Earlier this year, Motley Fool analyst Gaby Lapera shared her New Year's resolution to buy five stocks, one from each sector featured on Industry Focus.
And on this episode of the Consumer Goods show, she is making good on her promise and asking Vincent Shen and Sean O'Reilly to educate her on some of their favorite companies in the industry. For a fun sin stock theme, the pair have chosen beer giant Anheuser-Busch InBev (BUD +2.00%) and leading gun maker American Outdoor Brands (AOBC +3.07%).
Tune in to learn about the exciting prospects for both companies, and decide for yourself which sin stock is the better investment.
A full transcript follows the video.
This podcast was recorded on Feb. 7, 2017.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen. It is Tuesday, February 7th. We have a really fun show in store for you today as we continue with our company face-off, I guess you could call it, in each industry. Motley Fool financial analyst and baked goods extraordinaire Gaby Lapera will be a special guest on every Industry Focus segment this week as different analysts each pitch some of their favorite stocks in their sectors, giving her the opportunity to eventually pick a winner before potentially investing some of her own portfolio in those companies. Gaby, so glad to have you on the show with us.
Gaby Lapera: I'm really pumped to be here. I love being in the studio with people, because I'm never in the studio with people. It's just disembodied voices telling me about banks.
Shen: Yeah, I go through the same thing. Usually, the various contributors just call in. I very much love having you guys in studio with us. So, while I'll be pitching one company, Sean O'Reilly over here has wandered back to his old stomping grounds on the Industry Focus: Consumer Goods to pitch the other. Sean, you haven't been on the show for a long time since you ran off to Energy and Industrials.
Sean O'Reilly: I miss you terribly. Not only that, but I am not terribly confident in my stock-picking ability at all, so I actually have two horses in the race this week for Gaby -- I'm going to be on the Energy show, too. I'm really trying to win this thing.
Shen: So, when Sean and I were talking about what stocks we might discuss for you, Gaby, we thought it might be fun to spice things up with sin stocks, which tend to be unique to the consumer and retail world.
O'Reilly: They used to be our favorite thing to do, too.
Shen: But, before we get started, I think you mentioned, we have some important disclosures to cover.
Lapera: Yeah. Just in case you don't listen to the Financials show, we had to get this all approved with our legal team, and they said I needed to read some stuff to you guys.
O'Reilly: There's actually a lawyer in the corner staring at us with a very disapproving look right now. [laughs]
Lapera: [laughs] I'm sweating bullets. But, yes. Disclaimers. Listeners who have emailed me, this one is super familiar to you guys: They are not giving me personal advice, and this is not personal advice to you, so don't buy or sell anything based solely on what you hear on the show. We say that at the end of the show, even. You'll notice that no one is going to pitch me a stock and be like, "Hey, Gaby! I know you like horses, so I picked you a horse food manufacturer for you!" None of that. It's just stocks that they individually really like as people to enjoy learning about stocks. Not personally tailored for me. This is just so I can learn about their industries.
Secondly, we have some trading restrictions at The Motley Fool. Basically, no one on the show, including me, can buy any of the stocks that we talked about two days before or two days after the show. That way, we don't do any weird market manipulations. We also have to hold onto stocks for at least 10 days, because we're not about that short-term trading, that day-trading life. Also, every time we buy stocks, we have to notify our compliance department. So, yeah, once I decide on the stock to pick, which could be both, which could be none -- maybe you guys won't convince me at all -- you guys will be able to see what stocks I end up buying on my little profile on my TMF page.
Shen: OK. Thanks, Gaby, for covering that. To get started, just to give listeners an idea of the format, Sean and I will each spend about five minutes just giving an overview of our respective companies, their businesses. Then, we will try and leave the rest of the show open to you to just ask questions; we can counter each other, and we'll go from there. OK?
Lapera: Sounds good.
Shen: OK. Getting started -- and I've always wanted to do this -- in the blue corner, Sean, standing in at about $178 billion market cap, from Leuven, Belgium, with over 150,000 employees, the king of beer, Anheuser-Busch InBev.
O'Reilly: Did you see that commercial in the Super Bowl, by the way?
Shen: I did not.
O'Reilly: Everybody needs to go to YouTube, type in Budweiser Super Bowl commercial -- it's a tearjerker.
Lapera: Oh, the immigrant guy who comes --
O'Reilly: Yeah.
Lapera: OK, we were talking about that commercial, that journal that he has that survived being thrown off a ship and fire, I want to buy that journal. I don't want to buy the beer. [laughs]
O'Reilly: They made paper better back then. [laughs] So, Gaby, for my consumer goods pick, I am going to seek to appeal to your love, not of anything, but of civilization. I'm going to really ham it up with this one. What is one of the first things that humans do when they develop civilizations? Certainly not weapons, those destroy civilizations. Is it canals or bridges? Maybe, but those are hard to invest in, and civilizations have existed without them. Housing? Sure, but that's pretty cyclical, as we saw in 2008. No, the way to truly generate strong, long-term returns for your portfolio for years to come is to invest in that most sainted of civilizational characteristics: beer brewing.
I first came to this idea last year, when I saw an article on Google news about a 5,000-year old brewery that was just unearthed in Central China. I was immediately like, "This is kind of what humans do." You, I believe you have a master's degree in anthropology?
Lapera: Yes. This isn't personal advice, right?
O'Reilly: No! I'm just saying, you know full well that this is a global tale, and quite frankly, there is nothing the ancient Greeks love more than wine, right?
Lapera: That's true, that's true.
O'Reilly: That is why, today, I want to talk to you about AB InBev. This is the world's largest beer brewer. I don't even wish to build my case around any of AB InBev's extremely attractive financial metrics. These may or may not include a current 3.8% dividend yield, which is, on its own, compares nicely to the 8% long-term average returns that you can expect from the stock market. It also happens to be more than supported by $10 billion a year in free cash flow. Pretty good. Its return on equity has averaged a more than respectable 22.88% for the last five reported fiscal years. This sheer gargantuan size of its product offerings, over 400 beer brands -- so you'll never get bored. The fact that it employs more than 200,000 people, and since the SABMiller acquisition closed, there you go. Or the simple fact that they operate in over 100 countries. I don't know how many there are in the world, 192 or 193, depending on the day. What I want to focus on is AB InBev's moat. Its competitive advantage is consumer monopoly. This, after all, is what's really going to generate long-term returns for you or anybody else.
As we all know, everybody's favorite investor, Warren Buffett, prefers to invest in businesses with strong, long-term competitive advantages, a brand name, if possible. It's also no coincidence that the man that merged Anheuser-Busch and InBev some years ago was Buffett's good friend, 3G Capital founder, Jorge Paulo Lemann, who also happens to be the richest man in Brazil, although he lives in Switzerland, if anybody is curious. What makes AB InBev a fantastic buy today is not only its globally recognizable brands, but its extraordinary competitive market position in fast-growing markets in South America and Africa. With the year-old purchase of SABMiller, AB InBev gained control of nine of the top 30 beer markets in the world. These include Poland, with a population of 32 billion people, and they will have a market share of 38%; South Africa, 82% market share; Columbia, 98% market share; Australia, 37.8% market share. If anybody is curious, these are 2015 numbers; the Beer Association hasn't done it for the last year. The Czech Republic, 13 million in population, 44% market share; Peru, 95% market share; Hungary, 30%; Ecuador, 92%; Slovakia, 39%. This is in addition to all of the markets that AB InBev already dominated. This included Brazil, with a population of 200 million, and they had a 64% market share. Argentina with 80% market share, 40 million people; Colombia, 48 million people, 98% market share; Mexico, 60 million people, 51% market share; China, 1.35 billion people, 14% market share; United States, 45% market share on a population of 320 million people.
I said this in an article I wrote last year -- in a world where there are antitrust laws, and governments don't like it when there is no competition, this is as good as it gets. You cannot get a better market share than this legally. This is the cream of the crop, this is as good as it gets. You look around at a company like a Coca-Cola. They have a duopoly. That is the only thing that could possibly improve upon, just in terms of market share, with this thing.
Earnings per share expected to grow this here from $3.53 per share to $6.84 per share by fiscal year 2020, according to S&P 500 Capital IQ estimates. My competitor, who will begin chatting in a moment, American Outdoor Brands lacks the dominance and predictability of AB InBev. Analysts expect earnings per share over there to go down a little bit --
Lapera: [laughs] Getting in some shots already!
Shen: I honestly had no idea that you were going to, essentially, name my company before I even had a chance to introduce it!
O'Reilly: This is a competition, sir. [laughs]
Shen: All right, well, I'm going to have to drop some bombs on you later, then.
O'Reilly: That's fine.
Shen: Are you done?
O'Reilly: No. I want to reiterate once again, they make guns, they make tents, that's lovely, but at the end of the day, if you're --
Lapera: Not AB InBev.
O'Reilly: No.
Lapera: That's Vince's stock that makes guns and tents.
O'Reilly: My competition --
Shen: So weak.
O'Reilly: -- which will, for now, go unnamed. At the end of the day, you look out to where are species going to be in 50 years, in 30 years --
Lapera: They're going to be drunk? [laughs]
O'Reilly: Well, no, but everybody needs a cold one after a long day. And the markets in the United States, Europe, they're mature, but GDP growth in South America and Africa, as these countries continue to develop, it's going to continue chugging along. And as these people get more more wealth, there's nothing that anybody loves more after a long day, once you can afford it, than an ice-cold beer.
Lapera: I just want to put in a pitch really quick for How Beer Saved The World -- it's a documentary on Netflix. I have actually shown that to classes that I have taught. It's pretty good --
O'Reilly: I am so happy right now.
Lapera: And when I say "shown it to them," I mean I was sick and I couldn't teach class, so I told someone else to show it. But, it does keep the college students entertained. [laughs]
Shen: All right. So, since Sean already named my company -- I hate you -- I'm still going to do this, though, because I want to. In the red corner, standing in at $1.1 billion market cap, seems kind of humble now, from Springfield, Massachusetts, with 1,500 employees, American Outdoor Brands.
Lapera: Home-grown!
Shen: Home of the legendary Smith & Wesson. So, not as big, but I will show you why -- I actually love both companies, frankly, so this isn't that hard for me. Smith & Wesson's name dates back to 1852. Today, it remains an undisputed leader in the firearms industry. For example, with revolvers, one out of every two revolvers owned in this country is from Smith & Wesson. So, they have their own dominant kind of market share. Half of the general population over 18 years of age knows the brand, while nine in ten handgun buyers are familiar with Smith & Wesson.
American Outdoor Brands, which they recently changed their name to, as of the beginning of this year, the company operates in two segments. They have their firearms and their outdoor products and accessories. Those further break down into their own divisions. I'll get into that a little bit more later. But, what you should know is that for the most recent reported quarter, their total sales were about $234 million. But that's up 63% year over year. So, they've seen very strong growth. Their gross margins are similarly improving; they came in at 41.8% with 2.6% expansion over the prior-year quarter. Bottom-line adjusted earnings -- and that's adjusted for some cost because they've been going through a lot of different acquisitions -- was at about $0.68 per share compared to $0.25 per share last year. Overall, with those two segments, between firearms and their accessories, the firearm segment is about $195 billion of those sales, and that was up 60% year over year. So, this is about 83% of their top line, the core of the business.
Being in the industry for so long, the company has a very strong brand. They have also developed a ton of expertise in metalworking, plastics casting, and other engineering and manufacturing specialties. What they're really doing is, they're kind of leveraging this expertise for their core firearms business, but also for these other accessories and outdoors businesses they're expanding to. I'll describe those a little bit more later.
But they are also outsourcing some of these capabilities to, essentially, B2B services, to other business partners. They have plans for this part of the business, I see this is one of the growth catalysts, to hit $100 million in the next five years. This, essentially, exposes them beyond the firearms industry, because they can help companies in aerospace, automotive, oil and gas, and medical industries, too.
And then, on the outdoor products and accessories side, that includes three different divisions. You have their core accessories, this includes stuff like what you need to clean your gun, to repair it, gunsmithing, things like that, if you're not as familiar with the space. They also have electro-optics, which includes things like laser sights and scopes.
Then, outdoor recreation, which is the newest division that was established with news that came out just toward the beginning of this year. This is really targeting things like camping, hiking, fishing, paddling sports, things along those lines. So, this is a smaller portion of the business, with just $39 million in sales, about 17% of the top line. But the high gross margins, usually approaching 50%. So, that should help the company, overall.
Without getting into too much detail, just know that, just like with Smith & Wesson, some of the brands that operate within this umbrella, like Crimson Trace and Battenfeld Technologies, Taylor, a bunch of different cutlery brands and things along those lines, these are very well-known names among enthusiasts in this market. Similarly very well-respected, like the legendary Smith & Wesson name.
So, big picture, the way I like to look at it is, you take all these diverse businesses, and then you roll together the back office administrative functions, which is what the company has been doing. So, you roll together things like accounting, human resources, legal departments into more of a centralized operation. You let the divisions focus on their innovation and their growth, and you let American Outdoor Brands lever this kind of consolidation as they seek acquisition targets. Long term, they have a gross margin target of about 37%-41%. This was just 31% in 2012, so it has clearly improved over time. They are targeting fiscal year 2017 revenue of over $900 million, with just $723 million in 2016. Some of that growth, both organic and inorganic with those acquisitions.
The thing is, what I find really interesting is, international sales for them are still really a small part of the business, just about 3% or so. They have a very flexible manufacturing model. Basically, in the firearms industry with various politics, it can be very cyclical. And ultimately, what they have tried to do is really make their model as flexible as possible so they can adjust to the demand in the market. But also, with this increasing portfolio of different products, they can basically optimize the product mix as well, for their very well-established manufacturing facilities. This means more efficiency, more cost savings. For industry dynamics overall -- this is what I'll end on, because I'm probably running short on time -- the market for non-military firearms is only about $4 billion, and the company's market share is somewhere around 13% or 15% in this space. So, while it's a leading name, it still has plenty of room to run, and the company has very happily been taking market share for several years now. ATF estimates that the firearm industry has enjoyed a CAGR (compound annual growth rate) of about 10% from 2009 to 2014.
But the real thing here is, the shooting and hunting market is much bigger, $15 billion. You expand that to the outdoor recreation market, which they are now getting into, which is $30-$35 billion. So, what they have really done here is taken that core, respected Smith & Wesson name, the expertise that they developed in that space, and they basically opened it up to a much bigger addressable market. So, what I see is a really long runway for growth. If we're taking shots [at] each other, Sean here has a dominant name, incredible cash flows; you can't deny that -- 4% dividend yield, that's very attractive. But here, you have a much longer potential runway for actual growth. Like I said, leading name, but only 15% market share in their core industry. And now, they have all these acquisitions, these new brands in their portfolio to leverage with their other expertise, and to really expand that beyond just firearms into these new divisions.
Lapera: Wow, OK. A lot of information from both of you. And I have questions for both of you. Sean, actually, that growth that Vince was just talking about, I heard a lot of market shares that were already pretty high in a lot of countries. And sure, it's about 50% of the countries in the world, around there. What are their plans for growth? Do they have stated plans for growth?
O'Reilly: The reason I found AB InBev so attractive when I first started looking into it was how analogous it was to Warren Buffett's 1988 investment in Coca-Cola.
Lapera: Sorry to interrupt, everybody has been pulling on Warren Buffett.
O'Reilly: It's just so easy.
Lapera: [laughs] Maxfield, Jordan...
O'Reilly: [laughs] Well, it works. So, Coca-Cola was dominant in the United States, but since the 70s and the 80s, Pepsi had been giving them a bit of a run for their money. When Buffett invested, he actually did it because of Coca-Cola's global story. The United States is about 50-50 between Coca-Cola and Pepsi. But this planet, in terms of carbonated soda, is owned by Coca-Cola. It is staggering. If you hear about Buffett talk about it anymore -- he's been an owner for 25 or 30 years -- he says he'll never sell a share because per capita consumption by volume continues to grow on planet Earth. And that's the story with AB InBev. They're not going to see a lot of growth here domestically in the United States. I mean, they're buying craft breweries now, left and right, because they have to play catch-up somehow, but they're not going to go much above 45% market share here in the United States.
Lapera: That's actually another one of my questions -- what is their bread-and-butter product? Is it cheap beer? Is it nice beer?
O'Reilly: It is Budweiser at sporting events. [laughs] What you need to focus on is, the population in the United States is 320 million people. That is lovely. But the per-capita consumption of beer and its key growth markets, which I wanted to highlight, which is Africa and South America, is a fraction. How many beers do people drink there? I think it's about a sixth or a seventh or something. The population of Africa is 1.216 billion people. South America is 422 million people. So, that's, I don't know, 1.7 billion human beings that are, throughout the century, become wealthier and drink more beer.
Lapera: That includes babies, by the way. [laughs]
O'Reilly: Well, this is the long-term story. Think of the average age of these countries.
Lapera: This is fair.
O'Reilly: So, that is the growth story. It's not so much, "Oh, we're going to innovate new beers." It's, "These people are going to become wealthier, and it is almost a sure thing that when people become wealthier, they drink more."
Lapera: OK, real talk, are there any problems with AB InBev?
O'Reilly: Well, you have this thing called a liver, and if you drink a lot of alcohol...No, the minor problem, which is more than funded by their free cash flow generation and, as I said, monopolistic market positions is, they took on a bit of debt to buy SABMiller. It is manageable and it is fine, but it is a little bit higher than ideal. The return on capital more than covers this, it's like 12%-13%, I believe. The only other problem is its size. You will not get crazy-rich owning this, but you will do reasonably well, I would think.
Lapera: OK. So, this is a steady earner, for people looking for income in their retirement years. [laughs] That's just a funny concept, beer, old people. Old people like to drink, too. My grandfather would put down a Jack Daniel's, or a Johnnie Walker. Johnnie Walker is a very popular brand in South America, interestingly enough.
Shen: Question for me?
Lapera: Question for you. You mentioned legislation. I know that you said that they are moving toward the camping equipment to help smooth that out. Do you actually foresee that as being a problem in the United States? I feel like every time we have gotten close to gun regulation, we've backed away.
Shen: I feel that is definitely a risk factor that you have to take into account for the industry. The fact of the matter is, demand often goes hand-in-hand with greater calls for gun control. So, I think about 2012, 2015, after some shooting tragedies in this country, you had government officials and some leadership, including the president, speak to potential calls for new assault weapons bans, and what that results in is a run for this industry, where a lot of these companies could not even keep up with demand. And part of that is the reason why American Outdoor Brands has really focused on having some of that flexibility in their manufacturing, to address things like this, because it can be so cyclical. It can happen so quickly. But in terms of regulation, I think, overall, things are much steadier now in this administration. I can't speak to that 10-15 years from now. But overall, it seems like the Second Amendment is here to stay.
Something that I have seen that's more encouraging for the industry is the idea that there were record numbers of NICs check in 2016, that is the National Instant Criminal background check system. Each time you want to purchase a firearm from the store, they will run a check. So, it's not a perfect one-to-one. But these checks are usually seen as a proxy for demand. Record numbers in 2016. And overall, there have been record numbers of concealed-carry permit applications in several states. Industry surveys show outsized interest from new shooters, first-time shooters, from under-represented demographics like women and minorities. Overall, it seems like interest is growing. And you'll see mixed polls and surveys about whether gun ownership in this country is going up or down. But, by all these other metrics, it seems like demand there is strong and growing, and I generally see this as a very sustainable market. That's my take on it, in terms of the regulatory situation.
Lapera: That's really interesting. I don't have a lot of real-life experience with guns. My father does because he's South American, and that was something that everyone had in South America to protect themselves. And my college roommate was a big turkey hunter. She was on a turkey hunting video. That's a thing. People watch other people hunt turkeys.
O'Reilly: Did you ever come back to the dorm and see a dead turkey carcass from the corner? [laughs]
Lapera: No, but she caught -- well, not caught -- she killed [laughs] all sorts of things. She wasn't freaky, she was really cool. She didn't do anything in our college dorm. But she would go home every once in awhile to go deer hunting with her dad or something, and we would get big bags of venison jerky and stuff.
But, the other thing I wanted to ask you about -- there are two things, but let's focus on one because I think we're running a little bit short on time -- the B2B partnerships. Can you talk a little bit more about those? Is that going to be a flaw in the plan? Are they going to look to vertically integrate eventually?
Shen: What it really comes down to is the company diversifying some of their business away from that cyclical nature. For example, the stock, I'm not going to deny, has taken quite a beating since Trump won the election. It's down over 30%. I think a lot of people see it as, if Hillary had won, then people would have seen that as, probably more calls for gun control, demand would surge, the stocks probably would have done much better. But under Trump, people aren't in as much of a rush anymore to buy, because they feel like their gun rights are safer now.
Lapera: That's interesting.
O'Reilly: It's counterintuitive.
Lapera: Yeah, I never would have guessed that.
Shen: It is counterintuitive.
Lapera: But, like you were talking about, the camping businesses, I know that in general, a lot more people are going outside. It's actually a huge problem for the national parks, because you have so many more people going out than were going before, that it's starting to be a parks management issue, especially with people who are new to camping and are doing stuff like camping in the wrong spot, or not burying their waste properly, or not maintaining the trail well -- I learned about trail etiquette this weekend.
Shen: Ultimately, to answer your question, I feel like it's just part of the fact that they have this capacity, they're trying to find the best ways to use it as efficiently as possible. And that's between their firearms business, between their various accessories businesses that they've recently acquired in the past few years, and now, through this B2B outlet. But, a question that I would pose to you, or a way to look at it is, think about your roommate who was a turkey hunter. Think about the amount of gear that she had when she went on these hunts, think about the amount of gear that you need to have to go on a hike or something. These are all opportunities, I think, for the company. And the thing is, they have all this specialty in making these kinds of goods with plastic injection molding, metal working, they're very familiar with hunters, this market, with the firearms they make for them, what they like. And the people in any type of hobby, I think, tend to trust the brands they already know. And this is definitely a case where that stands strong.
Lapera: Interesting. OK, I actually have one last question for the both of you. If you were to give a beginning investor one piece of advice, what would it be?
Shen: I'll happily go first. I've been talking about it with this company in terms of diversifying, and I've recently had a lot of conversations with my younger cousin. He's, I think, a sophomore now at Notre Dame, and he has recently gotten super interested in investing, asking me a ton of questions because of my work here at The Motley Fool. Everyone knows that you're supposed to diversify your portfolio, even out some of your risks, invest in different sectors, different kinds of stocks, and just diversify your portfolio the best you can.
I think something else I've been trying to hammer into him is to diversify the sources of your information and how your research companies learn about them, as well. He would very commonly call me and say, "Hey, I read about this article in Bloomberg, very bullish on a company, do you think I should buy?" And I told him, "Hold your horses, what else do you know? This is based on one person's potential opinion. One analyst's opinion. You should really round out where you're getting your information from. Make sure you know more about the company and what the actual prospects are before you dive in." In that sense, I would say, make sure you're looking at the primary sources, like the financial statements, the press releases, and also getting opinions so you can get the bear case, the bull case, and make a decision, probably, somewhere in between there.
Lapera: And also, for listeners who are college students, that's great advice for any paper that you write. Look for sources that have different opinions from the ones that support your viewpoint. And, make sure you look at the primary sources. I can't tell you how many people never look at them in history papers.
O'Reilly: Actually, my word of advice echoes that a bit. I actually recommend literally writing a bear piece on anything you're interested in buying. Literally, make it your goal to wake up fresh in the morning and write a bear case.
Lapera: That makes a lot of sense to me. That way, you're very familiar with the company's weaknesses. Guys, thanks for having me on. I'm taking the hosting duties away from Vince, and I don't mean to. Go for it.
Shen: No, it's fine, Gaby. I appreciate it. We have to stay on time here. That's all the time we have, unless you guys have any final comments, I'll leave it at that.
O'Reilly: This was fun, you guys. I enjoyed it.
Shen: We would love to hear which company you think may have made the stronger case. You can reach out to us and the rest of the IF crew via Twitter @MFIndustryFocus, or send us any questions via email to industryf[email protected]. Don't forget to check out our other very Foolish podcasts at fool.com/podcasts. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening, and Fool on!
