and local microbreweries proliferated over the past decade. This is still the fastest growing beer segment.
Healthy lifestyles and changing preferences: Younger generations are generally shifting away from alcohol.
Producer price inflation: While product inflation has been passed on to consumers, this has exhausted the consumer's price tolerance.
Alcohol consumption per capita is declining or stagnating in most places.
Growth is coming mostly from Asia, which has more than likely informed Carlsberg's push into Vietnam and China. The chart below shows the change in per capita consumption of alcohol over the 2010-2017 period.
Currently, Carlsberg is trading at a discount to both it's long-term average (~30%) and to its peers.
If the last 3 years are any guide, Carlsberg can generate approximately DKK 11B operating profit and 8B net. These numbers exclude the Russian operations. Average free cash flow over the past 5 years is close to the 8B net. The company trades at DKK 123 currently. This translates into 6.5% earnings yield. Meanwhile, the dividend yield is 3.14% and repurchases are another 3.5% of it shares annually since 2019. Shares outstanding are down 13%.
On the downside, this has coincided with a near doubling of long-term debt, which is now 50% of total capital (up from 30% in 2019). However, it is not a problem for a mature business, such as Carlsberg, to have this kind of debt level, and it made sense to issue debt in the free-money period we lived through. Besides, Carlsberg EBITDA/interest expense coverage is 17.7 at the moment, which is way higher than Heineken (9.4) and InBev (4.9).
Conclusion
I was fascinated by Carlsberg's story, and I love more than a few of their brews. They were hit bad by the unexpected exit from the Russian market. Besides, it is a mature company that is not expected to grow much faster than the global rate of GDP growth + inflation. It is likely to get an expected short-term boost from the Euro Cup, and it has the share repurchases going for it. The company has a strong presence in Europe and Asia. The big negative scenario is already a fact. The downside seems depleted at this point. The char below shows the 3 big drops in recent years. We have the Covid 36% drop, the Ukraine invasion 32% drop, and the Russia asset seizure drop of 26%
The thesis is really simple. There is no magical growth story - just a simple rebound from the lowish 15 times FCF to a more normal 20 times multiple. As seen, these re-pricings don't take long - just 1-2 years. Meanwhile, investors also have the dividend and the repurchases to lean on.
Of course, all this is valid in normal market conditions, given no extinction level event happens. You might think owning a boring beer company (beer is classified as a Consumer Staple, FYI) would offer you some semblance of smoother sailing in a global crisis, and you would be wrong. Carlsberg was down a massive 77% in late 2008. And it was not because they were the smallest of the big players. InBev, the largest one, was down over 80%. Heineken fared the best of the three and declined "only" 60%.
I am only mentioning this doomsday scenario, because it has been ever so popular in the past few years. Safe havens are rare in this type of circumstances. I get it that people got burned by Covid, crypto, inflation, home prices, high interest rates, war, and senile leadership overall. The yield curve has been inverted for 2 years now, and we have been waiting for an imminent crisis ever since. That's a lot of worrying and many missed opportunities. Meanwhile, the S&P 500 is up 40%. Investing has be some balance between risk-taking and caution.
I am curious to know if and how you are preparing for "the big one."