Investment Thesis Anheuser-Busch is the largest domestic producer of beer and one the largest global producers of beer. Although the company has a dominant position in the global beer market, its production and revenues are concentrated within the domestic marketplace. The trends within the domestic marketplace are not overly favorable to traditional brewers at this time for several reasons. First, commodity prices have been rising and brewers have not been able to raise prices quickly enough to offset costs. While the pricing environment is improving, this cycle is expected to continue. Second, consumers have been trading up to alcoholic beverages that are perceived to be higher quality than Anheuser-Busch’s product line. This has shifted consumption patterns away from the company’s products to import beers, craft beers, wine, and spirits. Third, population growth within the domestic market is minimal making it difficult for Anheuser-Busch to generate measurable growth. The company has developed a strategy to counteract the current trends. The strategy includes further international expansion and the establishment of import and distribution agreements with foreign beer producers, spirits producers, and nonalcoholic beverage producers. While this strategy has promise, it remains to be seen whether or not Anheuser-Busch will be able to capitalize on the opportunities rapidly enough to replace the sales declines in its core brands. To date, there has been little information provide to gauge the success of their initial foray into this strategy. In my opinion, there is a great deal of uncertainty as to how well the company’s new strategy will perform. As such, I feel the market is attaching a penalty to the shares and will continue to do so until it becomes clearer as to how well Anheuser-Busch strategy will counteract its slowing domestic business.

Price Target I have assigned a price target of $52.00 to the shares. The target price is based on a DCF model with a 9.0% cost of capital and a 3.5% terminal growth rate. The 9.0% cost of capital factors in an additional risk premium that I believe is currently influencing the share price due to uncertainty about Anheuser-Busch’s growth prospects. I expect the stock to be range bound in the near term and to under-perform its peers and the broader market indexes.

Stock Details Sector: Consumer Staples Industry: Brewers Price: $48.73 52 week low: $46.05 52 week high: $55.19 Beta: 0.35 Market Cap: $36,526MM Shares Outstanding: 749MM Average Volume: 5.9M P/E (ttm): 18.61 EPS (ttm): 2.62 Dividend (Yield): 1.32 (2.7%)

Anheuser-Busch NYSE: BUD Price Target: $52.00 Recommendation: HOLD Report Date: August 10, 2007

Fund: OSU SIM Class (BUS FIN 824) Fund Managers: Royce West, CFA Chris Henneforth, CFA Analyst: Robert Blake Fisher College of Business The Ohio State University Columbus, Ohio Contact: 614-657-5136

blake.176@osu.edu

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TABLE OF CONTENTS

INVESTMENT THESIS 1 PRICE TARGET 1 COMPANY OVERVIEW 3

DOMESTIC BEER OPERATIONS 3 INTERNATIONAL BEER 3 PACKAGING 4 FAMILY ENTERTAINMENT 4

MACROECONOMIC ANALYSIS 5 CONSUMER SPENDING 5

Market Demographics 5 BREWER PROFITABILITY 6

SECTOR AND INDUSTRY ANALYSIS 7 SECTOR ANALYSIS 7 BREWING INDUSTRY ANALYSIS 8 ANHEUSER-BUSCH’S POSITION IN THE INDUSTRY 10

STRATEGIC ANALYSIS 11 GROWTH OPPORTUNITIES AND CATALYSTS 12

Domestic Opportunities 12 International Opportunities 12 Cost Control 13 Pricing Environment 13

RISKS 13 FINANCIAL ANALYSIS 14

DUPONT ANALYTICS 14 CASH CONVERSION CYCLE 16

VALUATION 16 EQUITY VALUATION: MULTIPLES 16 COMPARABLES ANALYSIS 17 EQUITY VALUATION: DCF 18

CONCLUSIONS 20 APPENDIX A – ANHEUSER BUSCH BALANCE SHEET 21 APPENDIX B – ANHEUSER BUSCH INCOME STATEMENT 22 APPENDIX C – ANHEUSER BUSCH CASH FLOW STATEMENT 22 APPENDIX D – INCOME STATEMENT PROJECTIONS 23 APPENDIX E – DISCOUNTED CASH FLOW ANALYSIS 24

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Company Overview1 Anheuser-Busch Companies, Inc. was organized in 1979 as the holding company of Anheuser-Busch, Incorporated (“ABI”), a Missouri corporation whose origins date back to 1875. In addition to ABI, which is the nation’s leading brewer of beer, the Company also has subsidiaries that conduct various other business operations. The company’s operations are comprised of the following principal business segments: domestic beer, international beer, packaging, and entertainment.

Domestic Beer Operations ABI has developed a system of twelve breweries, strategically located across the country, to economically serve its distribution system. Ongoing modernization programs at the company’s breweries are part of ABI’s overall strategic initiatives. During 2006, approximately 94% of the beer sold by ABI reached retail channels through more than 600 independent wholesalers. By wholesaler use of controlled environment warehouses and stringent inventory monitoring policies, the quality and freshness of the product are protected, thus providing ABI a significant competitive advantage. ABI provides national and local media advertising, point-of-sale advertising, and sales promotion programs to promote its brands, and complements national brand strategies with geographic marketing teams focused on delivering relevant programming addressing local interests and opportunities. ABI’s peak selling periods are the second and third quarters. There are more than 100 companies engaged in the highly competitive brewing industry in the United States. ABI’s domestic beers are distributed and sold in competition with other nationally distributed beers, with locally and regionally distributed beers, and with imported beers. Although the methods of competition in the industry vary widely, in part due to differences in applicable state laws, the principal methods of competition are product quality, taste and freshness, packaging, price, advertising, point-of-sale materials, and service to retail customers. ABI’s beers compete in different price categories. Major competitors in the United States brewing industry during 2006 included SABMiller, Molson Coors Brewing Company, Grupo Modelo, S.A.B. de C.V., and Heineken. In addition to competing with the other brewers’ brands, the company’s beer brands must also compete in the marketplace with other types of alcohol beverage choices available to consumers.

International Beer Anheuser-Busch International, Inc. (“ABII”), a wholly-owned subsidiary of the company, oversees the marketing and sale of Budweiser and other brands outside the U.S., operates breweries in the United Kingdom (U.K.) and China, negotiates and administers license and contract brewing agreements on behalf of ABI with various foreign brewers, and negotiates and manages equity investments in foreign brewing partners. Through Anheuser-Busch Europe Limited (“ABEL”), an indirect, wholly-owned subsidiary of the company, certain ABI beer brands are marketed, distributed, and sold in more than thirty countries. In China, the Company has a 97% equity interest in the Budweiser Wuhan International Brewing Company Limited (BWIB), a joint venture that owns and operates a brewery in Wuhan. The company also operates the Budweiser (China) Sales Company, Ltd., an indirect wholly-owned subsidiary (“China Sales Co.”). BWIB and China Sales Co. are responsible for the marketing and distribution of the company’s products in China. The company owns 100% of Harbin Brewery Group Limited. Harbin Brewery Group has thirteen breweries in northeast China. Harbin Brewery Group owns 100% of the entities operating nine of the breweries and a majority interest in the remaining four breweries. In Canada, Budweiser, Bud Light, Busch and Busch Light are brewed and sold through a license agreement with Labatt Brewing Co. In Japan, Budweiser is brewed and sold through a license agreement with Kirin Brewery Company, Limited. A licensing agreement allows Guinness Ireland Limited to brew and sell Budweiser in the

1 Adapted from Anheuser-Busch Companies 2006 10-K

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Republic of Ireland and Northern Ireland and Bud Light in the Republic of Ireland. Budweiser is also brewed under license and sold by brewers in Italy (Heineken Italia SpA), Spain (Sociedad Anonima Damm), Korea (Oriental Brewery Co., Ltd.) and Russia (Heineken). The company owns a 7.9% stake in a subsidiary in Argentina of Compañía Cervecerías Unidas S.A. (‘‘CCU’’), the leading Chilean brewer, that brews and distributes Budweiser under license in Argentina and distributes Budweiser in Chile and Uruguay. The company also sells in over 60 other countries by exporting various brands including Budweiser and Bud Light from company breweries in the U.S., U.K. and China and from its license partners’ breweries in Argentina, Italy and Spain. The company has a strategic investment agreement with Tsingtao Brewery Company Limited, the second largest brewer in China, and producer of the Tsingtao brand. The company has an economic stake in Tsingtao of 27%, and a voting stake of 20%. The company owns a 35.12% direct interest in Grupo Modelo, S.A.B. de C.V., Mexico’s largest brewer, and a 23.25% direct interest in Diblo S.A. de C.V., Grupo Modelo’s operating subsidiary, providing the company with, directly and indirectly, a 50.2% interest in Diblo. However, the company does not have voting or other control of either Grupo Modelo or Diblo. The company’s primary foreign markets for beer sales are China, the United Kingdom, Canada, Mexico and Ireland. In each international market, the company competes against a mix of national, regional, local, and imported beer brands. In China, competition is primarily from numerous national and regional brands. There is no dominant competitor in China. In the United Kingdom, the top four competitors are Scottish & Newcastle, Molson Coors Brewers, InBev UK, and Carlsberg UK. In Ireland, the market leader is the company’s license brewing partner, Guinness Ireland. In Canada, the top two competitors, of similar size, are the Molson Coors Brewing Company and the company’s license brewing partner, Labatt Brewing.

Packaging The company’s packaging operations are handled through the following wholly-owned subsidiaries of the company: Metal Container Corporation (MCC), which manufactures beverage cans and beverage can lids for sale to ABI and U.S. soft drink; Anheuser-Busch Recycling Corporation, which buys and sells used aluminum beverage containers and recycles aluminum and plastic containers; Precision Printing and Packaging, Inc., which manufactures pressure sensitive, metalized, plastic and paper labels; and Eagle Packaging, Inc., which manufactures crown and closure liner materials for ABI. Through a wholly-owned limited partnership, Longhorn Glass Manufacturing, L.P., the company owns and operates a glass manufacturing plant, which manufactures glass bottles for the company’s Houston brewery. The packaging industry is highly competitive. MCC’s competitors include Ball Corporation, Rexam Corporation, and Crown Holdings. In addition, the can industry faces competition from other beverage containers, such as glass and plastic bottles.

Family Entertainment The company is active in the family entertainment industry, primarily through its wholly-owned subsidiary, Busch Entertainment Corporation (“BEC”), which currently owns, directly and through subsidiaries, nine theme parks. Due to the seasonality of the theme park business, BEC experiences higher revenues in the second and third quarters than in the first and fourth quarters. The company is the fourth largest theme park operator in the United States. It faces competition in the family entertainment industry from other theme and amusement parks, public zoos, public parks, and other family entertainment events and attractions. Major competitors in the theme park industry during 2006 include Walt Disney Co., Six Flags Parks, Cedar Fair Parks, and Universal Studios Theme Parks.

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Macroeconomic Analysis Although demand for beer is relatively stable in a variety of economic conditions, there are a number of economic factors influencing the profitability and growth of the brewing industry. These factors include: the types of products being purchased by consumers, market demographics, production costs, and the ability to raise prices. Each of the factors influencing the industry is briefly explored below.

Consumer Spending Consumer spending on alcoholic beverages is influenced not only by the growth of the economy (GDP) but also by the amount of disposable income they have for purchasing goods. While neither of these factors has a significant influence on consumer demanded they do influence the price points the consumers is willing to consider when making a purchase decision. During times of economic expansion when consumers typically have more disposable income, they are more apt to trade up to premium products at higher price points. The evidence of consumers changing preferences can be seen today as they shift their purchasing dollars to craft beers and imported brands, as well as spirits and wine which tend to be associated with more expensive lifestyles. Leaner economic periods see consumers shifting to lower priced valued brands.

Figure 1: Year over Year %Change in Disposable Income

Standard and Poor’s is currently projecting real GDP growth will slow in 2007 to 2.2% which reflects around a 1% drop from historical readings taken in 2005 and 2006. The drop in GDP represents a general softening in consumer spending; however, Standard and Poor’s is projecting the consumer’s real disposable income will grow at 3.3% through 2007 and 2008, which is slightly above the historical mean of 3.2% (refer to Figure 1) and the 1.2% and 2.6% increases in 2005 and 2006 respectively. I believe Standard and Poor’s predictions indicate consumers will be spending less, although they will continue to focus on higher end merchandise when spending their money. The net result is traditional domestic brewers, like Anheuser-Busch, will continue to lose sales as consumers trade-up to products that are perceived to be higher quality such as craft beer, import beer, wine, and spirits.

Market Demographics Young adults in the 21-27 age range tend to be the largest consumers of alcoholic beverages. Between 1990 and 2000, this segment of the population in the United States declined, (refer to Figure 2) putting pressure on the sales of domestic beer producers. The 21-27 age group began increasing in size during 2000 and just recently reached levels seen before the decline. The segment is projected to grow 16% between 2004 and 2010.2 The growth of the industry’s target audience is positive for the industry, but traditional brewers such as Anheuser-Busch may have difficulty translating the growth to profits due the current trend towards craft and import beers discussed above. 2 Here’s To Beer – Beer Industry Overview 4th Quarter 2006

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Figure 2: Population Trend of Key Beer Drinking Segment

The population growth in the United States has been rather limited as shown in Figure 3.3 Producers who are heavily reliant on the domestic market for growth have extremely limited prospects in the near future. Longer term trends do not look any better as the birth rate within the US continues to decline and the demographics continue the skew towards an older population. There is hope for domestic based brewers however. A population explosion is occurring in developing countries. Almost all of the world’s future growth is expected to occur in Asia, Africa, and Latin America.4 In an effort to take advantage of the overseas population growth, brewers have begun to shift from a regional focus to a global focus. The industry’s globalization is explored further in the Industry Analysis portion of this report.

Brewer Profitability Brewer profitability is impacted by these three factors: the costs required to produce their product, the price at which they are able to sell their products, and the volume they are able to achieve at a given price. I have already explored some of the factors influencing sales volumes, so in this section I will concentrate on examining factors that influence the cost and pricing environment for brewers. Beer production requires a number of agricultural inputs such as barley, wheat, corn, rice, and hops. The price of these products, like any farm commodity product, fluctuates based on the quantity planted, success of the growing season, and market demand. Because there are no substitutes for these products, brewers are highly exposed to price fluctuations in these farm goods. Containers are also needed to package the finish product. Aluminum cans are one of the primary packages used in the beer industry, and therefore, brewers are exposed to fluctuations in aluminum prices. Energy, both electricity and fuel, are key inputs required to convert the raw input materials into beer and deliver it to wholesalers or retailers. Each of these inputs has experienced a dramatic run-up in price in recent years although, it appears aluminum costs may now be moderating somewhat. The Producer Price Index (PPI) can be used as a gauge to understand how raw material prices, such as the ones needed by the brewing industry, may impact a brewers cost of goods sold. In recent years the index has shown significant price increases across the board for input materials. Standard and Poor’s projects a moderation of commodity prices in general over the next couple of years. However, farm goods, which are key inputs for brewers, are predicted to rise dramatically in 2007. It is believed that an increased production of corn to meet the

3 US Census Projections 4 Standard & Poor’s Industry Survey Alcohol and Tobacco, June 21, 2007

Figure 3: US Population Growth

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needs of ethanol producers will lead to reductions in other crops and therefore higher prices.5 Fuel costs are likely to be an ongoing issue for producers as well. On the demand side, the pricing environment has been favorable for brewers. Anheuser-Busch has put in place price increases this year and plans to implement another round of price increases next year. In general though, traditional brewers do not have a significant amount of pricing power and price increases are largely relegated to increases that are inline with Consumer Price Index (CPI) for all items. Standards and Poor’s is currently projecting that CPI will moderate in 2007 and 2008 with growth of 2.2% and 1.7% respectively.6 These predictions are below the historical average (refer to Figure 4) increase of 2.5%. With opportunities for price increases moderating and input costs rising brewers may have a difficulty time generating profit growth in the coming years.

Figure 4: Year over Year %Change in CPI

Sector and Industry Analysis

Sector Analysis The Consumer Staples Sector is made up of the following types of companies: manufacturers and distributors of food, beverages and tobacco producers, and producers of non-durable household goods and personal products. It also includes food & drug retailing companies, as well as hypermarkets and consumer super centers. Companies within this sector are generally household names, as branding is extremely important, and many have long histories in the industry. Demand for products produced by this sector is relatively inelastic. Companies within the sector normally have solid cash flow, which enables them to pay above average dividends. Investments within the sector are usually seen as defensive because the sector’s returns are only very loosely correlated with the broader market as implied by their low betas. This means in market downturns the sector typically outperforms market benchmarks whereas in good market conditions the sector usually lags the broader indexes.

Figure 5: Consumer Staples Price Performance

5 Standard & Poor’s Industry Survey Alcohol and Tobacco, June 21, 2007 6 Standard & Poor’s Industry Survey Alcohol and Tobacco, June 21, 2007

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Valuation multiples and historical pricing for the sector provide a mixed view as to its value. Figure 5 shows the 10-year price performance of the sector. The sector currently appears to be overvalued when comparing its current price of $48.67 to its historical mean of $40. Figure 6 contains valuation multiples on both an absolute basis and relative to the S&P500. On an absolute basis, the sector appears to be undervalued. The relative measures provide yet another view that indicates the sector is fairly valued by all accounts except Price/Forward EPS, which indicates the sector is slightly overvalued, and Price/Book, which indicates the sector is undervalued. I believe the relative measures are the best predictor, because they should help to counteract any “bubbles” in the market. Furthermore, I believe Price/Forward EPS is the best indicator for this sector and therefore conclude that the sector is slightly overvalued.

Figure 6: 10-year Consumer Staples Valuation Metrics

Brewing Industry Analysis The brewing industry is responsible for the production and distribution of beer and other malt beverages. The demand for beer, like other products within the Consumer Staples sector, is highly inelastic. While adverse conditions may slow consumer spending on alcoholic beverages, consumers tend to continue buying them even in the worst of times. This trend is in sharp contrast to discretionary items like cars, appliances, and luxury items. Production of beer has roots dating back hundreds of years and many companies currently in the industry, especially in Europe, have histories dating back more than 100 years. Anheuser-Busch, the largest domestic producer, has participated in the industry since 1875. Given the brewing industry’s extensive history, classifying it as a mature industry is reasonable. Domestically and globally, the industry has evolved in a similar manner. Because beer purchases are largely driven by taste preferences, brewers initially established their scope, reputation, and branding based on the tastes of consumers in the market they served. This led to an industry structure where there were a number of regional players that served the needs of a select group of people. Over time, a few producers expanded to cover entire countries, even multiple countries, while many simply continued to serve their original region. In the last few decades, a wave of mergers, acquisition, and investment has taken place within the industry as brewers tried to achieve larger footprints and achieve greater economies of scale. Even with the flurry of mergers and acquisition in recent years, no one player has developed a commanding lead over the competition. At the close of 2006, Anheuser-Busch held the highest market share at 10.3%, followed closely by InBev with a share of 9.8%, and SABMiller with a share of 9.0%7. The key point is that the industry structure is evolving as a few large players are actively building a stable of diverse brands and then leveraging their distribution networks to introduce the brands throughout the world. Consumption trends are also impacting the industry. In North America for instance, consumers have increased their consumption of wine and spirits as shown in Figure 7 at the expense of beer producers. Between 1994 and 2006, beer consumption has decreased approximately 2.5%. Increased health consciousness has also led consumers to limit their intake of alcoholic beverages. Finally, there has been a growing trend for the consumer

7 DataMonitor Global Brewers Industry Profile, March 2007

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to become more focused quality and uniqueness. This trend has led consumers to shift their purchasing dollars from traditional domestic brand names to imports and craft beers/microbrews.

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Figure 7: Alcoholic Beverage Consumption Trends

Large domestic brewers faced with declining demand are searching for growth opportunities in the global marketplace. Global growth has historically increased in the low to mid single digits on an annual basis, as shown in Figure 8. In recent years, regions such as Latin America, Africa, and Asia have offered above average growth opportunities. These regions are the same areas that are predicted to have explosive population growth in the coming years based on census data. The opportunity for growth in these markets has drawn established brewers to invest in these areas.

Figure 8: Global Demand by Region

The changing global demographics and consumption trends are resulting in projected declines in volume growth. The graph in Figure 9 indicates that annual growth is predicted to slow from 2.8% in 2006 to 2.3% in 2011.8 While 0.5% decrease in growth does not appear substantial, if beer volume growth is assumed to grow on average 3% annually, the reduction amounts to a 16.7% decline in growth. Declining global growth may indicate that the rapid growth recently seen in Africa, Asia, and Latin America is not sustainable in the long term.

Figure 9: Projected World Beer Volumes

8 DataMonitor Global Brewers Industry Profile, March 2007

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Slow growth within the industry has created an environment that fosters vigorous competition among brewers. Brand image, price, and quality are three of the key areas in which brewers compete. Creating and maintaining brand image requires a significant investment in marketing. However, brewers typically invest heavily in this area, because it is essential for generating and maintaining sales. Price wars are not uncommon within the industry. Price wars are especially seen in the domestic market where demographic trends are working against the brewers and market share is a key metric investors use to judge the health of the company. Because maintaining market share is important and regaining lost market share in a stagnant market is difficult, brewers are apt to discount their products in order to maintain their position within the market.9 As was previously mentioned, brewers are huge consumers of commodities. The brewing process utilizes a number of agricultural inputs, such as wheat, corn, rice, and barley. The distribution process requires large amounts of gasoline to move the finished product to wholesalers and retailers. The packaging process is a huge consumer of aluminum, since the aluminum can is still one of the most widely used forms of packaging. Finally, the production process relies on electricity. Unfortunately, brewers cannot substitute lower cost inputs when making their product, so they are highly exposed to fluctuations in commodity prices. Certainly, many brewers attempt to smooth out the fluctuations through the use of long term contracts and hedges, but some volatility is inevitable. Even in favorable pricing environments where brewers can raise prices, they often cannot raise prices fast enough to cope with the large swings in commodity prices. This inability to react quickly to price fluctuations can have a major impact on a brewer’s profits in the short term. A discussion on the brewing industry would not be complete without at least mentioning industry regulation. Domestically, the industry is highly regulated. Brewers must pay excise taxes at both the national and state level. In addition to excise taxes, brewers must cope with a myriad of regulations specified at the national, state, and the local level. Global brewers experience even more complexity as each country has their own way of regulating alcoholic beverages. Brewers currently have to deal with a number of challenges. Industry consolidation is changing the dynamics of the business. Increasing commodity prices are putting a damper on corporate profits. Changing consumer tastes are resulting in decreased beer consumption. This change in consumer trends has led to extremely stiff competition as brewers try to maintain their market share and revenue streams. The result for brewers is lower revenues, as they compete on price and incur increased raw material, marketing, and research and development costs. Clearly, the brewing industry is experiencing some daunting challenges, which is likely to put a damper on brewers’ earnings and as a result, the returns on their stocks.

Anheuser-Busch’s Position in the Industry Anheuser-Busch is the largest domestic producer of beer with 48.8% share of the market.10 The next closest competitor, SABMiller, has less than a 20% market share domestically. Anheuser- Busch’s market dominance allows it to achieve economies of scale across its 12 domestic breweries, giving it a level of efficiency few of its competitors can match. As a result of the company’s operational efficiency, Anheuser-Busch is able to generate above average profits. While the company’s market dominance domestically is clearly a positive, the domestic brewing industry is currently faced with a number of challenges, as I discussed above. If Anheuser-Busch were a well diversified global brewer, its market dominance in the domestic market would not be a big concern. However, as depicted in Figure 10, the company’s revenues are primarily derived from the domestic market. Given the current and projected weakness in the domestic market, Anheuser-Busch is likely to have trouble growing its business. Even more disturbing is the fact that between 2006 and 2007 revenues from the international segment only increased 0.3%. With sizeable distribution contracts already in place in some of the fastest growing areas of the world, it appears Anheuser-Busch is not able to capitalize on the growing international markets.

9 Standard & Poor’s Industry Survey Alcohol and Tobacco, June 21, 2007 10 Anheuser-Busch, Second Quarter 10-Q

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Figure 10: Anheuser-Busch First Half Revenues by Segment

The company’s revenue distribution indicates significant exposure to fluctuations within the domestic market with minimal diversification into other markets that might insulate Anheuser-Busch from the current trends in the domestic market. Therefore, I have to conclude that the company’s dominance within the domestic market and its high percentage of revenues derived from the region is actually a negative at this point in time. The current trends within the domestic market serve to effectively cap Anheuser-Busch’s opportunities for organic growth of its core brands, which puts a damper on any corporate growth, and thus, limits the upside to the stock. Without any proven growth opportunities in the company’s funnel, I believe the market is viewing Anheuser-Busch’s lack of diversification as an additional risk and discounting the stock appropriately.

Figure 11: Anheuser-Busch First Half Net Income by Segment

In all fairness to Anheuser-Busch, the company is making a concerted effort to decrease its reliance on growth from its core brands domestically, counteract trends towards imports and beer alternatives in the domestic market, and take advantage of international growth opportunities. One step the company is taking is overseas investments. The company has acquired equity stakes in breweries located in Japan, China, and Latin America. This move has helped Anheuser-Busch capture growth within these regions without having to manage the associated operations. It has also created channels for Anheuser-Busch to sell their product in their partner’s region and the opportunity to import their partner’s products into the domestic market. These investments have also generated income that applies directly to the bottom line, and this income helps to further diversify the company. The distribution of net income across segments is presented in Figure 11. This distribution indicates Anheuser-Busch has greater diversification than the company’s revenues indicate. International growth is also greater, indicating Anheuser-Busch’s equity investments are responsible for most of the company’s international growth. While this development is positive, it signals the company has had little success in generating organic growth domestically or abroad. Future acquisitions and investments will be needed in order to continue generating growth internationally. Due to the consolidation within the industry, prices are already high and Anheuser-Busch may be forced to pay a premium for growth opportunities.

Strategic Analysis Faced with increasing competition and limited prospects for growth in the domestic beer market, Anheuser-Busch has begun implementing a strategy to diversify its revenue streams domestically and increase its international exposure. It has also launched a concerted effort to compete directly in the craft brew segment, where industry

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growth has far outpaced the growth of traditional domestic brewers. The company’s strategy also seeks to reduce the overall cost structure of the company, thereby allowing more of its revenues to reach the bottom-line.

Growth Opportunities and Catalysts

Domestic Opportunities Anheuser-Busch’s dominance in the domestic beer market makes it difficult for the company to achieve any long term sustainable growth. In fact, the company has to work extremely hard just to maintain its existing share. Losing market share is a big concern for the company, and the likelihood of the company losing ground is much greater than them establishing an even more dominant position in the market. Anheuser-Busch fully recognizes the precarious position they are in, and the company is taking steps to remedy the situation. However, I do not believe these changes will have any material impact on earnings until 2009 at the earliest. Anheuser-Busch’s distribution network provides a competitive advantage for the company, as few competitors in the beer market or any other market for that matter can match its scale. Recognizing the value of its network, Anheuser-Busch has begun to distribute beverages produced by other companies. The company has begun to forge relationships with overseas beer producers, energy drink manufacturers, spirit producers, and bottled water manufacturers, forming partnerships whereby Anheuser-Busch has rights to import, if necessary, and distribute the partner’s products within Anheuser-Busch’s domestic market. The company’s strategy to leverage its distribution network helps the company in two ways. First, it further diversifies its domestic revenue streams, making it less dependent on growth in the company’s core beer markets to drive its profit growth. Second, the products it is starting to distribute are to a large degree the same products that are chipping away at the company’s domestic market. This strategy allows the company to participate in sales transactions that in the past would have been written off as lost business. The net result is the company begins to replace at least a percentage of the revenues it was losing as consumers switched to import beer, craft beer, and spirits. Although I have not seen any details on the margins associated with its distribution agreements, I am inclined to believe they compare favorably with the margins the company receives on its core products, because the margins associated with the products the company is distributing are generally higher. Anheuser-Busch is also taking steps to get more exposure directly in the craft brew market. It recently purchased Latrobe Brewing Company, which owns the Rolling Rock brand. Additionally, the company has equity stakes in Widmer Brothers Brewing Company and Redhook Ale Brewery, Inc. All of these brands are perceived to be more unique and higher quality than the product line produced by Anheuser-Busch. Besides investing in smaller breweries, the company has been developing a variety of specialty and seasonal beers that it restricts to certain regional markets. By limiting the distribution and creating brands names that are not readily associated with the company’s core brands, the beers are more likely to appeal to the consumer seeking a craft beer. These investments and new products give Anheuser-Busch direct access to the craft beer segment of the market, which has recently been growing at a double digit pace. Finally, the company is constantly working on developing new products in order to tap into new markets. The company recently released a series of fruit infused beers that should appeal to females and upscale beer drinkers. It has also developed a malt beverage product called Spykes that should appeal to those who enjoy energy drinks mixed with alcohol. An Anheuser-Busch subsidiary, Long Tail Libations Inc., is currently test marketing a new liqueur product that is providing promising results.

International Opportunities The company is no stranger to the international beer business. It began investing in Grupo Modelo, the largest beer producer in Mexico, in 1993 and has since increased its investment to 50.2%. The company also has a stake in Tsingtao, one of the largest beer producers in China. Both of these investments have provided Anheuser-Busch with exposure to the international markets and have contributed significantly to its profits in recent years.

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Additionally, the company has several overseas breweries and distribution companies that it owns directly as well as a number of licensees who manufacture and distribute the company’s core products. However, as I previously noted, international revenues only account for 6% of the company’s total revenues, and international net income only accounts for 26% of the company’s total net income. Fortunately, the company is already well positioned for international growth; it is a matter of execution at this point. Anheuser-Busch has recently announced some actions that should help spur its international growth. First, leveraging its acquisition of the Chinese brand Harbin, the company announced it will distribute the beer in 33 new markets within China. The company also announced plans to double it distribution of Budweiser in China within the next 5 years. To accommodate the growth, Anheuser-Busch is building a greenfield brewery in Foshan.11 Additionally, Anheuser-Busch’s import company, China Sales Co., is starting to import Grupo Modelo’s Corona brand this year. China has experienced double digit volume growth the last 3 years and is the fastest growing beer market in the world. India is another area Anheuser-Busch is targeting for growth.12 Currently, the Indian beer market is in its infancy, although it has had a compound annual growth rate of 8% over the last 5 years. Anheuser-Busch believes that it is a good time to begin cultivating this market and recently opened a new brewery in partnership with Crown Beers to begin serving this market. The Indian economy is extremely strong with a growing middle class. Approximately 60% of the population is 30 and under. These demographics fit well within Anheuser-Busch’s target audience.

Cost Control Anheuser-Busch’s size is beneficial from the perspective of controlling costs. As one of the most dominant brewers in the world, it can wield significant power over its suppliers and distribution partners. The company’s size also helps in maximizing the utilization of its facilities, lending to lower operating costs. Finally, the company funds an annual manual maintenance plan that is used to keep its facilities up to date. By continually maintaining its facilities, the company is able to streamline plant operations, reduce energy costs as newer equipment comes available, and get higher utilization out of its plants by minimizing downtime.

Pricing Environment The company’s strong brand and current economic conditions are supportive of pricing increases. The company successfully rolled out pricing increases earlier during the first half of this year and intends to roll out another round of price increases beginning the end of this year and into 2008. With the recent run-up in commodity prices, pricing increases will help the company minimize the impact of increased raw material costs on its bottom line.

Risks Anheuser-Busch faces a number of risks both domestically and internationally that could impact the company’s profits and therefore its stock price. Potential risks include: Lack of organic domestic and international growth. The company has been experiencing weakness in its core

brands domestically and market trends suggest this will continue. International growth of the company’s core brands has been minimal even with a long established group of distributors and licensed producers.

Commodity costs are likely to continue to rise, especially in the farm goods area. There are no readily available low cost substitutes that Anheuser-Busch can switch to in order to offset price increases. If the company is unsuccessful in hedging this risk, raw materials may adversely impact the bottom line until prices can be increased to offset the rise in raw materials.

11 Anheuser-Busch Press Release April 3, 2007 12 Anheuser-Busch Press Release February 22, 2007

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The inability to increase prices in the future. The company has had success with price increases so far this year. However, with CPI growth projected to slow over the next few years Anheuser-Busch may have difficulty raising prices in the future, and profits would be impacted.

The possibility of a price war, especially as the market traditional brewers serve continues to decline. If a price war were to erupt, it is almost inevitable the Anheuser-Busch would cut prices in order to maintain its market share.

The company’s Grupo Modelo investment has been contributing heavily to the growth of the company in recent quarters. Should there be a slowdown in demand for Grupo Modelo products domestically or in Mexico, Anheuser-Busch’s profits would be adversely affected.

Anheuser-Busch’s latest strategy for growth in the domestic markets has been to establish import and distribution agreements with spirits manufacturers, non-alcoholic drink manufacturers, and international beer producers. If the company is unable to rationalize the new product lines within its distribution system, its growth targets will not be met. There also exists the possibility that the partner will be unable to supply the necessary quantities in order to meet market demand. This type of supply shortage happened recently as the company was trying to integrate InBev’s products into its distribution system.

Changing consumer trends could negatively affect Anheuser-Busch. The company has been investing a great deal of time to integrate import and craft beers into its portfolio. Consumers can be quite fickle and what is popular today is no longer popular tomorrow. It certainly is not inconceivable that the growth trend and/or the ability to achieve high margins within these segments will dissipate before Anheuser-Busch has been able to benefit from its distribution agreements.

Accumulated inventory in distribution network could dictate a decline in future sales. In the most recent quarter, Anheuser-Busch reported that sales to wholesalers had increased while sales to retailers were flat. This indicates sales may be down in the next quarter, if wholesalers are not able to clear the inventory that was built up last quarter.

Rising acquisition costs could impact the business. The industry has gone through a great deal of consolidation in recent years. Should Anheuser-Busch find the need to acquire another brewer in order to tap into a target market, it may be forced to pay a premium.

Potential lawsuits affect the company’s earning and marketing. In today’s litigious environment, there always exists the possibility of a lawsuit. Some of the products Anheuser-Busch has been developing have already been accused of appealing to minors. A lawsuit of this nature could be detrimental to the company’s earnings as well as its ability to successfully develop and market new products.

Financial Analysis Anheuser-Busch’s financial statements (Refer to Appendix A-C) are a very transparent, although I would like to see more information provided on the performance of their investments and distribution partnerships. A brief evaluation of the balance sheet indicates the company has kept its cash relatively constant, approximately $200M, in the years evaluated. Inventories and receivables have risen, but the rise is expected as the company is continuing to grow, albeit slowly. The Income Statement indicates that while sales have been increasing, cost have been rising at the same pace and sometimes exceeding the rise in sales (e.g. 2005). The company’s equity investments have performed very well and have helped sustain and grow Anheuser-Busch’s net income. Earnings per share have been growing, thanks to the company’s stock repurchase program. Examining the cash flow statement, it becomes clear Anheuser-Busch’s operations generate a lot of cash. The company does periodically borrow, but this behavior typically occurs during periods where it is making investments in other companies. It is also evident by the size of its annual capital expenditures that the company invests heavily in maintaining and growing its facilities. From my assessment, I would conclude the company is a well run business that is currently experiencing some dramatic changes in the market place which are posing a challenge to its financial health. Management aggressively pursuing new growth opportunities but it will take time for results to materialize. Time will tell if its strategy to adapt will permit the company to return to a path of sustainable growth.

DuPont Analytics

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DuPont analysis allows for a quick evaluation of how well the firm is performing in regards to operations management, asset management, and capital structure management. The statistics for Anheuser-Busch are provided for the last 5 years of operation in Figure 12.

Figure 12: DuPont Ratio Analysis

Evaluating the company’s profit margin is an easy way to ascertain how well management is doing maintaining the firms operations. Profit margin indicates the percentage of each dollar of sales that translates into operating profit. Anheuser-Busch’s profit margin has been declining for the last 3 years and is down 5.5% from its peak in 2003. This decline is a troubling trend but not unexpected given the increasing cost of raw materials and the market conditions the company has been facing. I expect that profit margins will improve this year and in 2008 as the company implements price increases, which should allow for more of each dollar of sales to trickle to the bottom line. Asset turnover is an indication of how well the firm is performing in managing its assets. It is a measure of annual sales generated by each dollar of investment. This ratio has remained relatively steady over the period being analyzed, but like other ratios within this data set, there was a decline in 2005 and 2006. I would characterize these as “blips” due to the rough market Anheuser-Busch encountered in 2005 and 2006. In 2005, the company’s sales were flat in comparison to 2004, while the company continued to invest in property, plant, and equipment, as well as making equity investments in other brewers. Hence, the ratio was driven lower. I expect the ratio to improve in coming years as the company begins to benefit from its distribution agreements and increased international exposure. Return on investment measures how well the firm translates its assets into earnings. In the case of Anheuser-Busch, ROI has declined in the last couple of years. This can be attributed to the factors influencing lower profit margins and asset turnover mentioned above. The leverage multiplier provides insight into the capital structure of the firm. The larger the leverage multiplier the more debt the firm has in its capital structure. Anheuser-Busch’s leverage factor has fluctuated quite a bit in the years evaluated above. This fluctuation is not surprising considering Anheuser-Busch is a mature company with strong cash flow. By adding leverage to its capital structure, it is able to take advantage of the tax benefits associated with interest payments on debt. The company has also been actively investing in and purchasing other brewers. Purchases of this nature are typically funded with at least some percentage of debt. The company recently announced that it will be increasing its leverage, so I expect this measure to increase over time. Return on equity is a measure of the return the company is able to achieve on the investment made by the firm’s owners. Anheuser-Busch’s return on equity has been quite respectable. Discounting the exceptional high returns generated in 2003 and 2004 due to a large boost in leverage, the company has generated an average ROE of 69.94%. Once again the return in 2006 was lower than the norm. This resulted from a reduction in leverage. With the company’s announcement that it will increase leverage, I expect that ROE will return something closer to the historical average. In summary, Anheuser-Busch has generated solid consistent returns for its equity investors. There have certainly been bumps in the road as the company adjusts to changing markets conditions. I expect that the company will continue to generate strong consistent returns especially as it gets further along in implementing its strategy to leverage its distribution network.

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Cash Conversion Cycle The cash conversion cycle or operating cycle offers insight into how quickly the company’s operations turn invested capital into cash. The operating cycle is computed by adding days in accounts receivable and days in inventory and subtracting days in accounts payable. The figures for Anheuser-Busch last 5 years of operation are shown in Figure 13. Examining the figures, a few things jump out. The company keeps remarkably low inventory, and it has maintained this trend for a minimum of the last 5 years. This makes sense, because beer is a perishable item and excess inventory would eventually spoil. Furthermore, the company established a “Born on Dating” program a number of years ago. This system allows consumers to determine the date when their beer was made. Keeping inventory turns high is essential for the born on dating program to be an effective marketing tool. The company’s receivables are also remarkably low. The company has been lengthening the time period in which it settles accounts payable. This change is a positive as long as the company is not having cash flow issue which Anheuser-Busch is not. By delaying payment, the company is able to use the cash in its operations rather than having to try down cash from other sources.

Figure 13: Cash Conversion Analysis

The operating cycle numbers in Figure 13 indicate that Anheuser-Busch is very effective in converting their investments in operations into cash. In fact, they turn inventory and collectible receivables faster than they have to pay cash out to their suppliers. Furthermore, the trend has been improving over time. The company is currently collecting cash almost 10 days in advance of having to pay for the raw materials used in making their products. This situation is enviable and is a sign of the quality management and financial controls within the organization.

Valuation Several different valuation techniques were used to assess the value of Anheuser-Busch. A description of each technique and the resulting analysis is provided below.

Equity Valuation: Multiples One technique I used to assess the value of Anheuser-Busch was multiples analysis. To begin with, I compared Anheuser-Busch’s valuation multiples to several benchmarks in the market. First, I compared the performance of Anheuser-Busch to the S&P500 (Refer to Figure 14). Based on this comparison, Anheuser-Busch priced above it historical value in relation to the S&P500.

Figure 14: Anheuser-Busch Relative to the S&P500

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Next, I compared Anheuser-Busch to the consumer staples sectors and the alcoholic beverages industry within the consumer staples sectors (Refer to Figure 15). My comparison of Anheuser-Busch to the consumer staples sector indicated that the stock is fairly valued with the exception of Price/Book. Finally, I compared Anheuser-Busch with the alcoholic beverages industry as defined by StockVal. This comparison provided some surprising results. According to 3 of the measures, Anheuser-Busch was undervalued, in some cases significantly (e.g. Price/Sales). In other cases, the company was significantly overvalued (e.g. Price/Book). Examining the companies StockVal includes in the alcoholic beverage industry sheds some light on the results. Many of the companies included are wine producers, spirits producers, foreign beer producers, or craft beer producers. These are the same producers who have been performing well based on their position in the industry and their growth prospects. Therefore, I would conclude it is only natural that Anheuser-Busch would be undervalued in comparison because its multiple growth has not kept pace with its peers in the alcoholic beverage index.

Figure 15: Anheuser-Busch Relative to Sector and Industry Valuations

Having gotten a feel for how Anheuser-Busch’s prices compared to several benchmarks, I selected target multiples for each of the valuation measures. This allowed me to compute target prices based on each measure. The results of this analysis are presented in Figure 16. While I assumed Price/Book, Price/EBITDA, and Price/Cash Flow would revert to the mean, I felt as if Price/Forward EPS and Price/Sales would not reach their mean value again. I came to this conclusion based my outlook for market conditions and the recent performance of the multiple in regards to whether or not it was trending towards its historical mean. For Price/Forward EPS and Price/Sales there did not appear to be a trend toward reverting to the mean in the last few years. Therefore, I assumed that, given market and industry shifts, the recent past was a more relevant predictor of the future. I then selected a target multiple based on what was roughly the 3 year mean for the measures in question. Based on the target multiples selected for each measure, I computed prices ranging from $48.42 to $56.89 a share. I do not put a great deal of weight on any of these estimates as the tend carry a number of embedded assumptions that only allow for a rough approximation of the intrinsic value of a stock. However, they do give credence that my DCF valuations are in a reasonable range. With that being said, if forced to choose the most appropriate measure, I believe Price/Forward EPS is the best approximation of the intrinsic value of companies in this sector.

Figure 16: Anheuser-Busch Target Multiples and Valuation

Comparables Analysis I performed a more granular valuation comparison by examining valuation measures of some of Anheuser-Busch’s peers (Refer to Figure 17). With the exception of Price/Cash Flow and Price/Forward EPS, Anheuser-Busch has higher multiples than it peers. In terms of Price/Cash Flow, the company lagged both SABMiller and Heineken. Price/Forward EPS information was not available for SABMiller so it is unknown how Anheuser-Busch compares to it but Anheuser-Busch did trail Heineken in this category.

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Figure 17: Comparable Analysis

Next, I took an arithmetic average of each multiple and using same target multiple from the previous valuation exercise I computed an additional set of price targets for Anheuser-Busch. The results are presented in Figure 18. Admittedly, an arithmetic average is to simplistic as it fails to account for market weights but once again I am just looking for rough confirmation the pricing generated via my DCF model is in the correct range.

Figure 18: Comparables Valuation

Equity Valuation: DCF I believe that a Discounted Cash Flow (DCF) model yields the best target price for Anheuser-Busch. It leaves a great deal of room for error since the analyst is making a number of assumptions but it has the benefit that all assumptions are known and understood. This is not the case when using multiples for valuation purpose. Multiples have a number of implied assumptions. Unless the analysts studies and understands the makeup of the multiple, it can easily provide them with a price that does not make sense in the situation being evaluated. The model I developed is presented in Appendix E. The model yields an intrinsic value of $52.35 for Anheuser-Busch. This is within the range of prices generated using multiples analysis in the sections above. Below, I outline the assumptions I made when defining the model. Incomes Statement Assumptions

o Net sales growth was predicted to be 5.0% and 5.25% in 2007 and 2008 respectively. Beginning in 2009, the growth was projected to slowly return to long term historical average. The spike in 2007 and 2008 was intended to capture growth from new import and distribution agreements as well as the company’s expansions in India and China.

o Operating margins were predicted to decline to 16.0% in 2009 as pressure from commodities prices increases and higher marketing expenses weigh on the company. Long term, these pressures are expected to moderate and operate margins were projected to return to their historical norm.

o Interest expenses were predicted to remain flat year-over-year which is inline with historical trends. o The company’s tax rate was projected to be 39.5%. o Equity Income from the company’s investments is projected to peak at 5.25% of sales in 2010 and

then trend down to a long term rate of 4.75% of sales. Balance Sheet Assumptions

o Given Anheuser-Busch excellent control of Accounts Payable, Accounts Receivable, and Inventories growth projections for these categories were based on historical norms.

o Depreciation was projected to follow historical trends. Cash Flow Statement Assumptions

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o Near term capital expenditure estimates were made based on company statements about planned expenditures. Longer term estimates were set to equal depreciation expenses.

The discount rate was assumed to be 9.0%. A CAPM model would have predicted a discount rate of 8.0% to 8.5%. I felt that a higher discount rate was warranted given the company’s concentration in the domestic markets and the current trends within this market. With little in the way of material growth and an unproven strategy, the company is riskier than it has been historically in my opinion.

The terminal growth rate was assumed to be 3.5% which about 1% below the long term historical growth rate of the company.

Figure 19 outlines the differences between my model and consensus estimates for revenues and earning per share. From a revenue perspective, my model diverges from consensus by 2.8%. The difference stems from my belief that Anheuser-Busch’s strategy to leverage its distribution channels will result in above average growth over the next few years. However, I believe the company will experience higher costs which will offset much of their growth. Therefore, my EPS estimates lag the consensus.

Figure 19: Comparison of Model Estimates versus Consensus

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Conclusions I am rating Anheuser-Busch a HOLD with a price target of $52. Anheuser-Busch is a solid company with excellent financial strength. Unfortunately, the company derives most of its business from the domestic market and it lacks the necessary diversification to shield it from the unfavorable trends that currently exist in the market today. To management’s credit, it is aggressively pursuing opportunities to generate additional international growth. With domestic population growth flat and changing consumer buying patterns, international presence is key to re-vitalizing growth of the company’s core brands. Additionally, the company is forming relationships with other alcoholic and non-alcoholic beverage producers. The company intends utilize these relationships to leverage its massive distribution in order to capitalize on the changing domestic consumption trends. It will take time for these strategies to be fully deployed and the affects to be realized in the company’s financials. I believe the market is skeptical about the results the company’s strategy will be able to produce and it has good reason to be skeptical. The company has had substantial investments overseas for almost 20 years. Even so, judging by it lack of organic revenue growth internationally, it does not appear that Anheuser-Busch has been able to fully capitalize on the tremendous growth that has occurred in the last decade. I think it is valid to ask what is different today and why the company will be successful now. One key difference lies in management. August Busch IV assumed the CEO role at the end of last year. From the accounts I have seen, he appears to be more aggressive than his predecessors were in finding and attacking strategic opportunities. In my opinion, there is not enough data at this point to draw any real conclusions about how the company’s new strategy will play out. Doing so would be pure speculation on my part. I think that this is the very problem with this stock. The market is uncertain about its fate and therefore is assigning an additional risk premium to the shares. If the company’s strategy succeeds in restarting its stalled domestic business and generates international growth, the shares could easily reach $60/share. Until the market sees signs of growth, I believe the shares will be range bound in the high $40’s to low $50’s as the market searches for a reason to drive the shares higher or lower. Based on the results of my DCF model, which accounts for the additional market penalty I perceive, I have a target price of $52 on the shares. Given the current upside potential of 6.7%, this warrants a HOLD. The price target and rating should be re-evaluated following any material developments related to: international expansion, domestic distribution agreements, dramatic changes in domestic sales, or changes in Grupo Modelo’s sales. The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but the Fisher College of Business makes

no representation as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. This report is not an offer to sell or a solicitation of an offer to buy any security. The information and material presented in this report are for general information only and do not specifically address individual investment objectives, financial situations or the particular needs of any specific person who may receive this report. Investing in any

security or investment strategies discussed may not be suitable for you and it is recommended that you consult an independent investment advisor. Nothing in this report constitutes individual investment, legal or tax advice.

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Appendix A – Anheuser Busch Balance Sheet

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Appendix B – Anheuser Busch Income Statement

Appendix C – Anheuser Busch Cash Flow Statement

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Appendix D – Income Statement Projections13

13 Adapted from Anheuser-Busch’s 2004, 2005, and 2006 Annual Reports

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Appendix E – Discounted Cash Flow Analysis

DCF Sensitivity Analysis