Overblown Political Worries Drove CCU To Very Low Valuations

Chile corcho de vino Horizontal

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I made the case for Chile’s leading beer brewing company, Compania Cervecerias Unidas (NYSE:CCU) — also called United Breweries — last summer. That came when insiders were engaged in a tender offer to buy up more stock in the company around $19/share. At the time, I rejected the tender saying shares were worth more than the offer.

Instead of rallying above the tender price, however, CCU stock has now slumped to $13. If I thought the stock was cheap when it was trading at $18, I must really like it down here, right? Indeed I do; CCU is badly mispriced at current levels.

I’d recommend my previous article linked above for the full details on the company. However, the elevator pitch is that CCU controls 60% of the beer market in Chile. It also has a smaller beer business in other Southern Cone countries such as Argentina. In addition to that, it’s the PepsiCo (PEP) bottler for Chile. It also produces and exports Gato Negro wine, which is a low price high volume brand that is well-known in various LatAm and Asian countries. Finally, it also has a higher-end business selling pisco (a brandy made from fermented grapes distilled into an 80-90 proof spirit).

CCU stock has been a significant underperformer since 2013, when Latin American economies including Chile rolled over. Here’s 15 years of CCU’s performance. I include both price and total return, since CCU has a policy of paying large dividends and thus you should factor in its dividend into its total returns:

United Breweries price and return
Data by YCharts

As you can see, CCU stock delivered a 175% return between 2007 and the 2013 economic cycle peak. Since then, however, CCU has performed poorly.

This is understandable, in particular since its earnings (at least for us ADR holders) is driven meaningfully by the exchange rate. The Chilean Peso (and other LatAm currencies) have fallen drastically over the past few years against the dollar.

As I’ve argued elsewhere, I believe LatAm currencies will now outperform. Copper, for example, is a massive piece of Chile’s export picture, and other key Chilean exports including lithium, wine, fresh fruit, salmon, and gold are also beneficiaries of an inflationary environment. So, the Chilean Peso should outperform going forward thanks to stronger terms of trade.

If you’re long-term bullish on copper, as I am, long Chilean assets is one of the single best ways to play. Personally, I’d rather own a Chilean brewery than simply buy Chilean bonds or currency; it’s great to express macroeconomic bets with cash flow-producing and dividend-paying assets when possible.

And, I should note, given the current government in Chile, it’s quite risky to buy mining companies directly. The Chilean Regional Evaluation Commission, which has a say over whether new mines are permitted or not, has started voting down projects on seemingly spurious grounds.

Meanwhile, there’s talk of windfall taxes for larger established miners in Chile. This makes it riskier to buy mining or resource firms in Chile as opposed to buying more general consumer products companies. The current Chilean government can make life difficult for resource firms for the next few years, but their odds of interfering in the beverage industry are minimal.

CCU: A Good Business At A Trough Valuation

Back to the broader currency and economy discussion. What does a rising Peso mean for CCU? One, it gets more return on its exports of Gato Negro wine, pisco, and other drinks aimed at foreign consumers. CCU has to import some materials from abroad, so it benefits substantially on both sides of the ledger when its currency improves.

CCU has grown its business organically (again, in local currency) at a reasonable mid-single digits rate in recent years. However, it has lost virtually all of that benefit due to the weak local economy and currency, which has hit both profit margins and reported profits after translation to dollars.

This results in EPS which has been effectively flat over the past decade (remember, the company goes by the translated name United Breweries on the NYSE):

United Breweries EPS
Data by YCharts

At a stock price of $13, CCU stock is now selling at less than 10x trailing earnings, while I’d note the current $1.40 of earnings is right around its historical median.

Even if we assumed CCU’s earnings will never go up, which would be an unduly negative assumption, the stock is still cheap at less than 10x average earnings, especially since the company aims to pay out half of earnings as dividends every year. Getting a 10% earnings yield and 5% dividend yield on a stable monopolistic beer and wine company is a great deal.

And that’s too conservative a take. CCU is going to show earnings growth again. Probably a great deal of it.

By my estimates, we’ll see the Chilean Peso strengthen sufficiently to boost CCU’s earnings by 30% simply due to higher commodity prices. That puts earnings closer to $2/share on a $13 stock going forward. Less than 7x earnings for a monopoly beer company is a steal.

And don’t be surprised if organic sales volumes pick up as well once the Chilean economy is growing again. Don’t forget that Chilean GDP has been essentially flat since 2014. Throw in some nice 4-5% annual GDP growth on the back of strong copper, lithium, gold, etc. prices and a strengthening Chilean Peso and you’ve got a great formula.

CCU is now selling at its cheapest P/E ratio ever, aside from a few moments at the dead bottom of the 2008 financial crisis:

United Breweries PE ratio
Data by YCharts
And it’s at 9.1x normalized earnings even with earnings being at a far from peak level at the moment. Get this back to a 16x let alone 20x P/E multiple on top of $2 of EPS going forward and we’re looking at a $32-$40 CCU stock price versus the current $13 quotation. More conservatively, fellow author Ohio Capital Ideas pegged CCU’s value at $19/share in a recent analysis.

What’s The Market Missing?

As eluded to above, the issue here is with the Chilean government. Chile voted for a left-wing president, Gabriel Boric, and is also talking about instituting a new constitution replacing the one from the Pinochet era. The Boric administration has taken a harder line on mining, though far short of the “nationalization” cries we were hearing last year.

As my refrain goes, when I’m selling beer, wine, and soft drinks, I hardly care about the structure of mining profits. If the government takes more of the mining pie, that simply means it will spend more on schools, hospitals and other social programs. Those public sector employees, in turn, will spend part of their salaries on beer, wine, and soft drinks. The route the money takes from the sale of copper to the grocery store drinks aisle is not of particular importance to a brewery shareholder.

Some have hailed the new constitution as an end to Chile’s exceptionally market-friendly policies. That’s certainly possible, it’s always worth considering the bear case. That said, it’s far from assured that voters will even approve the new constitution, recent polling has support under 50%. Meanwhile, Chilean stocks such as CCU are already trading at March 2009 valuations. The gap between sentiment and reality is exceptional.

A number of elections in South America have also favored left-wing governments over the past year, including in Colombia and Peru. Polling has the socialists leading in Brazil’s upcoming elections as well. People extrapolate this to mean that the continent will be bad for business. But, again, CCU sells beverages primarily in Chile and Argentina. And Argentina, for what it’s worth, has a brutally unpopular left-wing government now and has good odds of swinging to the right in its presidential election next year.

There’s reason to be cautious on a regionwide ETF such as the iShares Latin America 40 (ILF) for geopolitical reasons. But when you zoom in, political events in countries like Peru and Ecuador simply aren’t meaningful to a Chilean brewery company. People are lost in the political drama and missing a monopoly business, CCU, selling near its all-time low valuation. It pays a large dividend too, to put the icing on the cake.

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