Three beverage stocks to tap for frothy markets

These high-quality businesses are somewhat shielded from the vagaries of the global economy, have stable cash flows and are trading at a meaningful discount to their fair value, indicating some margin of safety, according to Morningstar equity analysis.

The largest brewer in the world,  Anheuser-Busch InBev (BUD) owns five of the top 10 beer brands by sales. Its portfolio includes global favourites Beck's, Corona and Budweiser, and as many as 18 of its brands generate more than US$1 billion in sales. The beer behemoth also owns a 62% stake in its Latin American subsidiary, Ambev.

AB InBev's sustainable competitive advantages are built on a cost advantage over its peers and its intangible assets, which have allowed the firm to generate excess returns on invested capital for several years. Its excess cash flow conversion has also been consistently higher than its peers. "ROIC has remained in the low-double-digit range over the past five years, even throughout the Great Recession and the large acquisitions made since then," says a Morningstar report, which adds that the firm's "cost advantage will sustain this level of returns for at least the next two decades."

The brewer has bolstered both its portfolio and market leadership though acquisition and a strong focus on cost control. "The firm has been acquisitive, having made transformative deals for Interbrew and Anheuser-Busch, and more recently acquiring Grupo Modelo, Oriental Brewery and SABMiller," says Morningstar equity analyst Philip Gorham, who places the fair value of the company's American Depository Receipt (ADR) at US$126, implying forward multiples of 23.7 times earnings per share and 5.3% free cash flow yield.

Management pursues a strategy of buying brands with promising growth prospects, expanding distribution and ruthlessly squeezing costs from the business, adds Gorham.

Although swallowing SABMiller provides AB InBev with a foothold in Africa, which could improve the growth profile of the merged entity, it's the developed markets business that will continue to mitigate the low- to mid-single-digit volume growth anticipated from emerging markets, says Gorham, who forecasts 3.3% medium-term revenue growth.

The second largest brewer by volume in the United States,  Molson Coors (TAP) owns popular brands inducing Coors Light (number-two beer brand in the U.S. and Canada), Miller Lite (number four in the U.S.), and Carling (number one in the United Kingdom). The company also owns several craft brands including Blue Moon and Leinenkugel. It holds a roughly 25% share of the U.S. beer market, 33% of the Canadian market and a 20% share in Europe.

"Its portfolio of leading brands -- including two of the top five U.S. beer brands, Coors Light and Miller Lite -- provides the firm with sufficient intangible assets to warrant a narrow economic moat," says a Morningstar report.

Although volume in the U.S. market is expected to remain flat in the near term, "Molson Coors will be able to increase average revenue per hectolitre by 100-150 basis points annually over [the next 10 years] through the introduction of craft beer and flavoured malt beverage line extensions on its home turf," says Morningstar equity analyst Sonia Vora, who is particularly sanguine about the company's craft and imported beer business adding to top-line gains as it continues to expand distribution and global presence reach. "We also see opportunity in the company's international business (sales outside the United States, Europe and Canada)," she says.

Further, Vora forecasts the brewer's core brands such as Coors Light and Miller Lite will gain share of the premium light category.

Vora recently trimmed the stock's fair value estimate from US$82 to US$80, prompted by ongoing competitive pressures and a sluggish U.S. beer landscape, but stresses that the tepid growth in volume could be offset by gains in international markets and an increasing proportion of above-premium beverages which could allow revenue to expand annually.

Global beverage and snack giant  PepsiCo (PEP) manufactures and distributes non-alcoholic beverages and snacks. Its portfolio of leading brands includes Pepsi, Gatorade, Mountain Dew, Tropicana, Quaker, Lay's, Doritos and Cheetos. Pepsi generates 58% of its revenue in the United States.

The soda maker recently doubled down on its drinks business with the US$3.2 billion acquisition of Israel-based fizzy drink maker SodaStream, opening up a new revenue stream as the company can now serve customers in their homes.

The firm receives a slight majority of revenue from food, with Frito-Lay North America (around a quarter of sales) contributing above 40% of operating profit. Its snack portfolio is well positioned for international gains. "Pepsi also has established agreements to distribute brands such as Starbucks, Sabra and Rockstar Energy, further strengthening its retailer relationships," says a Morningstar report.

Pepsi's growth will be fuelled by its noncarbonated beverage and snack businesses, "which should enable it to offset the impact of secular declines in the consumption of carbonated soft drinks in developed markets," asserts Vora.

The cola maker's robust competitive advantage flows from intangible assets and cost advantages. "Pepsi is a formidable player in the non-alcoholic beverage and snack categories, with the top seven brands in salty snacks and nearly a quarter of the share of the United States liquid refreshment beverage market," says Vora, whose US$123 estimate for the stock's value incorporates 3% annual revenue growth over the next five years and strengthening profitability boosted by the growth of higher-margin products.

The firm's portfolio includes 22 brands that generate over US$1 billion in revenue annually, creating solid relationships with distributors and retailers that depend on leading brands to generate store traffic. "Pepsi has consistently been a price leader, relying on product innovation to drive net pricing increases rather than competing on the basis of volume alone," notes Vora.