J.P Morgan CAZENOVE Anheuser Busch InBev Reinstating coverage with a Neutral rating. Premium valuation reflects superior growth We reinstate coverage on ABI with a Neutral recommendation, We continue to have confidence in ABI's ability to generate superior profit and cashflow growth through its dominance in key beer profit pools and best-in-class management ability. However, given limited EPS upside and catalysts (with limited sensitivity from higher synergies on a very high EBIT base and no benefit from refinancing) in the ST, we believe the valuation premium reflects the superior growth, Our Oct-17 PT is €119, On our estimates ABI trades on a CYI8E P/E of 22.4x versus European Beverages ex ABI on 18x and European Food/HPC on 18.7%/20.5x. © We have no doubts over ABI management's ability to execute on cost efficiencies to drive superior growth. However, we believe SABM was acquired for a heity price ($108bn) implying, we calculate, a full EBITDA multiple of 18.2x. We that estimate ROI of 7%, incl. synergies, by 2020 will only be in line with the WACC we previously used for SABM. © Limited upside and low growth sensitivity to synergies. In total, we expect synergies to amount to $1.65bn ($1.4bn enlarged ABI synergies and 250m of SABM’s ¢.$500m savings). We incorporate $1bn of cash flow synergies taking core working capital on aequired sales to -3% (from 6%). We believe revenue synergies will be limited in the S-MT. Importantly, on a $19bn EBIT base, we note even $1bn of extra synergies spread over 4 years will have limited impact on profit growth © De-gearing will take time and no ST upside from refinancing. We forecast net debt to EBITDA of 3.3x in FY20E down from 4.4x in FYI7E, ‘We expect dividend growth to be constrained by de-gearing in the medium term. With several potential uses of the balance sheet (Castel, Africa minorities, Efes) in the medium term, we do not foresee another transformational deal in the next 5 years. CYISE FCF yield of 4.4% is below global peers at 5%, © ABI now controls 44% of the global beer profit pool versus 33% pre transaction. ABI dominates beer profit pools in the US, Brazil, Mexico, China and now Colombia, Peru, and South Africa. The US and Brazil still make up ¢.50% of ABI’s profit, whilst Aftica (ex SA) is 4%, ‘Anheuser Busch InBev (ABLBR:ABI BB) Completed _ 10 Oct 2016 04:40 PM BS" Disseminated 10 Oct 2016 04:42 PM BST Europe Equity Research 10 October 2076 AABLBR, ABI BB Neutral Price: €118.28 Price Target: €119.00 up, BUD US. Neut Price: $127.28 Price Target: $133.28, European Beverages Koma! Dhillon “© (44-20) 7134-5686 eral hon@ipmorgan.com Bloomberg JPMA DHILLON Mike J Gibbs (44-20) 7134-5884 mike abe@pmergan com Rachel Stott (44-20) 742.7478 rachelbsttiajpmorgan cam ‘Stoyko Moev, CFA (44-20) 77428800 Soyo moewipmergan om LLP. Morgan Secutlos pe For Special contact: Sophie L Warrick (4-20) 71341473 sophie warrikajpmrgan.com t Sales advice please Ratan sae pant FYE Dec 20164 —2016E) —20T7E) _2018E —20T9E 2020 AGES, 520 aa 816 57a Bloomberg EPS FY (8) 501 4084888 - - gh PIE FY 2a 207 2482099183 Revenue FY ($ mn) 43607 45,743 56,808 59.499 62,380 65,487 EBITDA FY ($ mn) ees 17.877 22.845 24730 26089 28,469 Net Prof FY (S mn) 8273-2853 8.88 11168 12.251 13.328 DPS FY (8) 395 4054434887 S Dividend Viel EY. S4% 32% 35% 37% 41% aah Source Company cals, BSTEwa, J. Morgan esha. Company Data Price Ts Date OF Price 07 Oct 18 Price Target (€) 125.00, Price Target End Date 31-Oct-17 S2week Range (6) — 124.20-97.13, Market Gap (€ bn) 180.3 Shares OFS (on 1582 See page 119 for analyst certification and important disclosures, including non-US analyst disclosures, 41. Morgan does and seeks todo business with companies covered in is research reports. Asa resul, investors should be aware that the fm may have a confit of interest that could affect the objectivity ofthis report. Investors should consider this report as only a single factor in making their investment decision www.jpmorganmarkets.comoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Equity Ratings and Price Targets Wiicap Price ating Pica Tagat Company Titer (Soa) coy Pree Gur aw ‘Cur Pree ‘eheuser Soh Sar “TB wise EUR Tiss N NRT ‘house Buen InBev (ADR, sup. Us mass USD args NNR cue: Cary dl, Borba UP Wagan ai evn age Aan apo O= 1 Table of Contents Executive Summary 5 Valuation s Balance sheet, cash flow and dividend yield 6 ‘Transaction 6 Capital allocation . 7 Synergies limited upside and low growth sensitivity 7 Enlarged ABI 8 US is still a quarter of profit... sumnnnnnninnanenenanensnnnnd Brazil potentially past the WOrSt...snsnsnsnsnninininnnnnnsnnnnanansns]O) COPEC (12% of profit) 10 Africa (9% of profit) un Australia (3% of profit) 12 ABI controls 44% of the global beer profit pOOL rurususnsnsnnsnnnenenennnane 2 Valuation... oe (Our DCF derived price target is €119eunnnun se B Fastest growing large-cap global staple reflected in valutionssvcsoeseonel4 Dividend growth to be constrained by de-geating..nnonnnnnnnnnenennnselS Key risk to rating Recap of the transaction.. 18.2x EBITDA multiple paid for SABMiller. "7 Major disposals see Comparable multples.. Gearing up is working again. No transformational deal in the horizon..... Potential aequistions/divestitures... Buying in unlisted shares. Limited upside and growth sensitivity to synergies SABMillr's saving program. Synergies from the merger. Analysis of enlarged ABI synergies and SABMiller savings Cash flow synergies expected to be e-$1bn Revenue synergies to take time., [ABI growth sensitivity o synergies is low. Enlarged ABI details. New shareholder structure 38 New board structure. 39oral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com US and Brazil are still ¢.50% of enlarged ABI 40 Growing ahead of peers. Stable C4PEX. corona ABI financials... US still a quarter of profit ABI’s US portfolio, 46 ‘Over-indexed to value 47 ited price/mix growth in the past few years aT Muted profit growth in recent years 48 Sales and marketing spend has increased significantly 49 -but has not curbed market share decline ........csssesssensennenneennenneennensneenee Lean production and distribution senna SL Investment could be required to counter. Molson Coors. vs o o 51 Brazil potentially past the worst. Improving macro, 33 Beer margins broadly flat in recent years sa Soft drinks profitability has substantially improved 56 Diminishing tax advantage COPEC (12% of profit)... Dominant positions in three key markets... 61 Mid-single-digit volume growth... vs 62 despite consistent price increases 62 Profitability is very high 63 swith strict cost control 63 Package and direct distribution help drive margins. 64 Strong cash flow and returns 65 Strategy shif from value to volume.. soon ABI Beer Brazil and Mexico versus SABMller LatAm soe 68 Colombia (5% of enlarged ABI)... 69 Peru (4% of enlarged ABI) Africa (9% of profit) Background. n ‘There are significant minority and associate partners in SABMille's Africa platform SABMiiler and Castel have complementary platfonms across Africa 80 Castel is facing challenges a2 Very high market shares. 83 Volume growth opportitity...snnusmnnninnnianannnnnnnnnnn®8 ASfordablity isthe i88U¢....n.snnmnnnnnnnnnnannsnannnnnnnennn ‘Successful use of price ladders 84 Investment evel is stable... ssn Costs and supply... v ‘ v v v v ‘ Z 86 Guidance and outlook. a7 Structural impediments to margin expansion in Aftica 89 South A fica (5% of enlarged ABI) ...cnnnennnnnnnnnnnnnnnnneDOKomal Dion (420) T1343085 Komal ahllnemorgan.com Europe Baty Research J.PMorgan CAZENOVE Australia (3% of profit). ee Post-SABMiller takeover headwinds Beer market Rise of big retail. Brand investment Strong profit growth in recent years ABI now controls 44% of global beer profit . ABI: leverage inthe biggest profit pools Heineken: control over its destiny Carlsberg: weak competitive position .urussnsnunsnsonnnsonnsennson 101 Global beer industry profit Of $362 .uscuiansnsonnnsinsnnsonnnannsees OD The bigger the beter ee sonar 106 Some profit pools offer structurally higher profitability 110 Scale isnot the only driver of returns. 1 Investment Thesis, Valuation and Risks ..oral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com Executive Summary Following a period of restriction, we are moving from @ Not Rated designation to a ‘Neutral rating and an Oct-17 price target of €119 (prev. OW and Jul-16 price target, of €121). We continue to have confidence in ABI’s ability to generate superior profit and cashflow growth through dominance in key beer profit pools and best-in-class ‘management ability. However, given limited EPS upside and catalysts (with limited sensitivity from higher synergies on a very high EBIT base and no benefit from refinancing) in the ST, we believe the valuation premium fairly refleets the superior growth. Valuation ‘© We value ABI primarily on a discounted cash flow basis but also compare its current valuation to large cap global staples peers in the context of growth rates as well as dividend and FCF yields. ‘+ Our DCF detived October 2017 price target is €119. We apply a WAC of 6.7% (which was the cost of capital we applied to ABI on a standalone basis) and use a perpetual growth rate of 1.7% (versus 1.5% standalone) to reflect the higher growth potential of SABMiller’s acquired operations. ‘* ABI’s acquisition of SABMiller should lead to higher volume growth of 2% versus an average of 0.6% between 2010 and 2015, However, we expect organic revenue growth to be slower at c.5% between 2017E and 2020E versus 6.2% between 2010 and 2015 due to the priceimix drag from Africa (c.50% of group revenue/hl) as well as slower growth in Mexico and LatAm South. Similarly, we expect slower organic EBIT growth of c.8% between 2017E and 2020E versus .10% between 2010 and 2015 despite the incremental synergies with the very ‘material tailwind from Mexico (primarily €1bn of synergies) behind us and as the base has nearly doubled ($18.6bn in 2017E versus $10.3bn in 2010), At the EPS level, we expect growth to accelerate to an average of ¢.13% between 2017E and 20208, versus 11% between 2010 and 2015, primarily driven by de-gearing. ‘© ABI's medium-term growth is therefore faster than its global large cap staples peers as detailed in the table below. However, we believe this is fairly reflected in its valuation premium to these peers.oral Dion (aaa rise 580s formal cillonpnorgan com Table 1: Giobal staples valuation metrics so onoder 2016 JPMorgan CAZENOVE WCap FE EVEBIDA EPS growth 0T6-2010E CRGR PEG Owidend yield FOF yl Usom Ee WE 0E_TE10E EPS EBITDA a01e9E ATE we tee aT Hiss oan ae aad SOSK OTR 38 A Hoioken “40680 «Wak «8x10 Bk «TOK OTOK SK Tk 20K 27K ADR SAN. Dayeo GHOSE Dak TSMR OK Dk 28% ATH ASK SOM Poms Rea S685 18S Tk T2588 2TH AH Carstom 404818 AB Bk 12% BTM KT ZTK ZEMAN SIN. Cocatcole 180108 20k «Mx «TEx STB SKS DKA EK BBM 4am 4a Popsico 152008 -205x = 18x Task BOK BKK MUN OAZH SIR SBN New 758067 200k 189k THOKS3Tk SKB SK ST BZH ATK SOM. Unievor 138162 «202 RKTT Dk OAK OATH 4TH Aa Monddes ‘b5d05 «D0 «Bk: TKK 19% DR AN, LOred”— M0285 28x =k TSK 3K TTT BRIM 23% AA Recktt EAST DDAxaTEOK «SOx 12K SOM: BK Dk TK TAN ATR ABN. Coho 65128 Dk «x 3B kT 2AM AIH. PAG oa «220m «Sk Wk MeOH 2k BTM ADK MAK TH Philp Moris M958 198k = 18k M8 BKM: AEH MBH AK SAN ‘ia 120963 18k dk TKR BH kADK ASK SAH 8M gars M2718 TEKS OK TOK KT OOTK AON BR AN. Weigh 20 ” frilion _21te 19x s2e12de 102% 82K ZR TIKES Seat: Company dl, Bry, LP. Maan eto, Balance sheet, cash flow and dividend yield © ABI’s FCF yield of 4.4% in CYISE is below global peers at 4.9%, We have ineluded Son of cash flow synergies from the SABMiller deal, ‘© ABI continues to target net debUEBITDA of 2.0x as an optimal capital structure for the long term, but has not given a time frame as to when this will be achieved. We forecast net debv/EBITDA of 3.3x by December 2020E from 4.4x in 2017E ‘© Inthe medium term, we expect dividend growth to be constrained by de-gearing which remains a priority for ABI. We expect dividend growth of 5% in FY17E and FY I8E implying a payout of 89% and 83% respectively. From FY19E, we expect dividend growth of high single digits to low double digits in line with EPS growth and with payout at 81%, ‘© With several uses of capital in the short and medium term, we do not expect another transformational dealin the next 5 years. Transaction + On our estimates, post agreed divestitures net of tax, ABI has eventually paid a {ull multiple of 18.2x one-year forward EV/EBITDA for SABMiller versus @ multiple of 16.2x indicated by ABI when the transaction was agreed by the key shareholders in November 2015. Post synergies and disposals, we estimate ABI has paid a forward EV/EBITDA multiple of 15.6x. ‘* ABI has completed the combination with SABMiller ina transaction valued at '$93.2n post disposals, The cash consideration was $73.1bn with 326m restricted shares issued to the controlling shareholders of SABMiller —Alltria and BevCo, ‘The total EV was $103.8bn, ‘© We estimate the ROI post synergies in 2020 would be 7% in line with our assumption of SABMiller's WACC (albeit it could arguably be higher for this transaction given disposal of major developed market assets)oral Dion (aaa rise 580s formal cillonpnorgan com oon JPMorgan CAZENOVE ‘The disposals of SABMiller’s 58% investments in Miller-Coors and 49% in CR Snow, Peroni, Grolsch and SABMiller’s major European assets are expected to take place soon after deal closure, The disposal of all the above except SABMiller’s major European assets has been pre determined with binding offers from acquirers. In total, the pre-determined disposals are expected to raise $816.4bn of cash pre tax and $11.7bn post tax. Capital allocation Synergie: ABI has stated that do-gearing will be a priority in the short term with an ideal long-term capital structure of 2x net debt to EBITDA. This implies modest dividend growth in the short term, Key acquisitions/divestures, in our view, concern: 1, Castel, in which SABMiller had a 20% equity stake. We value Castel at '$30bn and the net cost to ABI at $22bn, SABMiller also had several other ‘minorities and associates in Africa, which ABI could acquire, ‘Anadolu Efes, which primarily operates in Turkey and Russia and has a 5 stake in the Turkish and Central European Coca-Cola bottler, Coca-Cola lcecek. The market capitalisation of Anadolu Efes is currently $3.6bn implying a market value of ¢.$900m for SABMille’s 24% equity stake. 3. Coca-Cola and Pepsi bottling. We believe there will be discussions around ABI’s ability to bottle both Coca-Cola in Africa and some in Central America, while also bottling Pepsi in South America. We estimate disposal of SABMillers controlling stake in CCBA would result in ¢.3% reduction in ABI's EBIT, Importantly, the disposal could reduce ABI’s group volume growth by -S0bps to 1,5% versus 2% currently forecast in the medium term, 4, Altria and BevCo together now own an expected ¢.14.5% of enlarged ABI ‘through unlisted shares awarded under the PSA. A buyback of these shares post lock up in S years time would amount to some $42bn at today’s share price. Assuming a 3% cost of debt, this acquisition would be 11% accretive to ABI in December 2017, discounted back at arate of 6.7%. However, a sale of shares for cash would trigger significant capital gains tax for both Altria and BevCo. Therefore, we are uncertain whether a buyout of these shares would bbe a feasible option, 5. Other possibilities include Vietnam that ABI is currently bidding for. In ‘Vietnam the largest state owned brewer, SABECO, is valued at $1,8bn, However, there are a number of bidders, including Heineken, Asahi, ThaiBev, Boon Rawd, other than ABI that are keen on the assets which could drive up the value of the business Therefore, with the above transactions taking precedence and with the balance sheet at 3.3x net debt to EBITDA by FY20E, we believe it will be a very long. time before ABI contemplates its next transformational acquisition imited upside and low growth sensitivity In total we expect synergies to amount to ¢, $1.65bn, made up of $1 4bn enlarged ABI synergies and $250m of SABMiller’s remaining c,$500m savings. We apply a haircut to SABMiller’s announced targets due to the sale of the European assets,oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE to satisfy the European Commission’s competition concerns. We believe SABMiller’s European assets were a key driver of its cost-savings program. ‘© We expect the majority of synergies to be generated in COPEC (Colombia, Peru and Beuador), Africa and Australia, We expect limited incremental synergies/efficiencies in the US, Mexico, Brazil, Europe or AsPae North (primarily China and South Korea). Based on the split of savings and underlying growth, we would expect COPEC EBIT margins to expand by 1200bps, while Arica and AsPae South (mainly Australia) expand by 1000bps between FY 16. and FY20E. Importantly, all other things being equal, the COPEC margin would increase to 48,2% by FY20E, which is ahead of the 46.6% margin ABI’'s Brazilian beer business generated in FY15, Margins in Africa would match ABI's North America margins ‘© As with cost savings, we believe that working capital savings at SABMiller ‘would be much more challenging to achieve than in ABI's prior deals. We expect $1bn of eash flow savings to be the ceiling. This would take SABMiller’s core ‘working capital to sales to -3% versus 5.6% in FY16 and ABI's -12.4% in FYIS. ‘© We expect enlarged ABI to generate significant revenue synergies, but we expect these to be very gradual, particularly in the short to medium term. The first phase of revenue synergies would involve replacing, rather than adding to, Miller Lite, Miller Genuine Draft, Peroni and Grolsch brands in LatAm and Australia, in our view. In Africa, we do not expect material revenue synergies in the short to ‘medium term. We have included an element (¢-$400m) of revenue synergies in our estimates for ABI’s central business, GEHC. ‘© Overall, the level of synergy does not have a material impact on earnings growth in the out years. We estimate enlarged ABI will grow earings at high single digits in FY20E (post full synergy capture) with a range of $1.65bn to $2.5bn total synergies and cost savings. On this synergy range, average annual earnings would be between 14% and 15.5% between FY 16E and FY20E, on our estimates. Table 3: Enlarged ABI earnings growth sensitivity to level of synorgios ‘Sey, mT SE FYB PYRE FREDO EPSCAGR cs ro 139% 23 138 42% 20% 13% 6% 2% 14 155%, ‘Som LF Magar ena Enlarged ABI ‘+ ABI will continue to be incorporated in Brussels, Belgium, and have four listings ~ Euronext Brussels, Johannesburg Stock Exchange, Mexican Stock Exchange and ADRs on the NYSE. ‘= Enlarged ABI is now 44% owned by the ABI control group (Stichting. Administratickantoor Anheuser-Busch InBev, EPS Participations Sarl, BRC Sil, Fonds Voorzitter Verhelst SPRL, Fonds InBev-Baillet Latour SPRL and certain other entities acting in concert with AB InBev), we expect c.14.5% owned by SABMiller controlling shareholders (Altria c.9.7% and BevCo c.4.8%), ¢ 2% owned by other restricted shareholders and has a five float of 39.5%, ‘© ABI’s board comprises of 15 directors, 3 of whom are independent. Altria has appointed 2 board members while BevCo has elected 1. ABI’s controlling,oral Dillon Europe Equity (aaa rise 580s so onoder 2016 formal cillonpnorgan com JPMorgan CAZENOVE shareholders have elected 9 board members, therefore giving the ABI Control Group effective contro! of the company despite holding less than 50% of voting and economic interest, ‘© North America will remain the largest market for ABI at 30% of EBIT in FY17E; though we expect this to reduce to 26% by FY20E as Africa gains prominence. LatAm North, which ineludes Brazil, will remain the second-largest profit contributor at 21% and will be followed by COPEC, the third-largest division of ABI at 12% of EBIT in FYITE. ‘+ The US will remain the largest single market for ABI; accounting for 26% of group EBIT in FY17E, We estimate Brazil will be the second-largest at 21% of profit, followed by Mexico 9%, Argentina 6%, Colombia 5%, South Aftica 5 Canada 4%, Peru 4%, Australia 3% and China 2%, We estimate thatthe total Africa EBIT contribution ex South Affica (and Coca-Cola bottling) will still be smaller than Canada and half the size of Mexico. ‘© ABI’s acquisition of SABMiller should lead to higher volume growth of 2% versus an average of 0.6% between 2010 and 2015. However, we expect organic revenue growth to be slower at c.5% between 2017E and 2020E versus 6.2% ‘between 2010 and 2015 due to the price/mix drag from Afica (¢.50% of group revenue/hl) as well as slower growth in Mexico and LatAm South. ‘© Similarly, we expect slower organic EBIT growth of c.8% between 2017E and 2020E versus ¢.10% between 2010 and 2015 despite the ineremental synergies with the very material tailwind from Mexico (primarily €bn of synergies) behind us and as the base is now much larger ($18.6bn in 2017E versus $10.3bn in 2010). ‘© Atthe EPS level, we expect growth to accelerate to an average of ¢.14% between 2016E and 2020E versus 11% between 2010 and 2015 primarily driven by de- gearing. US is still a quarter of profit ‘+ The US will account for ¢.17% of volume and 26% of profit for enlarged ABI in FYITE. Since InBev acquired A-B in 2008, the company’s sales in the US have increased from $13.3bn to $13.8bn in FY1S. A strong focus on costs has led to a marked improvement in profitability with EBITDA increasing from $3,8bn to '$5.Sbm in the seven years and margins expanding by 1,100 bps from 29% to 40%, while cash flow in the US has more than tripled from $1Sbn to an estimated $5bn, ‘© However, ABI's top line performance in the US since the AB aequisition has bbeen mixed with organic growth in North America averaging 0.7% p.a. boosted by 5% growth in 2012. Excluding 2012, organic sales would have been flat for ABI in North America between 2009 and 2015. The decline in US beer industry volume is decelerating but ABI continues to lose market share due to its skew towards the value’ economy brands. ‘© Looking forward, in ABI's North American segment we expect limited volume growth despite slightly better US beer industry trends with ABI continuing to lag, We forecast I-1.5% organic price/mix to result in 1% organic sales growth, Despite pressure on profitability over the past few years, we expect this business ccan generate low single digit organie profit growth and we forecast 2% p.a, tooral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE FY20E. The takeover of MillerCoors by Molson Coors could result in higher competition in the US, which could adversely impact ABI's margins in the region. Brazil potentially past the worst © We estimate Brazil will account for 21% of enlarged ABI’s EBIT and will therefore be the second largest market contributor to group profit. The country is the largest component of ABI's LatAm North division. ABI's exposure to Brazil is through its 62% equity stake in AmBev, the listed LatAm brewer. ‘© We forecast 2-3% p.a, volume growth in ABI’s LatAm North segment to FY20E, which, along with inflation-driven 5% price/mix growth, should result in 7-8% pa organic sales growth in the medium term. After a year of margin suppression, ‘we expect profitability to revive in FYI7E and thereafter remain broadly stable at the 52% EBITDA margin level ‘© Affer 3 years of contraction, J.P, Morgan's economists expect Brazilian GDP to grow by 1.4% in 2017, driven by higher manufacturing confidence. ‘© AmBev's beer volume increased by a CAGR of 3% between 2008 and 2015. The ‘company’s market share in beer was 67.5% in 2015, but has been under pressure recently, AmBev"s Brazil beer pricelmix increased at a CAGR of 8% between 2008 and 2015 ahead of average Brazil CPI of 6.5% in that time frame. EBIT ‘margins have declined from their recent peak of 49% in 2013 with higher SG&A driven by the football World Cup in 2014, In 2016, we expect continued pressure ‘on EBIT margin driven by higher COGS as well as negative operating leverage. ‘© AmBev is one of the largest PepsiCo bottlers globally with operations across LatAm in Brazil, Argentina, Bolivia, Uruguay and the Dominican Republic. The bottling agreement in Brazil expires in 2017 and will be automatically renewed for an additional 10 years. ‘© Overall, between FY10 and FY15, AmBev's soft drinks volume has been broadly flat with a decline in FY 15 due to pressure on disposable income. AmBev's soft drinks price/mix growth has been below inflation except in 2012 and 2013. Despite volatility at the gross profit level, EBIT margins have been maintained at the 44% level after a 1000bps step up between 2007 and 2013. ‘© AmBey has benefitted from various tax shields in Brazil, We believe the tax advantage will diminish going forward given the controversy around CONFAZ, tax assessment received for the special goodwill reserve and potential removal of TOC benefits, We forecast a mid 20%s effective tax rate in Brazil in the medium term, up from an average of c,19% over the past 6 years COPEC (12% of profit) + ABI’s new segment, COPEC, encompasses SABMiller’s LatAm operations, ‘which were the largest regional conrZbutor to SABMller’s group profit; accounting for 34% of group EBITA in FY 6. + COPEC accounts for 12% of enlarged ABIL Colombia and Peru are the key markets, accounting for over 90% of regional profit between them, on our estimates. SABMiller's operations in Colombia operate on .50% EBITDA ‘margin and, we estimate, 40% EBIT margin, In Peru, we estimate EBIT marginoral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE 0f 30%, We estimate Colombia accounts for ¢,60% of segmental profit or 5% of enlarged ABI, while Peru is ¢.30% of segmental profit and 4% of the group, ‘© Theregion has delivered mid single-digit volume growth, despite nominal price increases, resulting in high single-digit top-line growth. This, along with focus on costs, has led to near double-digit annual profit growth. EBIT margin of 35.9% in FY16 has inereased by over 1000bps since FY10, ‘+ Inthe medium term, we expect the region to deliver 2.5-3% organic volume growth p.a., 5% organic pricelmix growth and 7.5-8% organic sales growth to FY20E, We expect broadly flat underlying margins, but with over 1200bps EBIT ‘margin expansion, driven primarily by synergies. This will take EBIT margin of the COPEC segment to 48.2% in FY20E versus 36.1% in FY15; or above Brazil beer margin of 46.6% Africa (9% of profit) + Afica will account for 9% of enlarged ABI's profit in FY17E, on our estimates Given faster growth as well as synergies inthe region, we expect the contribution to increase to 11% by FY20E, © SABMiller’s Aftican business consists ofits dominant positions across much of the south and south-east of the continent. The largest profit contributors are South Africa, Tanzania, Nigeria, Botswana, Mozambique, Uganda and Zambia, The business also includes associate income from its 20% stake in Castel, which ‘operates predominantly in Francophone Aca, ‘© Inrecent years volume growth has been driven by soft drinks at high single digits, while beer growth has been lower at low to mid single digits, Price/mix has grown by mid single digits, resulting in overall net sales growth of 9% in FYIS and 11% in FY16. ‘+ SABMiller's organic EBITA increased by 6% in FY15 and by 11% in FY16, ‘Margins declined by 7Obps in FY15 and by 40bps in FY 16. ‘© InFYI6 (ending March), SABMiller's key associate, Castel, experienced very difficult trading conditions in its key market of Angola, where lager volume declined by 18% (total beverage volume -19%) due to challenging ‘macroeconomic conditions, 33% currency devaluation and lack of access to hard currency, Castel impaired its assets in Angola and scaled back materially in the country. Excluding Angola, Castel’s volume increased by mid single digits (in line with SABMiller’s subsidiaries), driven by double digit growth in the Congo, Madagascar and Burkina Faso. Castels total beverage volume declined by 1% in FY16, which was offset by 7% growth in priceimix resulting in 6% net revenue growth, ‘+ InQII7, SABMiller’s Africa organic volume growth slowed considerably to flat (on a4% comp) post 6% in Q416 (comp 94). Lager volume declined by 1%, while soft drinks grew by 3%, Lager volume decline was driven by a -16% fallin Tanzania and -12% in Mozambique, offsetting growth of 12% in Zambia, 36% in Nigeria and 2% in South Africa, SABMiller’s price/mix growth remained intact at , resulting in net revenue increasing by 6% (South Africa 6%, rest of Africa 9%). Castel’s volume declined by 4%, driven by Angola, excluding which volume, would have declined by 3%, Castel’s net revenue grew 1% (4%Komal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 excluding Angola) implying price’mix of 5%. We expect challenging trading conditions to continue in key markets in Africa over the next 12 0 18 months. ‘© We expect continued pressure in the short term, but, in the medium, term we believe the region can deliver mid single-digit volume and price/mix growth resulting in low double-digit sales growth, We expect underlying margin expansion to be subdued but synergies to result in 960bps EBIT margin expansion between FY15 and FY20E. This would take EBIT margin to 36.1% in line with ABI's margins in North America. Australia (3% of profit) ‘+ Australia will eecount for 3% of enlarged ABI’s profit in FY17E, on our estimates, ‘© SABMiller acquired the Foster’s beer business at end 2011. In 2015, we estimate Australia generated $1.5bn of sales on 7m his of volume and EBIT was some '8430m; implying nearly 30% margin. + SABMiller’s Australian business has been adversely impacted by macroeconomic challenges that have resulted in volume declining by 1% on average between FY1S and FY16, Organic price/mix has been positive 2% on average pa. driven by premiumisation and some price increases resulting in 1% average annual organic revenue increase, Despite this, SABMiller has successfully expanded ‘margins ofits Australian operations by over 1000bps over the past 4 years. ‘= Importantly, given the significant intangibles ($5.4bn) recorded as part of the Foster's acquisition, amortisation charges are very high at over 10% of sales ‘+ Inthe medium term, we expect volume to remain under pressure in Australia but price'mix to continue to grow by low single digits to result in some revenue growth. We believe most of the $115m of AsPac South synergies will be generated in Australia, This will take EBIT margins in the country to high 30%s by FY20E or above ABI's margin in North America. ABI controls 44% of the global beer profit pool ‘© ABI is now present and, in many cases, is dominant in most ofthe largest profit pools globally. The market positions acquired by ABI through the SABMiller deal provide attractive long term plays in Colombia, Peru and a number of African countries, including South Arica. ‘© Our analysis shows that EBIT per hl is already very high Australia and Colombia at $58 and $55 respectively; ahead of US Imports ($47) and Canada (S48). In Peru beer EBIT per hl is at $44 only slightly below Canada,oral Dillon Europe Equity (aaa rise 580s so onoder 2016 formal cillonpnorgan com JPMorgan CAZENOVE Valuation We value ABI primarily on a discounted cash flow basis, but also compare its current valuation to large cap global staples peers, keeping in mind the growth rate as well as, dividend and FCF yields. We look at these in turn below Our DCF-derived price target is €119 (Our DCF-derived December 2017 price target is €119. We apply a WACC of 6.7% (which was the cost of capital we applied to ABI on a standalone basis) and use a perpetual growth rate of 1.7% to reflect the higher growth potential of SABMiller's acquired operations. ‘Table 2: ABI DCF valuation $ilion renee —_pomE aE se oe Wasa ‘soe SEAGe—Gz380 eda ——eBda1 TH. 71.698 Seat orouth 22% AT 48% 45% 40% 25% parsing prof aso 70788 22057 mags 25938 wie 516 Margin Jer 61% 35.9% 365% 31% 0% Tax ae Add Wild 4880 sas sat Taxrat en EBITA 161% 170% 184s farm 8M BTR 18TH NaH BT NoPAT $s007 $688 7975 ams 207) 710067 2ias Deprecaton aan ad 453 520855585599 SOTS a5 BM Wacke 15% 15% TA 70% 78% «BOK «BUR «BOH. cari sie? 5355-5102, sie 5592569050558 Yisbs 2% 0% Bas 20% «BOK «BOK BOOK «BON. rng espa foo 8000 an wea TS ‘sake 10% 10% 088% 06% 06% 6% 08K 88H. cash Fow for OCF ssts2 165267006 mw 21068 aa aater e470 Timing 1 2 3 5 6 7 8 8 0 Poat tx acount cate Sm 8M BT BTH«8I% ATH. BTK. BT Value mutipie eC PVeteasiiow Mies 94523 Hos HODES sth aa7 87 AMS 2805 Popatial growth % 70% Tena aliph ‘at 142003 2778 Tota frm valve atest aif" MY of Aerts Equty Shares nse (m) Imp value par share (6) USDIEUR rat Implied val Ccrrent snare price UpsidlDDownside Suc LP Magan eins 010 ‘Our WACC is derived by cost of debt of 2.8% and cost of equity of 8.4%. We use a risk free rate of 2%, market risk premium of 7.5%, beta of 0.85 to arrive at aur cost of equity. For cost of debt, we use a gross debt coupon of 3.4% reflecting the blended cost of debt (ABI and SABMiller standalone as well as incremental funding cost) and tax rate of 19% on EBIToral Dion (aaa rise 580s formal cillonpnorgan com ‘able 3: Global stapes valuation metrics so onoder 2016 JPMorgan CAZENOVE In the medium term, we expect revenue growth of mid single digits (underpinned by volume growth and EM inflation), which we fade down to 2.6% by 2026. In our explicit forecast to 2020, we expect EBIT margin expansion of 440bps, primarily driven by synergies. Over the long term, we expect leverage to the bottom line 10 result in 20bps EBIT margin expansion from 2021 to 2026. We expect eapex to sales of 9.5%/9% in FY17E/I8E reducing to 8% in the long, term, which we believe is enough to fund .2% volume growth, Fastest growing large-cap global staple reflected in valuation ABI’s acquisition of SABMiller has led to higher volume growth of 2% versus an average of 0.6% between 2010 and 2015. However, we expect organic revenue growth to be slower, a ¢.5%, between 2017E and 2020E versus 6.2% between 2010 and 2015, due to the price/mix drag from Afica (¢.50% of group revenue/hl) as well as slower growth in Mexico and LatAm South. Similarly, we expect slower organic EBIT growth of c.8% between 2017E and. 2020E versus ¢.10% between 2010 and 2015, despite the incremental synergies, with the very material tailwind from Mexico (primarily €1bn of synergies) behind us and as the base has nearly doubled ($18.6bn in 2017E versus $10.3bn in 2010). At the EPS level, we expect growth to accelerate to an average of ¢.14% between 2016E and 20208 versus 11% between 2010 and 2015, primarily driven by de- gearing. We expect ABI to grow faster than global large-cap staples peers in the medium term as detailed in the table below. However, we believe this is reflected in its valuation premium to these peers. FCF yield of 4.4% in FY 18E is below global peers at 4.9% Wi Cap FE EVEBIDA _EPSgrowh WTERTGECAGR PEG OWvidendyesd FOF yea Usom Ee TE 0E_TE10E_—EPS EBITDA aoietoc ATE MRE TEE aT Hiss sax Ze Task Tae 0a TOR Ce 35K 87H Tam aah Heloken “43660 18Axk =k TOK KTH OHNO SKK 2AM 27H OM SAH Daye GOH Dk TSK TEMS TOM OK Dk 29% ATH AK SOW. Perna Read sagas Wk 1x12 TH OK kK RTH ABH OH Carter a8 Wk eB 12% HOH 2TH 25K 5H ocala 18,108 ia 187k tee TBH k2HK BRK AAR aN Poprico 152008 1M 1TH BKK BOHR SIH OH Neste 238067 ax Wok GK EK k AIK BDH ATH 5K Unilever 138162 ax ee TOOT 2k OAK ATK AIM ak Monde 66406 ao SMe 12TH dk TAN TBH DOH ABH ‘Od 102388 Ne OTT DTK 23H IG a Rockit E57 Pik 18k 18k kK 25k 22K 2K ATH BN Cofale R128 Bh a rH EK 2k 22K 24K TOK AIK P46 0.285 ok Mk THe ATK B3H MBH TN Philp Moris s4h58 time hae kASK ABH A8H H in rage we 9% me Ok BKK 2k ADH ASK SAK BK gars 114211 va ak Ted ATH ADK BOHN Weighted 2 average tillon __2icte 195 142e 19d 102% 82H 02TH AAS eur: Crean dl Bhim, Mann inaKomal Dion (420) T1343085 Komal ahllnemorgan.com ‘0 October 2016 JPMorgan CAZENOVE Table 4: Global staples sales, EBIT and EPS growth forecast Sale, ear oe awe aoe ase 2a 20m ae __“zve___ zoe aT 4a 28% are 28% SIS TH TN% 25% 2.2% Heinen tae 20% am fee Be GBH. am Ie a8 Diageo 35% TAS a8 cn 1% 13% 8K Pemes Read 19% 2% 34% 20% 28h aT 40m Sah 8a carer me 27 23% As Teh ba 49% oe baw. coca Coa 59% 158% 12% 26% 28 ABH 4% AI 73% Pepsico a3 33% 35% 24% BBR SB 50%. 90% Neste 1% 28% aK 25% 43h Bou, 11% 5%. Unilever 5% Am a8 2m Te BT 18% 78% TA Mondelex 20% 15% 13%. Wom BK BK ame ta 18am, Lora ame 52% 45% 4% BO TAM 49% Tah TAN Recht wos% Te 40K 1se% 02% SH mse tte 82 alate am AI 33% 2h TR 58 1 N78 PG 7% 2K aK. 5% 30% GOW 5% TA 75% Philp Moris ome 6am 59% 05% TO 78% 13% 77% 8 ‘ia 2% 28% 2%. ri am aah Ta BATS wsx a8 45% a sama asm Sue: Carpary dla Borba, LP. Marg ene Dividend growth to be constrained by de-gearing ABI continues to target net debvEBITDA of 2.0x as an optimal capital structure for the long term, but has given no time frame for when this will be achieved. We forecast 3.3x net debt to EBITDA by FY20E from 4.4x in FY17E. Figure 1: ABI de-gearing profile ox 60 50 400 a0 20 10 om ee ee ee ee Sous Company aa, LP. Megan sits ‘We currently forecast an ABI dividend of €3.60 and $4.05 for FY16E. This implies no growth from FY15 and a payout of 100% in FY16 versus 76% in FY15 and 65% in FY14. Bloomberg consensus expectations are for FY16E dividend of $3.98. In the medium term, we expect dividend growth to be constrained by de-gearing, which remains a priority for ABI. We expect dividend growth of 5% in FY7E and FYI8E, with constant payouts of 89% and 83% respectively. From FY19E, weKomal Dion (420) T1343085 Komal ahllnemorgan.com Europe Baty Research J.PMorgan CAZENOVE expect dividend growth of high single digits to low double digits in line with EPS growth, implying payout of 81%, Figure 2: ABI dividend payout trend and forecast 20% 100% ao oo 0% 20% o% 2508 2008” z010 zott "2012 2013 2ON4 2O18 AMIE ZOITE zOHBE Z0I¥E 20206 Sse Company la. Man eit Key risk to rating ‘The key risks that, in our view, could keep our rating and target price from being achieved include the following: 1. Any significant volume growth or decline in key markets, notably the US, Brazil and Mexico. 2 3. Significant further volatility in key currencies, notably a weakening BRL, ZAR, COP, and commodity inflation.oral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com Recap of the transaction 18.2x EBITDA multiple paid for SABMiller (On our estimates, post agreed divestures net of tax, ABI has paid 18.2x one-year forward EV/EBITDA for SABMiller versus a multiple of 16.2x indicated by ABI when the transaction was agreed by the key shareholders in November 2015. Post synergies and disposals, we estimate ABI has paid a forward EV/EBITDA multiple of 15.6x. ‘© ABI has completed the combination with SABMiller in a transaction valued at $$93.2bn post disposals, The cash consideration was $73.1bn with 326m restricted shares issued to the controlling shareholders of SABMiller ~Alltria and BevCo, ‘The total EV was $103.8bn. ‘© The transaction closed on 10" October 2016 and ABI will consolidate the bbusiness from that date ‘© The deal was structured with both debt and equity through a Partial Share Altemative (PSA). Election for the PSA was primarily for the major shareholders of SABMiiller, ie. Altria and BevCo, who together owned 40.45% of SABMiiler. Under the PSA, shares provided in the enlarged ABI are restricted and thereby not traded on any stock exchange and subject toa S-year lock up. The PSA was ‘made available to a maximum of 326m new ABI shares equating to 41.6% of ‘SABMiller’s shares. The new shares rank pari passu with existing ABI shares for dividends and voting rights. ‘© The disposals of SABMiller’s 58% investment in Miller-Coors and 49% in CR. Snow, Peroni, Grolsch and SABMiller’s major European assets are expected to take place soon after deal closure, The disposals of all the above, except SABMiller's major European assets, have been pre determined with binding offers from acquirors, In total, the pre determined disposals are expected to raise 816.4bn of cash pre tax and $11.7bn post tax. ‘© The deal is being funded by $61.9 of bonds issued in QII6 as well as senior facilities. ABI had already indicated an average coupon of 3.2% and weighted average maturity of 13.7 years on the bonds, ‘© ABI expects cost synergies to be $1.4bn in addition to $500m of savings still to be delivered under SABMiller’s existing programs. Our detailed analysis of the quantum and delivery of synergies is included in the following section, ‘© ABI continues to target net debt/EBITDA of 2.0x as an optimal capital structure for the long term, but has given no time frame for when this will be achieved. We forecast 3.2x net debt to EBITDA by 2020E. ‘© ABI indicated that it would consolidate $11.9bn of revenues and $4.2bn of EBITDA ona pro forma FY16 basis. We assume a 20% tax rate in FYI7E on the combined earnings. SABMiller's tax rate was 26.3% in FY16 while ABI's was. 19.1% in FY15. ABI has guided to a blended tax rate for the combined entity, but this guidance does not include potential benefits from funding and tax. efficiencies,oral Dillon Europe Equity (aaa rise 580s so onoder 2016 formal cillonpnorgan com ‘Table 5: SABMiler acquisition equty and enterprise value GP and USO mion JPMorgan CAZENOVE SAB shares New ABlaharen ah Shares vale Options Toa Tahar mas 7502 7 lez Psa: ‘i 230 08 2008 20282 mass Bevo 5 ‘09 joe 10597 nats TotlPSA 88 a 3082 sowie sist Total equity vale, GBPm aaa aso T3002 Adjustvort or uaheeged porn, USO 13) Total equity value, USD 03 ante (7m) ise Non quayng poten of hedge ca) Totloquly vate 109587 Nat det, USD aera EV pre divest 2,178 Divestres (post ta Nir Coos 7300) CR Snow (09 Poon & Goch (ea) Ev post divesturs, USOm ‘a4 EVIEBITOA,CY17 post synergis Pre dvestras 428 PoaiMC, CR Snow & Pro, Gch hoe BITDA,CY17 pre syeries Pre dvesires 182 Posi MC, CR Snow & Pro, Gren ade Sear: Ces Pern ee Major disposals ABI has made major disposals to satisfy competition authorities in various jurisdictions. These have i Juded the disposal of SABMiller's 58% investment in Miller-Coors and 49% in CR Snow as well as Peroni, Grolsch and major European operations of SABMiller in Poland, the Czech Republic, Hungary, Slovakia and Romania, The pre-determined disposals include all of the above except SABMiller's major European assets. In total, pre-determined disposals are expected to raise $11.7bn post tax ($16.4bn pre tax) and will be sold on a combined CY 16E. EV/EBITDA of 11.3x, on our estimates. We expect these disposals to take place in the coming few weeks/months. ‘We detail the pre-determined transactions in the table below, Table 6: Summary of disposals Smlon ‘Asset doposed Pretax price, $m Taam TZ CRSrow ‘600 i Groeh 288 sian Posttax Eat CYHRE EBITDA em 7300 TH ‘400 ait 00 1 4100 14st ‘CYIRE EVERTIOR multiple on pro tx price or Sh 0 imeoral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com us Molson Coors is acquiring SABMiller's 58% economic and $0% voting interest in MillerCoors for $12bn pretax and $7-5bn post tax. This deal includes the sale of the global Miller brand (sold in over 25 countries), related trademarks and IP, and the Import and distribution of other key brands such as Peroni and Pilsner Urguell in the us. (On our estimates, on a CY1GE EBITDA of c. $n for the 58% stake in MillerCoors owned by SABMiller, the EV/EBITDA multiple was 11.9%. China ABI is selling SABMiller’s 49% stake in China Resources Snow Breweries (CR Snow) to China Resources Beer Holdings, which holds the remaining $1% stake. ‘The disposal is being made for $1,6bn pre tax ($1.4bn post tax) and did not require an EGM, given approval by the majority shareholder and board. On our estimates, on a CY16E EBITDA of $31 1m for the 49% stake in CR Snow owned by SABMiller, the EV/EBITDA multiple was 5.1. Peroni and Grolsch ‘On 19" April 2016, ABI accepted a binding offer from Asahi to acquite Peroni Grolsch and the Meantime brand family and related businesses in Italy, the ‘Netherlands, the UK and interationally (excluding certain US rights). Asahi acquired these brands for €2.Sbn ($2.884bn using @ EUR/USD rate of 1.13 on 10" Feb 2016 when the sale was agreed) on a debt free/cash free basis On our estimates, with the assets expected to generate $131m of EBITDA in CY16E, the EV/EBITDA multiple was 22x. ‘SAB Europe — Poland, Czech Republic, Romania, Hungary, Slovakia To satisfy European regulators, ABI has agreed to dispose of SABMiller’s operations in Poland, the Czech Republic, Hungary, Slovakia and Romania. These, along with Peroni and Grolsch, comprise the bulk of SABMiller's $589m EBIT generated in FY16, There has been recent press speculation about bidders for these assets and we ‘would expect ABI to dispose of these in the coming months. LatAm assets In addition to the above disposals, ABI and Ambev exchanged assets in LatAm on 13" May 2016, ABI tansferred SABMille's Panamanian operations to Ambev in exchange for Ambev’s operations in Colombia, Peru and Ecuador. (On our estimates Colombia, Peru and Ecuador were not meaningful to Ambey, given 0.5% market share in Colombia and 4.4% each in Peru and Ecuador. We estimate that the other countries in the Ambev Latin America South division (Argentina, Bolivia, Paraguay, Uruguay and Chile) likely represent nearly 97-100% of this, division's profit. In total, we estimate Ambev sold c.1.01m his in Colombia, Peru and Ecuador in 2015. In comparison, SABMiller bas published that it sold 1.9mm hls of beer, representing 69% market share, and Imn hls of Pepsi brands and other soft drinks in Panama in 2015.oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE Comparable multiples (Over the past few years, brewers have been acquired for EBITDA multiples of between 9x and 16x as detailed in the table below. This includes a variety of acquisitions in emerging as well as developed markets. The scale and geographi exposure of the SABMiller acquisition however is unprecedented, Teble 7: Key major brewing transactions over $0.55n involving European ited brewers TOR Korea Tani Honekenuntrow wd 4 fara 6 HenekoritPs Now12 5 ABINodele M2 6 AnBestoND Ape a ‘Siafev poeta " AEFESSAB eet 8 Soptt 8 a8 KriSehineool apt 6 55 HenetenFENSA santo " 4 Krintion Nahin | owas a a3 SABNiePolon rinoty May-08 5 iW ashing mnoty Age ” ar InBowanneare usch 8 1 22 Cersberg and Heineken SBN Janae “ 60 SBNeGroh Nowa 5 w Ingewauilnesminosty ors 0 12 SaNFosior band A908 2 05 InBewFujan Sern sana 2 ar Henetenivan Trsaov dogs " a8 SAalBavae "uso “ 48 InBewkorea mney Jana 4 ag InorrewSur are hope 2 a5 Halsoncaor ‘bot 0 80 Inkerawitmew Marae " so Corbeil take Nawte 8 35 Casbertilten Jana 8 a5 Inetrewkores| Deons 1" 08 Irerrewispaen Sop3 a SAB Peron y-03 a Heiekon@Bx< Way-03 21 InetrawiGite Nowe ae SBN May-02 56 Walsnier Mart? a8 58 Nawal Jan 12 Cearating Desat 7 SABBeW Now: a5 Ireraremiecks Aut 18 Corba lsehssen Now as Ineremidaee duno 35 Corsbargrla Way-c0 13 S8NKronanurg aeoo at SABPIbnr Ural oc8 a8 HenetenCuzzamgo nt 2 a8 We estimate that most ofthe key brewing transaetions involving European brewers have or will deliver retums above cost of capital after five years. Notable exceptions are due to significant currency headwinds diminishing returns to a material extent, particularly for the SABMiller acquisition of Fosters in 2011, and through ‘unexpected volume declines notably across Europe. Additionally, in recent years, ‘multiples paid have been high, lowering retums lower despite high level of synergies,oral ilon Europe Equity (aanzp) 7243805 so onoder 2016 J.PMorgan CAZENOVE ‘Smalenoraerersanam We estimate ABI has paid 18.2x EBITDA multiple for SABMiller. We estimate the deal ROI post synergies in FY20E will be 7% in line with our previous assumption of SABMiller’s WACC (albeit it could arguably be higher for this transaction given disposal of major developed market assets). Figure 3: Returns on most beer transactions have exceeded WACC. Heineken APB *81-Mede ABN Foxes oiakon-FEMSA Coneza 48-AB Helnoon-S8N ‘casbarg- 880 ‘ABYier-Bovara tran Ander Shakir Pe Heron 846 oaan Russia ‘Aster ier ‘SABtier- Coal Amara 481-Gorany 81-uK Saat -Caech Heineken -Cascango 0% 5OKSCTOUSCTSOK NOSSO. Rol awace Souce Company a. Moran eatoral ilon Europe Equly Research (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Gearing up is working again Gearing up the balance sheet on lowerate debt has become the biggest generator of value in the deal. This isa bigger driver of earings growth than synergies, in our J.PMorgan CAZENOVE view. The alternative of buying back equity, as we had previously suggested, would have had a much lower impact on the balance sheet and there was no other similarly sized feasible target. ABI has financed the transaction through £61.9bn medium to long term notes at an effective interest rate of 3.2% and average maturity of 13.7 years as detailed in the table below. The remainder has been funded by senior bank facilities. “Table 8: ABI bond istues to fund the transaction Soilton ud Da rage) Pana Tarot rm ean a0 e000 10% 1 2elan6 2 170 orm 3s Mar 28 as 60% 0 Tota a1918 320% 4 Sour: Caray dla ABI has taken advantage of the prevailing low costs of debt and issued long-term notes with 62% at 10 years and above for the $46bn of notes issued in January. The average tenure for these notes is 14 years. Figure 4: ABI $46bn notes maturity By wy 2% 2% ny 13% ‘oy 2h ‘soe Compary data In November 2015, ABI had committed senior facilities totaling $75bn related to the acquisition of SABMiller. Of these, the DCM Facility A and B (together $30bn) and the Term Facil ‘A ($25bn) were cancelled post the $61.9bn notes issued in QI 2016. The Disposals Bridge Facility of $10bn is expected to be paid down on the sale of SABMiller’s 58% stake in MillerCoors and the Miller brand globally (agreed at $12bn) and other disposals. This currently leaves ABI with $10bn of senior Disposals Bridge Facilityoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Table 8: ABI's committed senior facilites for the acquisition of SABMiler Shion Fae ‘Amount — Tem “Tem Fay "253 year pla 1 yea enon cplon Tem aay 8 10 5year Disposals Bg Factty a0 tyeor Brageto CesnOCM Feely A 15 year rage o CassDCM Fach 8 38 41 year ps1 yer extension option Tou 75 _upto 18 mths aval of funding ‘Sor Comp le ‘The cash cost of the acquisition was $73.1bn versus $61.9bn debt raised as detailed above. The remainder will be funded by the sale of SABMiller’s 58% stake in MillerCoors ($12bn), Peroni and Grolsch (together $2.8bn), SABMiller’s 49% stake in CR Snow (S1.6bn) and SABMiller's European assets in Poland, Czech Republic, ‘Hungary, Romania and Slovakia (undisclosed). na standalone basis, ABI is guiding to an effective interest rate of 3.5-4% for FYIGE. The incremental debt was issued at 3.2% and SABMiller’s cost of debt was 3.2% in FY16 (down from 3.5% in FY 15), implying total effective rate of debt of 63.4% for the combined entity. This compares to cost of equity of e. 8.5 SABMiller’s debt is predominantly over 5 years and in USD as illustrated in the figures below. Figure §: SABMiller debt spit by maturity, March 2016 Figure 6; SABMiller debt spit by currency, March 2016 yeas zag CoP mo a payee ae us es ne ‘esyean 1% Sears: Company dla Sauce: Company aa ‘The cost of pre-funding the transaction amounted to $450m per quarter or ¢.$1.2bn in total ‘The rating agencies rated the new debt at (P) A3 by Moody's and A- for Senior Unsecured as well as A2 for short term by S&P. The Moody's rating on the new debt is one notch below ABI's existing debt rating by Moody's, which was put under review. Additionally, the Moody's rating is on the assumption that the deal closes for the anticipated $108bn (funded by equity and debt) and the simultaneous sale of SABNMiller’s stake in MillerCoors,oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE No transformational deal in the horizon ‘© ABIhas stated that de-gearing will be a priority inthe short term with an ideal long-term capital structure of 2x net debt to EBITDA. This implies modest dividend growth in the short term. 1, Key acquisitions/divestitures, in our view, are: Castel, in which SABMiller hhad a 20% equity stake. We value Castel at $30bn and the net cost to ABI at $22bn, SABMiller also has several other minorities in Africa that ABI could acquire. Anadolu Efes, which primarily operates in Turkey and Russia and has a 50% stake in the Turkish and Central European Coca-Cola bottler Coca-Cola lcecek. The market capitalisation of Anadolu Efes is currently $3.6bn, with SABM's 24% equity stake therefore valued at ¢.$900m, 3. Coca-Cola and Pepsi bottling, We believe there will be discussions around ABI’s ability to bottle both Coca-Cola in Africa and some in Central America, while also bottling Pepsi in South America. We estimate disposal of SABMiller's controlling stake in CCBA would result in 3% reduction in ABI's EBIT. Importantly, the disposal could reduce ABI’s group volume growth by -S0bps to 1,5% versus 2% currently forecast in the medium term, 4, Buying out unlisted shares in 5 years time. Altria and BevCo together now ‘own 16.5% of the enlarged ABI through unlisted shares awarded under the PSA. A buyback of these shares post lock up in 5 years time would amount to some $42bn at today’s share price. Assuming a 3% cost of debt would make this acquisition 11% accretive to ABI in December 2017, discounted back at a rate of 6.7%, However, a sale of shares for cash would trigger significant capital gains tax for both Altria and BevCo. Therefore, we are uncertain whether a buyout of these shares would be a feasible option, 5. Other possibilities include Vietnam, which ABI is currently bidding for. In ‘Vietnam the largest state owned brewer, SABECO, is valued at $1.8bn, However, as reported in Bloomberg on Sep 16, there are a number of bidders other than ABI, including Heineken, Asahi, ThaiBev, Boon Rawd (none have commented publicly on the article), that potentially are keen on the assets, which could drive up the value ofthe business. ‘© Therefore, with the above transactions taking precedence and with the balance sheet at net debt to EBITDA of 3.3x by FY20E, we believe it will be a long time before ABI contemplates its next transformational acquisition. Potential acquisitions/divestitures In the short to medium term, we expect ABI to utilize its balance sheet to acquire Castel, in which SABMiller had a 20% equity stake, minorities in Afiea and potentially major beer assets in Vietnam. We value Castel at $30bn and the net cost to ABI at $22bn. In Vietnam, the largest state-owned brewer, SABECO, is valued at $1.8bn, However, Heineken, Asahi, ThaiBev, Boon Rawd are also reported to be keen on the assets (source: Bloomberg Sep 16), which could drive up its value, SABMiller had a 24% equity stake in Anadolu Efes, which primarily operates in Turkey and Russia, and has a 50% stake in the Turkish and Central European C Cola bottler Coca-Cola leecek. Finally, we believe there will be diseussions aroundferal Europe Equly Research J.PMorgan Cazenove formal cillonpnorgan com ABI’s ability to bottle Coca-Cola in Africa, while also bottling Pepsi in South America. Castel SABMiller owns a 20% equity stake in Castel’s African beverages businesses following the deal concluded in 2001 where SABMiller swapped a 38% stake in its Arica operations outside South Africa. Since then, the two partners have also jointly invested in a further five new markets (Algeria and Morocco 60% Castel and 40% ‘SABM) as well as extending their presence in the original combined platform, though the equity participation of each partner in extending the platform has varied with each transaction. In total, the alliance covers 21 markets (with SABM active in 15 markets directly, as well as in Zimbabwe through the Delta Corp associate stake). In 14 markets, the alliance in Afica is also a Coca-Cola bottler In January 2012, the alliance was revised via the combination of the operational management of the Castel and SABM businesses in Nigeria and Angola, with the ‘Nigerian businesses being managed in future by SABMiller and the Angolan businesses being managed by Castel. Amendments were also made to the strategic alliance agreement to provide for improved sharing of best practice and technical expertise and a more precise methodology for the existing mutual pre-emptive rights over the groups' respective heverage operations in Africa (excluding South Africa ‘and Namibia) CCastel is a privately owned French company with interests in wine in France, as well as beer and soft drinks in Africa following the acquisition of Brasseries et Glacieres Intemationales (BGI) in 1990. Initially, Castel was concentrated in Francophone West Africa, which complemented SABMiller’s historical focus on Southern and East Aftica. Given the longer-term growth opportunities from increasing consumption driven by increasing wealth across beverage categories in Africa, we think there would be a powerful strategic logic in time for ABI to secure a bigger slice ofthe growth in the Castel businesses. ‘We note prior press speculation that SABMiller might be interested in acquiring Castel’s equity interest in the alliance (Reuters Jan 9 2012, WS Jan 22 2014), though we note that neither partner has made any public comment on this speculation. We believe that a full combination with Castel/BGI, SABMiller’s joint venture partner in Africa (ex South Aftica), would offer very significant strategic atactions. ‘We would expecta positive impact on ABI’s volume growth and significant scope for both cost and revenue synergies across the combined platform. We estimate total CY 16E Caste/BGI EBITDA of $2bn (including Castel’s share of the JV's in Algeria and Morocco). In valuing Castel, we assume a multiple of 15x. EBITDA, based on comparable quoted A rican beer stocks. This would put a value of $30bn on the total Castel/BGI business in Africa and some $24bn on the 80% not owned by SABMiller. We estimate the value of CasteV/BGI's 38% stake in SABMiller Africa ex minorities at some $2bn, implying a “net” cost to ABI of $22bn.oral Dillon Europe Equity (aaa rise 580s so onoder 2016 formal cillonpnorgan com JPMorgan CAZENOVE In FY16, SABMiller recorded an impairment charge of $372m against its associate investment in Castel in Angola and a further $110m impairment as SABMiller’s share of Castes impairment. The operations in Angola have been materially scaled down following significant macroeconomic headwinds, material devaluation of the currency and lack of accessibility to hard currency, SABMiller also made a provision ‘of $20m for loan guarantees in Angola, Additionally, SABMiller had significant (between 20% and 40%) external minority shareholders, and it had associate stakes in businesses in Zimbabwe, Anadolu Efes In October 2011, SABMiller swapped its Russia and Ukrainian assets valued at $1.9bn for a 24% stake in Anadolu Efes. The Yazicilar and Ozilhan families along with Anadolu Endustri (Anadolu Group) together currently have a 43% equity stake in Anadolu Efes, with 33% free float. Anadolu Efes has beer operations in Turkey, Russia, Ukraine, Kazakhstan, Georgia and Moldova. The company also holds a $0% stake in Coca-Cola Icecek (CCI), the Coke bottler in Turkey, Central Asia and Pakistan. CCI is also listed on the Istanbul Stock Exchange and currently has a market capitalisation of $3bn; valuing Efes” stake at $1.52bn. CCI is forecast to have net debt (Bloomberg consensus) of $700m at December 2016. ‘The past few years have been volatile for Anadolu Efes due to trading deterioration in Turkey and in Russia; particularly post the integration with SABMiller, which did not go as initially planned, The hike in CY13 was due to the full consolidation of Coca-Cola Icecek (from 50.3% consolidation) per Turkish regulations. Anadolu Efes” performance improved in CY 14 driven by better trends in the beer business (both Turkey and Russia) offsetting pressure on profitability at CCl. ‘Table 10: Anadolu Efes summary financials, $ milion ‘ado Eas FY eV) ‘SABMY Waray ovw orn cy cya evi ovis _ cyte Bet evga YM rvs evt6e Tae “Tae ear Eos kan 4g a7 3586 fae 8008 tae A763 aA 3,720 EBITDA e500 ses S65 TD 08 se STB Gh 196% 199% 158% 16TH 183 TOK 28% ON SK 159% TERK TSH me me bMS aa) mean 8 166% 27H OI OTK OK OB 186% 114% BIR 8TH 8TH ota Ce en ee ee ee ee ee T% Th kB THOTH TH T% Th oH 5% HSH TRS % Bh am 8H 8% WG BR BK EN 2% oe sek 2% IO Suc Barba Anadolu Efes’ performance is largely reflected in SABMiller's associates in Europe. SABMiller other associates in Europe were Grolsch (UK) in which SABMiller had a '50% stake and Intemational Trade and Supply Ltd (incorporated in the British Virgin Islands), in which SABMiller had a 40% stake.oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE Table 11: SABMiler Europe associates performance, FYI2FY16 $nilon ria Fs Fig Fis ie Sale @ 008 Tat Tz a7 EBITDA i ‘et ie "a ‘7 arpa max Ho 152% 101% 85% rst 1 78 8 as a arg 120% 18% 6% 10% 10% sa 5 105 1% ra Py Seales % 10% % m% % Growth Sale wos 28% 3% 17% EBITDA 001% 0% 0% 20% est 81% a oe 1a ‘Sou Conny a ‘The market capitalisation of Anadolu Efes is currently $3.6bn with SABM's 24% equity stake therefore valued at c.$900m. Anadolu Etes has forecast net debt (Bloomberg consensus) of $I.1bn at December 2016, ‘SAB recorded a $63m impairment charge on its 24% stake in Anadolu Efes in FY1S, due to the deterioration of trading conditions in Russia and Ukraine, Coca-Cola and Pepsi bottling ABI is one of the largest PepsiCo bottlers globally with operations across LatAm in Brazil, Argentina, Bolivia, Uruguay and the Dominican Republic. The bottling ‘agreement in Brazil expires in 2017 and will be automatically renewed for an additional 10 years. SABMiller has minor Pepsi bottling operations in Panama. SABMilleris now the 10" largest Coca-Cola bottler globally, through its majority stake in Coca-Cola Beverages Africa (CCBA). CCBA began operations in July 2016 and covers nearly 40% of Coca-Cola bottling in Atria with operations in South Africa, Kenya, Ethiopia, Mozambique, Tanzania, Uganda, Namibia, Comoros and Mayotte. CCBA is currently (post Phase I) 54% owned by SABMiller, 34% by Gutsche Family Investments and 12% by The Coca-Cola Company (TCCC). Phase I is expected to be completed in the next 12 to 18 months and will include SABMiller's soft drinks bottling operations in Swaziland, Botswana and Zambia Post Phase II, SABMiller was expected to own 57% of CCBA, The Gutsche Family 32%and TCCC 11%. CCBA has S-year renewable bottling agreements with TCC, under which TCCC supplies concentrate to CCBA, while CCBA manufactures, packages and distributes the final product in its designated markets. The current bottling agreement with TCCC runs out on Ist July, 2021 Castel is also a major Coca-Cola bottler in Africa; primarily across Francophile Africa, where its beer operations are concentrated. Heineken is Coca-Cola's bottler in the DRC, Congo, Rwanda and Burundi. CCH bottles Coca-Cola in Nigeria. We believe there will be discussions around ABI's ability to bottle Coca-Cola in Africa, while also bottling Pepsi in South Americaoral ilon Europe Equity Res (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Figure 7 Cocs-Cols bottling in Atia is dominated by CCBA and Castel Castel CCBA post completion Heineken CCH Seure: Compara We estimate CCBA generated revenue of $2.6bn, EBITDA of nearly $600m (22% ‘margin) and EBIT of just over $400m (16% margin) in 2015. Disposal of SABMille’s controlling stake in CCBA would therefore result in €.3% reduction in ABI's EBIT. Importantly, the disposal would have a more pronounced impact on ABI’s volume growth in Africa with Coca-Cola volume growing at high single digits versus beer volume at low to mid single digits. This could reduce ABI’s group volume growth by -SObps to 1.5% versus 2% currently forecast in the medium term,oral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Buying in unlisted shares Altria and BevCo together now own ¢.14.5% of enlarged ABI through shares. awarded under the PSA described above, These shares are unrestricted and are locked up for 5 years, post which they will be convertible to ordinary ABI shares. A buyback of these shares would amount to some $42bn at today’s share price. Assuming 3 3% cost of debt would make this acquisition 11% aceretive to ABI in December 2017, discounted back ata rate of 6.7%. However, a sale of shares for cash would trigger significant capital gains tax for both Altria and BevCo. Therefore, we are uncertain whether a buyout of these shares, would be a feasible optionoral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE Limited upside and growth sensitivity to synergies ‘© Intotal we expect synergies to amount toc. $1.65bn, made up of $1.4bn enlarged ABI synergies and $250m of SABMiller’s remaining c.$500m savings. We apply haircut to SABMiller’s announced targets due tothe sale of the European assets to satisfy the European Commission's competition concerns. We believe SABMiller’s European assets were a key driver of its cost-savings program. ‘© We expect the majority of synergies to be generated in COPEC (Colombia, Peru and Ecuador), Aftica and Australia. We expect limited incremental synergieslefficiencies in the US, Mexico, Brazil, Europe or AsPac North (primarily China and South Korea). Based on the split of savings and underlying growth, we would expect COPEC EBIT margins to expand by 1200bps, while ‘Africa and AsPac South (mainly Australia) expand by 1000bps between FY 16E and FY20E. Importantly, all other things being equal, the COPEC margin would increase to 48.2% by FY20E, which is ahead of the 46.6% margin ABI’s Brazilian beer business generated in FY, Margins in Africa would match ABI's North America margins. ‘= As with cost savings, we believe that working capital savings at SABMiller ‘would be much more challenging to achieve than in ABI's prior deals. We expect, Stbn of eash flow savings to be the ceiling. This would take SABMiller’s core ‘working capita to sales to -3% versus 5.6% in FY16 and ABI's -12.4% in FYIS. ‘© We expect enlarged ABI to generate significant revenue synergies, but we expect these to be very gradual, particularly in the short to medium term. The first phase of revenue synergies would involve replacing, rather than adding to, Miller Lite, Miller Genuine Draft, Peroni and Grolsch brands in LatAm and Australia, in our view. In Africa, we do not expect material revenue synergies inthe short to ‘medium term. We have included an clement (¢.$400m) of revenue synergies in four estimates for ABI's central business, GEHC. ‘© Overall, the level of synergy does not have a material impact on earnings growth in the out years. We estimate enlarged ABI will grow earnings at high single digits in FY20E (post full synergy capture) with a range of $1,65bn to $2.5bn total synergies and cost savings, On this synergy range, average annual earnings ‘would be between 14% and 15.5% between FY16E and FY20E, on our estimates, Table 12: Enlarged ABI earings growth sensitivity to level of synergies mr FTE FRE FE FYTSEDIE EPSCAGR i ca ory Te maa 00 25% 135 1% me 2% 200 2% 18% m4 we Mm 2500 2% 145 1% 155% SABMiller's saving program SABMiller has an ongoing Cost & Efficiency Programme (CEP) to save $1,050m of costs by 31" March 2020, The company achieved $547m of cumulative savings under this program by the end of year 2 or 31st March 2016, These savings mitigated significant adverse transactional impact from currencies resulting in broadly flatoral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE reported margins. Over the course of two years ofthe savings program, SABMiller spent $105m to achieve these savings. On Sth October 2015, SABMiller upgraded its savings target under CEP to $1.0Sbn (on a $10bn cost base) from the initial $500m announced in May 2014. It expects the additional $550m (o arse from ils integrated supply chain, with 70% from procurement and 30% from manufacturing and distribution. Specifically, SABMiller intends to increase central procurement to 90% from 69% in March 2015 (46% in March 2014). The company is also in the process of rolling out procurement ‘operating models to inerease transparency and efficiency as well as driving, ‘manufacturing and distribution efficiencies based on best practices, Table 13: SABMiler Cost and Efficiency Programme $nilon “Renouned—AnnualnedConttotrgat ond savings achieve dats Ware 0 350 Sivarit oaets 1050 5 a0 ‘esos Company daa Table 14; SABMiler delivery of current costeaving program Snlion Saige Cotes est War DS sie 3 Mar 2016, 10 Prior to the CEP, SABMiller saved $500m under the Business Capability Programme (BCP) between FY11 and FY14 ahead of an initial target of $300m, ‘Synergies from the merger ABI expects to generate S1,400m of synergies by the end of four years following the completion of the deal, These savings are in addition to SABMiller’s $1,050m program described above and the company expects them to incur a one-off cost of '$900m. The S1.4bn of savings are split into the following buckets, 1, Procurement and engineering savings (25% or $350m). These are expected to be ‘gencrated by economies of scale in combined sourcing of raw materials, packaging and reengineering processes, Brewery and distribution efficiency gains (25% or $350m). These include ‘optimisation of the brewery, bottling and distribution footprint 3, Best practice sharing (20% or $280m) to reduce costs and increase productivity through implementation of programs such as Zero Based Budgeting (ZBB), 4. Corporate and regional headquarters (30% or $420m) are expected to be realigned resulting ina significant reduction of overlapping costs ABI expects the above listed $1 4bn of savings to be generated on the combined cost base of the two companies.Komal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 In total, we expect synergies to amount to ¢. $1.65bn, made up of $1.4bn enlarged ABI synergies and $250m of SABMiller’s remaining c.$500m savings. We apply a haircut to SABMiller’s announced targets due to the sale of the European assets to satisfy the European Commission's competition concerns. We believe that SABMiller’s European assets were a key driver of its cost savings program, Additionally, the sale of the European assets implies potentially lower regional headquarters synergies for ABI. ABI has indicated that there will be some CEP loss through disposal of SABMiller’s Central and Eastern European assets but has not quantified the amount, ‘The $1.65bn synergies plus savings equates to 13.4% of acquited sales. This isin line with synergies achieved from the Anheuser Busch (13.5% of acquired sales), lower than Modelo (15.6% of acquired sales) transactions, and higher than the 11% achieved from the Interbrew deal. We believe the Modelo deal enabled a higher level of synergy capture due to full control of the company in a single market with relatively strong inffastructure, For enlarged ABI, we believe there are some major impediments to surpassing synergy targets. These are: ‘© The lack of geographical overlap, particularly post the sale of the European assets, + The lack of full contro! over the assets, particularly in Africa where @ number of ‘major operations are with Castel (in which SABMiller had 2 20% equity stake) with other substantial minorities as detailed inthe following section. We would expect potential full control of Castel in the future to enhance the level of synergies. ‘©The nature of the Aftican “growth” businesses, where we do not expect ZBB can be implemented to the extent it has been in other more developed markets. ‘© South Attica, where ABI has already made concessions to the labour unions and ‘competition authorities that include no reduction in employees for five years following completion of the acquisition, Analysis of enlarged ABI synergies and SABMiller savings ‘We expect a majority ofthe synergies and savings to be generated in COPEC, Afica, ‘AsPac South (primarily Australia) and the central, GEHC, segment, ABI has {quantified the level of synergies by function forthe enlarged company and we have attempted to split these by geography, based on our knowledge of these operations and markets. We have also split SABMiiler savings by function and geography in the table below.Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE kdown of ABI synergies and SABMller cost savings by function and geography Sion Frage ABT aynargion ABM savings Tot Procure Bway ek Best Toul Procurement Supply Toul synergies ment stibuion practice cc chain SABIor pis ficiency savings Tr Avarea w o 7 © T 7 7 0 Male kmscas 5 ° 0 6 o a a 5 ua » 0 0 0 0 0 a 50 us 0 ° 0 0 ° o 0 » corEC 10 20 ws 5 109 © 0 ms, Europe 5 ° 5 5 o 4 ° 6 AsPae Noth 5 5 0 B ° 4 5 5 ‘sPac Sour 5 5 a 5 a 0 a 115 fea 50 00 50 8 « a 5 0 ‘GEC o o 0 x0 6 0 5 us Tota 30 30 200 wo 1" 6 Fe 1650 Sess spe 23% 28% 0% 0% Syrges and sings alt 21% 21% 17% 25% a8 1% 15% 0% eur: Cnpary dal, PW sna Figure 8: Estimated geographic split of $1.656n synergies and savings ide mecas Sous LP Maar etna In procurement, we expect @ majority of savings to be generated in Colombia, Peru and Ecuador (in COPEC), We would be wary of being over optimistic on procurement savings in Africa given the necessity of local contracts in a majority of, these operations. n the other regions, we expect some procurement synergies, given the scale ofthe combined business. We believe that enlarged ABI can optimise breweries and distribution footprint in COPEC, Africa and, to an extent, in Asia. In terms of central and regional headquarters, again we expect COPEC to be the primary beneficiary with some benefit in Asia and Africa, Implementation of best, practice of both ABI (ZBB) into SABMillers operations and vice versa, will, we expect, be a mangin enhancer forall regions.oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE In Affica, SABMiller already operates on EBIT margin of mid 20%s in line with largely single-market, near monopoly brewers in the continent such as East African Breweries. While brewery footprint and distribution could be optimized and ZBB can be implemented in SABMiller’s operations in LatAm and Australia, we believe any upside to stated synergies would be constrained by structural differences such as direct distribution, population distribution and pack type in the beer markets of Colombia compared to Brazil or Mexico, Outside procurement and best practice implementation, we expect limited synergies in Mexico, the US, Canada, Argentina and Europe given recent cost-saving efforts in these countries/regions. Based on the split of savings described above and underlying growth, we would expect COPEC EBIT margins to expand by nearly 1200bps and Afriea and AsPac South by c.1000bps between FY16E and FY20E, Importantly, all other things being equal, we estimate COPEC margin would increase to 48.2% by FY20E, which is ahead of the 46.6% margin ABI’s Brazilian beer business generated in FY15. ABI's beer operations in Brazil are among the most profitable in the world and we do not expect enlarged ABI will be able to surpass these profitability levels materially in COPEC. Additionally, margins in Africa ‘would match ABI's North America margins “Table 16: Enlarged ABI margin uplift post synergies and savings Srnion FYI6PF Frat Wagia ear margin Sales eat margin increas, Tori Arar 55 Ho 73.8 305 AT iH Mis Amereas ‘58 7% 507, 220 418% 18 aN 3588 223% shat 4958 83% a us 127 25% 3831 1598 40% % copec tam 65% 360 an 482% 1170 Ewope no 5% 2806 182 nak za AsPac Nath 4 9% m5 58 ‘spac South 48 29% mon 86 Dice 124 255% 6.05 2431 Pte 50 ene 28 13.0% 2510 a8 i 008 Tota seus ‘noe e507 ng08 Pa st? Overall, SABMiller’s group EBIT margin of 22.6% in FY16 was markedly lower than ABI’s 31.6% in FY1S. Adding the $1.65bn of synergies would take SABMiller’s margins up to 36% on acquired sales; well ahead of ABI’s. Given the structural impediments discussed above, we believe itis over optimistic to expect significantly higher synergies that will materially enhance ROIC, particularly in the context of an EV on acquisition by ABI of $108.5bn. Cash flow synergies expected to be c.$1bn While SABMiller has been steadily improving its core net working capital, its core net working capital to sales in FY16 was +5.6%; significantly higher than ABI’s at -12.4% in FYIS.Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE Figure : ABI and SABMiller core networking capital to sales 100% 50% 00% 0% 0.0% 8.0% FFF) FYS ‘=ABI_ wm SABI Sous Company ata, LP. Moran sates The cash conversion eycl also highlights how far behind SABMiller is compared to [ABI The difference primarily lies in trade payable days with SABMiller at 113 days or nearly 4 months versus ABI on 258 days or nearly 9 months. While there should be a material amount of savings here, we would be cautious of simplistically applying ABI's trade payable days to SABMiller operations, given some of the structural differences in SABMiller's markets discussed above. To be fair, however, wwe belive that enlarged ABI can probably apply North America and LatAm working capital management principals to COPEC and Australia ‘Table 17: Cash conversion cycle of ABI and SABMilr, FYOS -FY15, cays eA Saar Inve dys * 5 0 a BR aaye a M o a AP cays at as 18 ‘cash convrsion le a 0 7 2 1 Inveroy days 107 = 5 5 a 8 et AR daye 0 a 2 a a 0 2 2 AP anys 7 mt tam {cash eonverion le as es Sure: Cnpary dla, Megan tas Modelo’ net working capital to sales was 12% in FY 12, i. before the acquisition by [ABI. Post acquisition of Modelo ABI generated $500m of working capital savings, which reduced net working capital to sales to 5% If we assume that ABI can reduce SABMillr’s core nct working capital to sales by a similar magnitude, i. by high single digits to-3%, it would amount to cash flow savings ofc. $1bn on the owned subsidiaries, ost the disposals and including only the subsidiaries (as we assume [ABI will not be able to generate significant savings in SABMillr’s associates or INS), the acquired sales are $11 9bn As with the cost savings, we believe that working capital savings at SABMiller ‘would be much more challenging to achieve than in ABI’s prior deals. We expect, Stbn of eash flow savings to be the ceiling. This would take SABMiller’s core working capital to sales to -3% versus 5,6% in FY 16 and ABI's -12.4% in FYIS.Komal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 Working capital synergies could be limited in Colombia and South Arica given SABMiller’s receivables in these countries already under index as a proportion of group versus sales a illustrated in the figure below. On the other hand, working. capital management in Australia could be a key driver of cash flow synergies. Figure 10: SABMiler sales and receivables asa proportion of group forfour major countries, FYt6 25% 2% 1% ox s% 0% usta UK Colombia South Aca Motreshables mibot sales Sous Company data Revenue synergies to take time ‘We expect enlarged ABI to generate significant revenue synergies but we expect, ‘these to be very gradual, particularly in the short to medium term. Moreover, as we argue above, in the event of any positive surprise in terms of cost synergies we would not expect eventual revenue synergies to meaningfully shift the ROI from the acquisition of SABMiiler. The first phase of revenue synergies would involve replacing, rather than adding to, Miller Lite, Miller Genuine Draft, Peroni and Grolsch brands in LatAm and Australia, in our view. In SABMiller’s key LatAm markets of Colombia and Peru, premium accounts for 7% and 10% of total beer consumption, respectively. SABMiller created the intemational premium segment primarily through Miller Lite and Miller Genuine Draft, which we expect will be replaced by incremental growth of Budweiser and Corona that are already present in these countries Australia has a relatively large premium segment that accounts for about a third of beer consumption. Again, SABMiller is represented by the Miller brand family, Peroni, Grolsch and its craft brands in the premium segment. We believe ABI can increase penetration of key brands such as Budweiser, Corona and Stella Artois, However, in the short term, this volume will replace SABMillers rather than add to it, In Aftica we do not expect material revenue synergies in the short to medium term, ‘We have included an element (¢-$400m) of revenue synerpies in our estimates within ABI's central business, GEHC. ABI growth sensitivity to synergies is low (Overall, the level of synergy does not have a material impact on etoral Dion (aaa rise 580s formal cillonpnorgan com Europe Eau JPMorgan CAZENOVE FY20E (post full synergy capture) with a range of $1,65bn to $2.5bn total synergies and cost savings. On average, earnings CAGR would range between 14% and 15.5% between FYI6E and FY20E, on our estimates, In the table below, we provide a sensitivity analysis of the synergies (based on phasing of 33%!27%/25%'15% in FY17E/ISE/19E/20E), Table 18: Enlarged ABI earnings growh sensitivity to level of synergies ‘Syne, FTE FE FYTSE FYE FYTRE HE ‘CAGR Be ee Te 8% 23% 13% 1% me ZK 23% 13% 1% 8H 2% ey 1% sss ‘Sesoe LP Magar eaeoral Dion (aaa rise 580s formal cillonpnorgan com Europe Equity Research J.PMorgan CAZENOVE Enlarged ABI details ‘© ABI will continue to be incorporated in Brussels, Belgium, and have four listings — Euronext Brussels, Johannesburg Stock Exchange, Mexican Stock Exchange and ADR's on the NYSE. ‘© Enlarged ABI is now 44% owned by the ABI control group (Stichting, Administratickantoor Anheuser-Busch InBev, EPS Participations Sarl, BRC Sarl, Fonds Voorzitter Verhelst SPRL, Fonds InBev-Baillet Latour SPRL and certain other entities acting in concert with AB InBev), we expect c.14.5% owned by SABMiller controlling shareholders (Altria c.9.7% and BevCo c.4.8%), 2% owned by other restricted shareholders and has a five float of 39.5%, ‘© ABI’ board comprises 15 directors, 3 of whom are independent, Altria has appointed 2 board members while BevCo has elected 1. ABIs controlling, shareholders have elected 9 board members, therefore giving the ABI Control Group effective control of the company despite holding less than 50% of voting and economic interest ‘© North America will remain the largest market for ABI at 30% of EBIT in FY17E; though we expect this to reduce to 26% by FY20E as Africa gains prominence. LatAm North, which includes Brazil, will remain the second largest profit contributor at 21% and will be followed by COPEC, which will be the third- largest division of ABI at 12% of EBIT in FYE, ‘+ The US will remain the largest single market for ABI; accounting for 26% of group EBIT in FY17E, We estimate Brazil will be the second-largest at 21% of profit, Mexico 9%, Argentina 6%, Colombia 5%, South Aftica 5%, Canada 4%, Peru 4%, Australia 3% and China 2%, We estimate that the total Aftica EBIT contribution ex South Africa (and Coca-Cola bottling) will still be smaller than Canada and half the size of Mexico. + ABI’s acquisition of SABMiller should lead to higher volume growth of 2% versus an average of 0.6% between 2010 and 2013. However, we expect organic revenue growth tobe slower, at c-5%, between 2017E and 2020E versus 6.2% between 2010 and 2015, due tothe price/mix drag from Africa (c-50% of group revenue/l) as well as slower growth in Mexico and LatAm South ‘© Similarly, we expect slower organic EBIT growth of c.8% between 2017E and 2020E versus ¢.10% between 2010 and 2015 despite the ineremental synergies with the very material tailwind from Mexico (primarily €1n of synergies) finished and as the base is now much larger ($18.6bn in 2017 versus $10.3bn in 2010). ‘© Atthe EPS level, we expect growth to accelerate to an average of c.13% between 2016F and 2020E versus 11% between 2010 and 2015, primarily driven by de- gearing, New shareholder structure Enlarged ABI is now 44% owned by the ABI control group (Stichting Addministratickantoor Anheuser-Busch InBev, EPS Participations Sarl, BRC Sal, Fonds Voorzitter Verhelst SPRL, Fonds InBev-Baillet Latour SPRL and certain other entities acting in concert with AB InBev), we expect c.14.5% owned by SABMillerferal Europe Equity Research JPMorgan Cazenove formal cillonpnorgan com controlling shareholders (Altria ¢ 9.7% and BevCo ¢.4.8%), ¢.2% owned by other restricted shareholders and has a free float of 39, Figure 1: ABI shareholding structure Other restricted Altria | BEvCO | | Oo eT holders Free float 44% 97 48% 2% 39.5% AB! Snuos Conpary ata. Mean asin ‘The Stichting Anheuser-Busch InBev, BRC, EPS Participations, EPS, Rayvax, ‘Sébastien Holding, Fonds InBev Baillet Latour and Fonds Voorzitter Verhelst, act in concert On 12th April 2016, the controlling shareholders ~ Stichting Anheuser-Busch InBev, EPS, EPS Participations, BRC and Rayvax Société d'investissements— agreed to cextend their shareholders agreement until 27 August 2034, subject to the completion of the proposed acquisition of SABMiller. Since 2004, under the shareholders agreement BRC and EPS had equal voting and control rights of over Stichting Anheuser-Busch InBev and therefore indirectly over ABI shares (52.77% at 31 December 2015). New board structure ABI’s board now comprises 15 directors, 3 of whom will be independent. Altria has appointed 2 board members while BevCo has elected 1. ABI’s controlling shareholders have elected 9 board members therefore giving the ABI Control Group effective control of the company despite holding less than 50% of voting and ‘economic interest, ABI’s Chairman will remain Olivier Goudet, an independent director. Key restricted shareholders of enlarged ABI, ie. Altria and BevCo, have been allowed to elect board members under the following stipulations, © 3 directors for over 13.5% voting shares, + 2 directors for between 9% and 13.5% voting shares, © 1 director for between 4.5% and 9% voting share, ‘© No director under 4.5% voting share Restricted Share directors will be appointed for I year while all other directors will have a term of 4 yearsoral Dion (aaa rise 580s formal cillonpnorgan com Table 19: ABs board members JPMorgan CAZENOVE Represening ae ge Ger postions = (rope Ge Saab ‘48 Board ober of EPS Rayrar, Veil, Cobo RANGES o Sey Balt Laur Fura Morand Van Dane [88 _Boardmerberof ger king and UCB @egan pharma) Admins of nev Bale Latour Fund Solan Doschooranter {$8 CEO Group and member of Universe Lbre de Brales Fountaton Pau Comet de Ways Rust 47 Board mente of EPS, Rayra, Aten Invest ant several VC backed ta companies are Cates Seapra 4 Boarémonber of uger King, HBS board cl Dears Adisurs,co‘eunar and bard monber cf Fundeeao Ess scl Teles 5 Board ments of BurgerKing ad tauUnibanco, HBS boat of Dea’ Advises, co fundor ‘and bord moe of Fundagio Estar, unde and Chsimanof at Pao Leman 47 Board monte of jas Anercaras, Letana Foundation and Anbev Deron Bahng {48 Cossuner and Manogng Pane 3. Execdbe Charman of BrgarKng and Chalmon of ene Modelo aa Asuncion Aramburzatla 52 Board mendes of KO Newos, Abia, Red Universal, Grupo Model, Grupo Farle Banari, Banco Nacional Mn, ren, Mea Sur, ath Arica Cansenaton Cane, Cala é Vida and Progreso y Desa parla lua de Malo. avsry toad rember of TAM Seto of Sunes Independent liver Gout Chairman 51 Chima ofA. CEO cf AB, Charman of Pests Cafe & Te, Boel member of Cty an DE Waster Blenders ical ums 5 Boardmenberof Gelman Sachs, Alon Phamacautzal, iso Systm, Ea ane ile Online Franca lo Leo Seat 50. Chaim ct Zecbx Lis, Charman of LSGHolirgs, and @ Counselor st Ore Yourg Wor ia tn J Barron 83 CEO and President ota Group Wiliam Feed 45 CFO stam Group aoc jana Sarto Daningo Davia 35 MO of Quatre Capt Advisors. Famer non Sear: Corgan dla lorboy US and Brazil are still c.50% of enlarged ABI North America will remain the largest market for ABI at 30% of EBIT in FY17E; though we expect this to reduce to 26% by FY20E as Africa gains prominence. LatAm North, which includes Brazil, will remain the second-largest profit contributor at 21% and will be followed by COPEC, which will be the third-largest division of ABI at 12% of group in FYI7E.oral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Figure 12: Enlarged ABI spit of volume, sales and EBIT,FYI7E vs FY20E 100% co ‘= Global Export and Holding 80% mAtica 70% ‘= AsPae South 60% ss AsPac Noth 50%, s=Europe 40% s=coPec 30% ‘Latin Amorica- South 20% satin Amorica-North 10% ‘Neda Americas om North America 20178 200E = 2OHTE 20008 20178 20206 Volume Volume==‘Salos Sales BIT eat Sour: Mogan eit ‘We expect the US to remain the largest single market for ABI; accounting for 26% of group EBIT in FY17E, We estimate Brazil will be the second largest at 21% of profit, Mexico 9%, Argentina 6%, Colombia 5%, South Africa 5%, Canada 4%, Peru 4%, Australia 3% and China 2%. We estimate that the total Arica EBIT contribution ex South Africa (and Coca-Cola bottling) will stil be smaller than Canada and half the size of Mexico. Figure 13: Enlarged ABI's top 10 counties by EBIT, FYITE. ‘ter China 18% 2 28% ‘ustala om Sou Ain 3% Colonie Brat o% 2% Sous LP Maar eats “oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE Growing ahead of peers ABI’s acquisition of SABMiller should lead to higher volume growth of 2% versus ‘an average of 0,6% between 2010 and 2015, However, we expect organic revenue growth to be slower at ¢.5% between 2017E and 2020E versus 6.2% between 2010 and 2015 due to the price/mix drag from Africa (c.50% of group revenuc/hl) as well as slower growth in Mexico and LatAm South. ‘Similarly, we expect slower organic EBIT growth of ¢.8% between 2017E and. 2020E versus ¢.10% between 2010 and 2015, despite the incremental synergies with the very material tailwind from Mexico (primarily €1bn of synergies) behind us and as the base is now much larger (S18,6bn in 2017E versus $10.3bn in 2010). Atthe EPS level, we expect growth to accelerate to an average of ¢.14% between 2016E and 2020E versus 11% between 2010 and 2015 primarily driven by de- gearing. ‘Table 20: ABL organic volume growth, FY14A to FY20E ks ae TE aE TE aE Worlds 7% 16% 1% 13% 7% 21% 22% Noth Amerca Ast 18% aA% 02% ozs 22% 42% Mile Amereas ro 738 ase 50% 40% Pr er Lain Amie Not 4n% 15% 50% 50% 20% 20% 20% Latin mse: Sou 42% 15% 70% 20m 5% 40% ‘0% corec 3% 45% 15% 25%, 25% 0% 30% 40% 28% 20% S06 5% 25% 5% 17% an 15% 10% 15% 20% 30% 19% oz 05% cow, oss, 10% 10% 45% 49% 20% 20% 50%, 505, 50%, (bbe Expr are Hong 2%, 51% 0% ox, 0%, ao a Sure: Campa dl, 1P. Mogan tas ‘Table 21: ABLorganic sales grow, FY14A to FY20E aks ae TE aE iE iE Worltwie 52% 62% 3h 45% 53% 34% 55% Nort Amerca a7 a 1% 10% 10% 19% 10% Midd Amereas sr, Wom 8% sox, 70%, 55% on ap Areca: North 09% are 0% tom, 79% 1% 10% Latin Rese: South 19% Mm 140% 150% 10% now 0s corec e26 tik 50% 75% 75% 0% eon Euope on a3 30% 25%, 30% 30% 308 AsPae Noth ns 10% 22% 40% 45% bon bo ‘aPac South 3% 52%. 15%, 20% 25%, 30% Som Hs 2% 710% 70% 100% ia% ia a6 30% 10% 50% 50% 505 50%oral Dion (aaa rise 580s formal cillonpnorgan com JPMorgan CAZENOVE Table 22: ABI organic EBIT growth, FYT4A to FY20E a_i ae iE BE ane Words 5% 3% a ei az 72 Norm Amerca 19% 58% 21% 22% 23% 22% Mio Americas nz wax 708 7%. 12% en Latin Ames Not 50% 100% 40% 13% 13% 12% Latin mse. Sou 60% mes HO% nar are uss corEc 5% 7% 70% 157% 183% 108 ebm, 20% 19% 2% 2% 18% aa m% 35% rar naa% 1138 ‘spac South a 19% 40m eam 55% 32% tice 0% 03% 70% 135% 23% 102% (bbe Expr are Hotng 9% 195% 00% 3.8% nam. Bis eure: Cay dl, Maan ma ‘Table 3: ABL organic EBITDA growth, FY4A to FY20E aks ae TE aE ne iE Worldwide 5% ak 73% 7% 7% Tah sah Noth Amerca 2% 37% 20% 22% 2% 2% 2% Mil Amereas mas, my Or aay 10% 1% bem Latin Ames: Nort ea ax 55% eas 73%, 12% 1% Latin Rese: South sta Bm 20% 152% 12% 11% a corec em 1a 70% 175% a nase sare rope 15%. 1% 19% 20% 19% 18% 17% 2ePae Not 5% 2% HOw 08% ay aes az ‘sPac South 2m 71% 20% eam 52% aon 30% pac 19% 10% 1% 20% 19% in rox 97% 300% Hist 520% 258 usm. Stable capex ‘We expect enlarged ABI to keep capex to sales ratio in the high single digits in line with FY10 to FY1S average of 9% and in line with SABMiller’s capex to sales in LatAm and Africa, This implies a stable capex requirement of ¢.85.4bn for enlarged ABI versus $4.7bn for ABI standalone and $1.1bn for SABMiller in LatAm, Africa and Asia in FY16 We do not believe SABMiiller has underinvested in its key volume growth markets of LatAm and Affica. The decline in capex to sales ratio in Africa in FY16 was primarily a function of exchange rates, in our view. Table 24: SABMller capex to sales by region [a Tain eo 98% 81m 72% Tak 84% ea Ay BAK 8TH «BOH BB GBB asPas 4% «0% 27% 2h IH Europe 1% 63% 7K BORN Now Amrca oo% = OOK = UKHO To! Tok 58% GBH SEK SRK TH South ica 52% 59% 80ST Baw Othe aie 2s Tea 2%, ‘sous Conny ala(can rise sees Soonseer20t0° JPMorgan CAZENOVE somal stilorapmoran.con ABI financials ‘able 25: ABIPBL Sion 7a isis aT TBE Vai ago wir. sta wan 903 ta 005 wea Grow 713% “3% AO 280% 2% Revenue 7986 Ger 57355805 2380 Grow 0% 48 2D 4% ESITOA 18565 fees 25668 EBITOA magn 38% shox 380% 402% 20% Grom 3m 5K 75% aga 3528 ass ait 5: 1 nes7 FBT nai sh5% 309% 359% Non ecurng tes 18 1% 2s ws. ms ns rest cons 1g ee ee YY Gaspon 4% rd Nanrecuring nace cotter se za = 4000 - Nat iancing cont 1318 a re ee ey Reported PBT 13793 fast gam tasty 5428 nz PT ex on ecuring ops toms ‘ast 250 10174 gas basta Taxon curing 280 2s = 20 = 303. 3aeT = 0B = 428 Tacon pn ecuring a a . Total tax costs, (2s) (2554) se) a) A) 4s) 425) fever 18% Tim 200% = 205% 2a pat 1284 sasr tar t4gm0ragre tags tase Nineties 286 “ih sts S28 Irae em assoies 3 0 10 2 28 308 me Reported ntincome son az 2g sys tags tage st Nat income coan as ast 65 soo thos 230718378 No of stares average weighted) 1 15 188th gga Clean ajsted EPS 5a sm 40s Sk EPS grou 05% AM te sat Sure: Company dia. JP. enna |oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 ‘Table 26: ABI balance sheet JPMorgan CAZENOVE Sion aie ais 1016E ____T0V7E oe 70196 Fadia fs ter 250 ars tate 2985, Ofer non caren asses moses 97369208743 zon a3 oars 208 743 ola Non Curent asses ragos teat Zae289 Bar AMB 8381233728 Cash and cash uals east bets tease tae s60ue te lovers 2am zee 358067 asm 35m 3570 Trae ar ber eshables eas 7m 89367 950 9808950 ter ont asses Tat 730 4827 4a Aaa aa ola Curent assets att re re Toll Aseate oss Mss 288274 zTaazn That 288708 stleen 1482 ses wws02 = tsu toga tsa gne Ober rye east eas as ts ets Total Curent Lib a a a Long Ter oan ‘gem eat nraaat—targas zz saag09 see ‘ter Long temfad e745 Toate 22.388 ah 388th 2238 ola Noreurrnt abies stoas—anaso 35879 tayazd args e7 tT Total Listes mazes maT shan ase HOSAT 225155204 Shareholders Equly gas age arr szye zat Minories 3582 easy 1088 170018340 Total equity and iabitios teasso thas e827 raz arta e870 e885 as 28307958 se saga aTr shay 20 254 etx doe ae a Sur: Crp Sl, Won en Table 27: ABI cash flow 7a PHTGE__0TE___sE___D019E Ta Eo "esis —Tesus rar 20848 24730 Deas 20463 we ms ms =) tM gD Porson corrulons and uve of provisions ee Pe) ter costs mm 48 Cash ow rom operating actos essa woes rez sass ass 28863 bierest and Taxes srs geht ats tae? esr 7021, Dye payment ered 0 2 Cashflow bare mestng carat rarer nea toes atte Capex 4s 4ST SS se 288 Fred et dpocle mm a2 0 0 0 0 0 Free cash Flow a a a a Iovasmerts S186 a 0 0 0 a Aequsions si 286 Q 4 ° 0 Q Dspesalsf subsides 28 m0 5800 0 0 Q Owen aie sareholers aod 7985801 AOKI tows tz Cash Flow Before Financing a) Stressed 5 a 0 ° 0 0 Prat of Own Shares 09 4 0 ° 0 Q ‘cash Flow Bsfore Debt Finaneng a a Ober tons Se -s2000 0 0 0 0 Exchange Adsinens 38 Q 4 ° 0 ° Movement in net debt 55 nee Sodas tata 0 Changein wor capalsles 1% ORT UK ORK OK Capensales 83% tne 3% sh NBS 80K. Suc: Cpa da, 1. eran aesKomal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 US still a quarter of profit ‘© The US will account for ¢.17% of volume and 26% of profit for enlarged ABI in FYITE. Since InBev acquired A-B in 2008, the company’s sales in the US have inereased from $13.3bn to $13.8bn in FY1S. A strong focus on costs has led to @ marked improvement in profitability with EBITDA increasing from $3.8bn to '$5.Sbn in the seven years and margins expanding by 1,100 bps from 29% to 40%, while cash fiow in the US has more than tripled from $1 Sbn to an estimated $Sbn, on our estimates. ‘+ However, ABIs top line performance in the US since the AB acquisition has been mixed with organic growth in North America averaging 0.7% p.a. boosted by 5% growth in 2012. Excluding 2012, organic sales would have been flat for ABI in North America between 2009 and 2015. The decline in US beer industry volume is decelerating but ABI continues to lose market share due to its skew towards the value! economy brands, ‘© Looking forward, in ABI’s North American segment we expect limited volume growth despite slightly better US beer industry trends with ABI continuing to lag, We forecast 1-1.5% organic price/mix to result in 1% organic sales growth, Despite pressure on profitability over the past few years, we expect this business ccan generate low single digit organic profit growth and we forecast 2% p.a. to FY20E. The takeover of MillerCoors by Molson Coors could result in higher competition in the US, which could adversely impact ABI's margins in the region. ABI's US portfolio ‘The Bud Light family accounts for 45% of ABI's US portfolio. This includes brand extensions such as Ritas and Platinum. The Budweiser family comprises nearly 20% of the portfotio and we estimate premium brands such as Michelob Ultra, Stella, Artois and imports are ¢.10%, We estimate the Busch and Natural Light brand families account for about a quarter of ABI's US portfolio. Figure 14: ABI's US portfolio, 2014 tars, 12% Stl tis, 2% Mobeled Ul, 5% Bunch Sx Budge ary 8% Busch Lig 7 Nawal Ugh 8% Buel only, 1% Soe ae Hats [ABI’s commercial priorities in the US are to: 1) grow its global brands, ie. Stella ‘Artois and Budweiser; 2) Premiumise and invigorate beer; 3) Elevate core brands such as Bud Light, Budweiser and Michelob Ultra; and 4) Develop the near beer segment wit the Bud Light Ritas range as well as Best Damn brand range.Komal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 ABI launched a new campaign to increase brand equity of Bud Light in 2016, For Budweiser, ABI is emphasising the quality and heritage credentials. Michelob Ultra, remains one of the fastest growing major beer brands in the US. ABI's premiumisation efforts are concentrated on Stella Artois, which is already displaying, double-digit growth, and its key craft brands Goose Island and Shock Top. Over-indexed to value However, the big challenge for ABI remains its portfolio skew towards value and economy brands such as Busch and Natural and the fact that Budweiser and Bud Light continue to lose share as light beer as a whole continues to decline. The only segments of the US beer industry that are growing are craft, flavoured malt beverages and imports ABI is “structurally” underweight the faster growth craft and import segments and “overweight” the domestic economy segment, Gaining share atthe overall market level for ABI is therefore difficult to envisage without a slowdown in the decline of the economy brands, which in part requires a more buoyant core consumer, in our view, and without the turnaround of the core Budweiser brand still ¢.20% of ABI US volumes. Figure 15: US beer market volume market share by price segment Sous Company data Limited price/mix growth in the past few years ‘When InBev acquited AB in 2008, the company believed that beer in the US was very affordable post a price war in 2005. Since 2009, the industry has been more constructive on pricing as ABI increased price, which provided an "umbrella" for its key competitor, MillerCoors. Both the companies constructively took to investing in sales and marketing rather than risk trying to win share. Elsewhere, the major import players as well as craft brewers were even more motivated to take price to help drive profitability and recover cost inflation. Importantly, the average pricing gap between mainstream domestic beers and overall imports has narrowed by over 20%. However, since 2012 ABI's price/mix improvement in North America has decelerated (from 3% to 1%) as detailed in the figure below. In 2016, ABI expects to continue to improve its price/mix in the US helped by favourable brand mix. We ”oral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com JPMorgan CAZENOVE think the relative price increases across the portfolio may be less marked than in prior years and that ABI may price more tactically beer pricing Figure 17; ABI ‘real prielmix in North America Figure 16:US ‘Sout Bhontr, Canary al, 1. Mbgan eis Seu: enter, 1° Maga eat A keey driver of revenue per hl inerease in the US is mix. Craft, imports and near beer, which are sold at higher price points, are in growth, while other segments remain in decline. Innovation in the beer industry is also helping to reinvigorate the category. ‘Table 28: US beer industry by segment ‘Vu, 27k gain ase roc ‘otto ad Fg Ben aes ae Tak Tiga Tan TT TsZk 181% Tim 85% 9% Figs e570 0r4o) 108184 eee are ame 36K 2a. Premium + argo aogata 402880, 0% 158 45% aK 1a pt 1355s 13701705250 3% 38 am «7% HSS Popuar ‘ng7z0 "196400 et 72% 69% 88% Ingo ‘argato 400.170 Say Ba aK IK 18K Oher isa 15070 4m 32 55% 53% 51% Tota zeeoss 2943710 aim tm soog% 000% 100% eur: Baer aoc Muted profit growth in recent years ‘The price increases resulted in significant margin expansion even after completion of the $2.2bn cost savings from the AB deal. ABI’s gross margins increased by over 700 bps between 2008 and 2011, boosted by the synergies related to integration of AB and InBev. In 2012, margins improved by another 270bps, although we estimate this was entirely driven by a reclassification of distribution expenses, which reduced COGS but increased distribution expenses. Between 2012 and 2015, ABI delivered an average SObps p.. improvement in gross margin driven by priceimix growth of 3% and despite volume dectine of 1%. However, higher sales and marketing expenses have offset gross margin profit improvement and left organic EBITDA at -0.4% on average over the past 4 years. forward, in ABI’s North American segment, we expect limited volume growth despite slightly better US beer industry trends with ABI continuing to lag, We forecast 1-1.5% organi price/mix to result in 1% organic sales growth. Despite pressure on profitability over the past few years, we believe this business ean generate low single-digit organic profit growth and we forecast 2% p.a. to FY20E. ‘As we state in the section below, the takeover of MillerCoors by Molson Coors couldoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com ‘result in higher competition in the US, which could adversely impact ABI's margins in the region. Figure 18: ABI North America topine organic trends 2 aes 4.0% + 3.0% 20% vo ov) ov ot ov) 6 ov PEPE EEE ae elim tence eon Sous Company aa, LP Megan sits Sales and marketing spend has increased significantly... Post an initial period of cost savings and efficiencies, ABI has steadily increased sales and marketing investment in the US. Since 2012, the company has increased sales and marketing investment by high single digits p.a. on average on an organic basis. This amounts to $653m of incremental investment in sales and marketing over the past four years. Figure 19: ABI North America sales and marketing expenses Smlion 200 25% 20% 000 15% 10 10% a +1000 o% ‘0 sh 0% ° 18% maT (SE Sales and marteng expenses — Orme rom Son Conary la ..but has not curbed market share decline ABI dominates the US beer industry (45% volume share) with clear leadership in the it segment with its Bud Light family. However, the company has been losing share at -6Sbps in 2015, -SObps in 2014 and 2013, -20bps in 2012 (helped by innovation), -60bps in 2011 and -S0bps in 2010. Despite higher spend behind its brands, ABI's market share in the US has continued to decline. Between 2009 and 2015, ABI lost 400bps of market share atthe expense of smaller brewers and importers. Crown Imports has gained share since 2013 with ‘the company selling Grupo Modelo's Mexican beer brands (including Corona) in the 4“oral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com US. Mexican imports have continued to sign industry. cantly outperform the US beer Figure 20: US beer market share, 2008-2014 ox ms socusk oe Pesos ws crown mo soe snc 20% 08 ww Soc eines Craft brewers still account for less than 12% of US beer industry volume, However, these brewers have grown rapidly, with nearly S0Obps of collective market share gain between 2009 and 2015. Industry experts estimate craft brewers now account for 21% of US beer industry sales. However, this segment remains very fragmented with 3,500 brewers including microbreweries, brewpubs and regional brewers. The major brewers, ABI and MillerCoors, own a few relatively large erafl brands, such as Goose Island, Shock Top and Blue Moon, Figure 21: Craft beer continue to gain share se o tan n me [ L i : : = crat) vot indsty So ae Hts {In particular, ABI is facing challenges in stemming the market share decline of Budweiser and Bud Light, which together are nearly two thirds ofits US portfolio. In 2012, ABI launched the Ritas extension of Bud Light, which led to 70bps market share gain for the Bud Light brand family in the year. However, since 2013 the Bud ‘brand family has lost -2Sbps of market share on average every year. Budweiser has proven very difficult to stabilize, although ABI has decreased the shate loss from the -70bps to -90bps range to -20bps to -30bps in recent years(ean risesaes ‘eouoter 2010 JPMorgan CAZENOVE omaldilondserongan om Figure 22: Budweiser, Bud Light and ABI marketshare trend, 2009-0216 bs zoom atta Name ONS tt s=Budwosar a BudLight Souoe Conpary eta, LP. Mean sits ‘We expect ABI to continue to lose overall share, given this over-indexing to the ‘economy segment and relative under-index in premium and above. In the past, share loss has offset about a quarter of the uplift in price/mix, while about 40% of the improvement has been eroded by industry volume decline. Lean production and distribution ABI has 18 breweries that produce close to 2,000 SKUs. ABI also owns 7 packaging. plants that provide around half of its requirement of beer cans. ABI owns 19 wholesalers in the US, which account for ¢.10% of its volume in the country. About $00 equity wholesalers account for the remaining 90% of ABI's volumes. On average, ABI’s US wholesalers source 94% of their volume from ABI versus 70% for the average MillerCoors wholesaler. With the approval of the ABI-SABMiller deal, the Department of Justice (“Do”) in the U.S, stipulated that ABI would not be allowed to acquire a distributor iit would result in more than 10% of ABI's volume being sold by wholly-owned distributors Additionally, ABI will not be allowed to terminate contracts with any wholesaler as 8 result ofthe acquisition of SABMiller. The Dol is also reviewing and modifying certain aspects of ABT's U'S. sales programs and policies. Investment could be required to counter Molson Coors As deseribed earlier, Molson Coors has agreed to acquire SABMiller's 58% stake in the MillerCoors JV. Given the transaction is pre determined with Malson Coors under a binding obligation, we expect the transaction to take place in the coming, weeks. Molson Coors expects to generate total synergies of $200m by the fourth year following the completion of the Miller Coors IV acquisition. The company also expects to generate $250m of annual cash tax benefit for 15 years and $100m-150m Tower annual interest Post years of volume decline, Molson Coors expects fo achieve flat volume for Miller Coors by 2018 with growth from 2019 onwards. Molson Coors is expecting tooral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE gain share in American Light with Miller and Coors Light and stabilize its value brands, Table 28: ABI versus Miller Coors in the US, 2015, $nilon al TS tearvlane, eH “es ‘waar Netaake 13005 1708 EsrToA sar? 58 Margie 4 27% Cope ‘0 mm Copexto sales 5% ‘Seas Company a LP Megan ina |oral Dion (aaa rise 580s formal cillonpnorgan com Europe Equity Research J.PMorgan CAZENOVE Brazil potentially past the worst ‘© We estimate Brazil will account for 21% of enlarged ABI’s EBIT and will therefore be the second largest market contributor to group profit. The country is the largest component of ABI's LatAm North division. ABI’s exposure to Brazil is through its 62% equity stake in AmBev, the listed LatAm brewer. ‘© We forecast 2-3% p.a. volume growth in ABI’s LatAm North segment to FY20E, which, along with inflation-driven 5% price/mix growth, should result in 7-8% pa. organic sales growth in the medium term. After a year of margin suppression, ‘we expect profitability to revive in FY17E and thereafter remain broadly stable at the 52% EBITDA margin level ‘© Affer 3 years of contraction, J.P, Morgan's economists expect Brazilian GDP to grow by 1.4% in 2017, driven by higher manufacturing confidence. ‘© AmBev's beer volume increased by a CAGR of 3% between 2008 and 2015. The company’s market share in beer was 67.5% in 2015, but has been under pressure recently, AmBev’s Brazil beer price/mix increased at a CAGR of 8% between 2008 and 2015 ahead of average Brazil CPI of 6.5% in that time frame. EBIT ‘margins have declined from their recent peak of 49% in 2013 with higher SG&A driven by the football World Cup in 2014. In 2016, we expect continued pressure on EBIT margin driven by higher COGS as well as negative operating leverage. ‘+ AmBev is one of the largest PepsiCo bottlers globally with operations across LatAm in Brazil, Argentina, Bolivia, Uruguay and the Dominican Republic. The bottling agreement in Brazil expires in 2017 and will be automatically renewed for an additional 10 years. © Overall, between FY10 and FY15, AmBev’s soft drinks volume has been broadly flat with a decline in FY15 due to pressure on disposable income, AmBev's soft drinks price/mix growth has been below inflation except in 2012 and 2013. Despite volatility atthe gross profit level, EBITT margins have been maintained at the 44% level after a 1000bps step up between 2007 and 2013. ‘© AmBey has benefitted from various tax shields in Brazil. We believe the tax ‘advantage will diminish going forward given the controversy around CONFAZ, tax assessment received forthe special goodwill reserve and potential removal of IOC benefits, We forecast a mid 20%s effective tax rate in Brazil in the medium crm, up from an average of c.19% over the past 6 years Improving macro Afier 3 years of contraction, LP, Morgan's economists expect Brazilian GDP to grow by 1.4% in 2017. They expect expansion to be driven by higher manufacturing, confidence. Beer consumption is closely linked to growth in GDP per capita as illustrated inthe figure below. Per capita consumption of beer in Brazil is high, at nearly 70 liters, with considerable growth between 2004 and 2010 as the economy expanded. In the medium to long term, we expect low single-digit beer volume growth in Brazil as the macroeconomic situation normalizes and underlying growth is resumed,Komal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 Figure 23: GDP and beer per capita consumption growth in Brazil, 1996-2017F 0% 3% 5% % % 0% 2% 94 3% FE PEEESESELE SLES EELS EE room cP own ABI’s Brazilian business is one the most profitable beer and soft drinks businesses globally, driven by a combination of concerted efforts on pricing, mix and fixed and variable cost control, boosted by economies of scale of business and retumable packaging. Going forward, with lower volume growth, ess pricing and less low hanging fruit on the cost optimisation front, we believe material margin expansion will be more difficult to achieve. Beer margins broadly flat in recent years AmBev's beer volume increased at a CAGR of 3% between 2008 and 2015. The ‘company’s market share in beer was 67.5% in 2015, but was under pressure in the first half of 2016, due to AmBev taking price increases ahead of competition. AmBev's pricelmix for beer in Brazil has steadily increased driven by inflation led price increases, but also mix improvement. Mix growth has arisen from ppremiumisation and through increased direct distribution and despite faster growth in Iower-price (but more profitable) retumable bottles as consumers have dawn-traded over the recession. Overall, this led to AmBev's Brazil beer price/mix increasing at a CAGR of 8% between 2008 and 2015, ahead of average Brazil CPI of 6.5% in that time frame.Koma hin Europe Eau Research ‘ (era) rise sees So.oasber 2016 JPMorgan CazENovE omaldilondserongan om Figure 24: AmBev Brazil beer organic volume, sales and EBITOA Figure 25: AmBev Brazil beer prielmix growth aheed of Brazil CPI arowth trends $6 _ $$$ ‘08 « son ‘e cox ~ sm | —__________By soos | mm” mob mI BON ale wwe aE be be Bee wR wR we eat whose qa Sou: Campey 8 Sombs Seuce Congr dla i ‘Atthe profit level, gross margins have been dragged down by higher COGS in the past 3 years, but are still high at near 70%. We expect higher COGS to continue to ‘mpect margins in 2016, EBIT margins have declined from recent peak of 49% 2013 with higher SG&A driven by the football World Cup in 2014, In 2016, we expect continued pressure on EBIT margin driven by lower gross profitability as well as negative operating leverage with a 5% decline in AmBev's beer volume in Brazil. Figure 26: AmBev Brazil beer gross, EBITDA and EBIT margin expansion, FYO8-AS tes 400 300 200 mete NS Grose maqga SESITDA margin a EBIT margin Sous Company ata, LP. Megan sits AtHI16 results ABI reduced guidance for net revenue in Brazil from mid to high single-digit growth to flat due to a weaker than init environment. Transaction impact on beer in 2016 but muted AmBev hedges its raw material and packaging requirements on a rolling basis for the ‘upcoming 12 months. In H1116, AmBev’s cash COGS per hl in Brazil increased by 8.5% driven by inflation and FX headwinds. For 2016, AmBey expects cash COGS in Brazil to increase by mid to high single digits. This would require 3-6% price inereases to maintain gross margin.Komal Dion (420) T1343085 Komal ahllnemorgan.com {October 2016 J.PMorgan CAZENOVE For 2017, we estimate the commodity price changes and BRL devaluation impacting. USD-denominated commodity costs will mean AmBev would require a 1% price inerease to keep gross margin flat Table 30: Brazil beer FYITE COGS inflation and required price increase Wottoal — Yorn ORL Aor VITE Tare cone We 7% pi aH 4% Barby 12% 3% abou % 7% Com ca % er 2% ™% Weighted avg COGSIL YoY" FYIBE m% Geos pott magn 70% rich neraase require or stble GM % ‘Sous onto, JP. Mogan iris Soft drinks profitability has substantially improved ‘Amey is one ofthe largest PepsiCo botlers globally with operations across LatAm in Brazil, Argentina, Bolivia, Uruguay and the Dominican Republic, The botling agreement in Brazil expires in 2017 and isto be automatically renewed for an auditional 10 years, In Brazil, PepsiCo has 19% share of the carbonated soft drinks market, while Coca Cola has 61% and B-brands make up the remaining 20%. In addition to PepsiCo products, AmBev sells its own-brand soft drinks with the biggest brand, Guarana Antartica, being the leader in non-cola soft drinks. AmBev’s Antartica brand is actually nearly half of its Brazilian soft drinks portfolio having increased as a share ‘of portfolio from 43% in 2010 to over 45% in 2015. Pepsi (including Twist) is the second-largest brand in the portfolio at nearly 27% share. Figure 2: Ame’ so inks porto in Bax, 2010s 2015 ‘0% ee | “05% 7 1 oon so we we a 1% o% aie ais shvtrca Paps mutta =H20H x Ohes Some sree ‘The challenging macroeconomic environment, with declining disposable income and trading down, had a marked impact on soft drink consumption in Brazil, whichKomal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE declined by high single digits in 2015. Against this backdrop, AmBev gained share with its soft drinks volume declining by mid single digits. Overall, between FY 10 and FY15 AmBev's soft drinks volume has been broadly flat, AmBev"s soft drinks pricemix growth has been below inflation except in 2012 and 2013, Figure 28: AmBev Brazil soft drinks organic volume, sales and Figure 28: AmBev Brazil soft drink pricelmix growth below inflation EBITDA growth Pe eT an ae a ‘0% o * % » oa mn 2s” mom” ate” mae” ata teats ‘ume = Ske = EBITOA SERA CPL_=Aniev sot ra posix Sour: Carga dla ‘rues: Company esa, bono AmBev’s soft drinks gross margin declined by nearly 200bps in 2013, due to mid- teens COGS/hI inflation. Gross margin has been rebuilt in the past 2 years and is now at $9%, We expect material input cost pressure in 2016 to lead to margin deterioration in the year. Despite volatility at the gross profit level, EBIT margins have been maintained at the 44% level after a 1000bps step up between 2007 and 2013. EBITDA margin has inereased to 53% (up 1,400bps between 2007 and 2015) with higher depreciation in recent years. Figure 30: AmBev Brazil soft drinks gross, EBITDA and EBIT margin expansion, FYO8-15 bes 200 600 400 200 ° 200 00 00 meme? sGrosmamin EBITDA margin a ESIT margin Sour Company a, Moran ele soral Dion (aaa rise 580s formal cillonpnorgan com Europe Eau JPMorgan CAZENOVE AmBev’s soft drinks business in Brazil faces higher input cost headwinds driven by an over 50% hike in sugar price, AmBev would need to increase price by high single digits in 2017 across its sof drinks portfolio to maintain margins Table 31: Bra soft drinks FY ITE COGS inflation and required price increase Wetted —YoreMaRL for YATE Sar we 52% Per 2% 7% Alannun 2% 4% Labow os 7% Ober oh ™% Weighted avg COGSIL YoY" FYIGE 154 Geos proft magn 0% price ineaate require for stable GM we ‘Siuoe dooney JP. gun sires Overall, for ABI’s LatAm North division, we forecast 2-3% p.a. volume growth to FY20E, which, along with inflation-driven $% price/ mix growth should result in 7- 8% pa. organic sales growth in the medium term. After a year of margin suppression, we expect profitability to revive in FY17E, with gross margin pressure from higher input costs offset by synergies. Thereafter, we forecast broadly stable 52% EBITDA margin in the medium term, Diminishing tax advantage AmBey has benefitted from various tax shields in Brazil. We outline these below and believe the tax advantage will diminish going forward given the controversy around CONFAZ, tax assessment received for the special goodwill reserve and potential removal of IOC benefits. We forecast a mid-20%s effective tax rate in Brazil in the ‘medium term up, from an average of .19% over the past 6 years. Sales tax —ICMS and IPI ‘We detail the two types sales tax — ICMS value added and IPI excise — in Brazil 1. ICMS value added tax is levied by each state ranging between 20% and 25% of revenue for beer. The tax is charged on an ad valorem basis, ie. it isa proportion of revenue. Fach state is allowed to change the ICMS value added tax rate on 1* January. In 2015, major states such as Rio de Janeiro and Sao Paulo increased the rate by 4%pts on beer, spirits and soft drinks but kept it broadly stable for food. 2. IPL excise tax is levied at the federal level and amounts to a multiplier of 10-15 ‘of sales set to increase by SObps each year to 2019. The IPI excise tax rate changed from ad rem to ad valorem in May 2015. The old model was deemed to0 complex and lacked visibility for the industry as it meant unexpected tax, and therefore, price hikes. The new structure is simpler, without the "unpredictable table pricing and provides visibility of tax hikes until 2019, therefore lifting the overhang of a change in tax multiplier or reference table, ‘Additionally, the magnitude of the tax increase should only require beverage companies to hike real prices by 18% to 1.5% at the consumer level, implying, beverage inflation closer to overall ‘The above state taxes together account for about 40% of AmBev's gross sales.oral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com CONFAZ controversy CONFAZ, or Conselho Nacional de Politica Fazendaria, is a council formed by all 27 Treasury Secretaries from each state in Brazil. Some states in Brazil offer tax incentives to attract investment. Fundamentally, this is carried out via a rebate or deferral on the ICMS value added tax. The rebate ranges from 50-90% and AmBev accounts for it under ‘Other operating income’. In H116, the rebate amounted to nearly BRL700m for AmBev. The rebate is typically for a5 to 10 year period. ‘There is controversy around whether this tax incentive should be permissible without prior approval of every member state of CONFAZ. Since 2007, states such as Rio de Janeiro, Sao Paulo and Minas Gerais have given tax assessments to Ambev totaling '$500m. These assessments challenge the legality of tax eredits received in other states. Ambev has treated the $500m as a possible (not probable) loss, based on management estimates. In 2012, the Brazilian Supreme Cour issued a proposal to declare all tax incentives provided without prior unanimous approval by CONFAZ members to be ‘unconstitutional. Ambev does not expect the Supreme Court to vote on this before the Brazilian government passes a law to regulate the issue. Special goodwill reserve Ambev generated a special goodwill reserve of BRL2.96n following InBev Brasi’s merger with Ambev in 2005. Ambev generated tax benefits from the partial amortisation of the special premium reserve. The amortisation was carried out for 10 years post the merger. In 2011, Ambev received a tax assessment from the Brazilian federal tax authorities and again in June 2016 charging the remaining value of the goodwill amortisation. Ambev has made no provision for this but management estimates a possible loss of S2.3bn. Ifthe courts rule against Ambev, ABI will reimburse Ambev with the proportion of the benefit received by ABI. Additionally, in 2013, Ambev received a tax assessment relating to amortization of goodwill generated by the merger of Beverage Associate Holding and Ambev. In 2014, the court ruled against Ambev and Ambev appealed the decision, The possible loss from this isan estimated $400m as of 30 June 2016 and Ambev has made no provision, Interest on Capital benefits under scrutiny Interest on Capital (IOC) isa tax-deductible way for companies to distribute dividends to shareholders in Brazil It was implemented in 1995, but there has been recent speculation regarding its removal, which could provide the government with about BRL I4bn of annual revenue. However, instead of a full removal, some altemative options are reported to be under discussion. One of these includes a change inthe formula for the IOC from one based. ‘on Brazil's long-term interest rate (increased from 5% in 2014 to 7.5% currently) toa fixed rate. IOC helped Ambev save BRL1.7bn in tax payments in 2015, which, if removed, would reduce FY17E eamings by 15% (low single digit impact for ABI). However, we believe Ambev would be able ofiet this by gearing up from its current nt cash position.(ean risesaes Sooaseer ate JPMorgan CAZENOVE oma hilongemergan com A proposal to abolish IOC benefits failed to pass through the Brazilian parliament in January 2016. The bill cannot be presented to the parliament again this year without amendments. Ifthe bill does get passed in 2017, it will be implemented in 2018. We expect Bravit's long-term interest rate to decline to 5% by 2018 from 7.5% currently. This will reduce the tax shield and increase the effective tax rate. We forecast mid-20%s effective tax rate in Brazil in the medium term, up from an average of ¢.19% over the past 6 years, Figure 31: AmBev effective tx rate set to rie to mid 20%8 0% OPER OOP ELE EEE SERRE Sous Company ata, LP. Moran sites(ean risesaes Sooaseer ate JPMorgan CAZENOVE omaldilondserongan om COPEC (12% of profit) ‘+ ABI’s new segment, COPEC, encompasses SABMiller’s LatAm operations, which were the largest regional contributor to SABMiller’s group profit; accounting for 34% of group EBITA in FY16. + COPEC accounts for 12% of enlarged ABI, Colombia and Peru are the key markets, accounting for over 90% of regional profit between them, on our estimates. SABMille’s operations in Colombia operate on ¢.50% EBITDA margin and, we estimate, ¢.40% EBIT margin. In Peru, we estimate EBIT margin 0f 30%, We estimate Colombia accounts for ¢.60% of segmental profit or 5% of enlarged ABI, while Peru is ¢.30% of segmental profit and 4% of the group, ‘©The region has delivered mid-single-digit volume growth, despite nominal price increases, resulting in high-single-digit top-line growth. This, along with focus on costs, has led to near double-digit annual profit growth. EBIT margin of 35.9% in FY16 has increased by over 1000bps since FY10, ‘© Inthe medium term, we expect the region to deliver 2.5-3% organic volume growth p.a., 5% organic price/mix growth and 7.5-8% organic sales growth 10 FY20E, We expect broadly flat underlying margins, but with over 1200bps EBIT ‘margin expansion, driven primarily by synergies. This would take EBIT margin of the COPEC segment to 48.2% in FY20E versus 36.1% in FY1S; or above Brazil beer margin of 46.6%. Dominant positions in three key markets ‘SABM’s Latin American business consisted primarily ofits dominant positions in the beer markets of Colombia (98% beer market share), Peru (94%), Ecuador (95% Honduras (95%), Panama (70%) and El Salvador (90%), SABMiller also sells soft drinks in all of these markets. In November 2010, SABMiller added to its regional footprint with the acquisition of Casa Isenbeck, the no.3 brewer in Argentina with annual capacity of 1.2m HL and ¢.3% share. It also exports brands to Mexico (where it lost out to Heineken in the acquisition of the FEMSA Cerveza business and in the past has lobbied to weaken the power of the two incumbent brewers) as well as Chile, Bolivia, Paraguay and Uruguay. SABMiller had plans to enter Brazil through joint venture with Petropolis, SABMiller also has a high share of total aleohol in the majority ofits markets in LatAm despite local spirits and, in some cases, illegal aleohol accounting for a large part of alcohol consumption in these countries.Kemal Dion Europe Equty Research , (eran re sa9s ‘eosaeer2016 JPMorgan CAZENOVE ‘onal ilengemermancon Table $2: SABMiler share of total leohol in Key LatAm markets Figure 32: legal alohol remains material across LatAm am Gant Be Tm We am en o% sa Enon 55% caw Parana oo ox OS Hondas 2% 33% ee Fe Pee saleder 41% 2% VPPP IS PE ELE vee Carga Sous: Company a SABMiller estimated that ROIC moved up from 7.5% in FYO7 to 15.9% in FY13 for the acquired Colombia business, compared to a 10% estimated project WAC. ‘SABM estimated that from FY08 to FY 15 it generated $11.2bn in operating cash flow. In the region, we estimate capex for the region was around the $3bn mark in this timeframe leaving post capex free cash flow at c.$8hn. The company reduced ‘working capital by over $400m by FY13 and we expect a further significant decline since then, resulting in working capital running at negative mid to high single digits in the region versus an outflow at acquisition, Mid-single-digit volume growth... SABMiiler’s organic lager growth in Latin America picked up to 6% in FY16 post subdued low single-digit growth between FY13 and FY15. Growth was adversely impacted by civil unvest and tx inereases (and sometimes weather) that compounded the effects of macro softness and staples inflation. With beer facing regulatory headwinds, SABMiller's soft drinks volume grew organically by mid to high single digits in LatAm in FY 14 and FY 1S, Figure 33: SABMIller LatAm organie volume growth 20% 00% 80% 60% 40% 20% 00% 20% at Fria Fs Fie Fv Fs ssBeer Selle = Tolalvokine Sous Company dla ...despite consistent price increases Price increases have been the key driver of price/mix for SABMiller’s operations in LatAm. Pricing has averaged ¢.3% CAGR since 2010 while mix has been broadly flat, Affordability remains a key issue in this region and SABMiller has sought © reduce the level of price inereases in the past year, while improving mix primarily through premiumisation,Komal Dion (420) T1343085 Komal ahllnemorgan.com Figure 35: SABMIlle LatAm EBITA trend so onoder 2016 J.PMorgan CAZENOVE Figure 34: SABMiller LatAm organic volume, pricelmix and sales growth 20% 00% 0% som 40% 20% oo 20% 40% FoF? ‘Volume ce mx Sales Sse Company al, gan eile Profitability is very high SABNMiller has delivered strong double-digit organic EBITA growth across the region and consistent margin expansion both organically and on a reported basis in recent years. EBIT margin of 35.9% in FY16 marked an increase of more than 1000bps since FYI0. We believe this reflects SABM’s price strategy and control over fixed costs and has been achieved despite continuing investment behind brands and route to market and ongoing variable cost inflation. In recent years, margins have bbeen under pressure due to macroeconomic challenges and deterioration of focal currencies, Figure 38: SABMiller LatAm EBIT margin Serlon 0% S6B% SHOR caw vs Ss 100 ot 23 : 5 ean enc * Sou Company a ..with strict cost control SABMiiller rolled out Zero Based Budgeting to other LatAm markets after its success in Colombia, SABMiller also centralized various processes with a regional IT shared service center set up in 2009 followed by centralization of procurement (packaging and marketing material, capital equipment, transport ete) to the group's procurement ‘operation in Switzerland in 2011. ‘An Integrated Change Program, including Global Business Services, End-to-End Supply Chain and Procurement — is being deployed across SABMiller’s operations in LatAm, Global Business Services was established with a Global Delivery Centre set up in Bogota in 2014. This center enabled data available to foster businessKomal Dion (420) T1343085 Komal ahllnemorgan.com Europe Equity Research J.PMorgan CAZENOVE so onoder 2016 intelligence and enhance analytics capability. The End to End Supply Chain resulted in standardization of supply and operations, increased planning capability and lower costs and inventory levels. The regional procurement center led to near $100m of savings (on an EBIT of $1.6bn in FY12) between FY 13 and FY15 with a focus on quality, service, costs and working capital Overall, the Integrated Change Program resulted in a 7.1%pt reduction in costs to sales between FY10 and FY15 as detailed in the figure below. Material savings were achieved in manufacturing (5.3%pts as a percentage of sales). Other costs (including COGS) decreased by nearly 18%-pts as @ proportion of sales. Figure 37: SABMiler LatAm key costs as a proportion of sales, ‘000% s0a% aoe roe eae soa aoo% soak aoe 100% oom Fv1a Fri sMenuactuing = Disfeuion mCommaniol =Implie“ohe* Sous Company data Package and direct distribution help drive margins LatAm markets have high penetration of retumable and non-retumable glass packaging in beer, while cans penetration remains small, In Colombia and Peru, only ‘7% and 1% respectively of beer Volume is sold in cans. This isa function of the high skew towards mainstream beer while premium beer, primarily packaged in cans or non-returnable bottles, is still small. Despite being the cheaper package format, returnable bottles provide high profit margins as they are reused 8-10 times with the initial investment capitalized instead of expensed. Figure 38: Can packaging i low in Lata 19% 10% 17% TH 36 hm 4m 1m a mH Om OCEELISEES POEEE EI Soe: Company dla ‘The dominance of returnable bottles ereates high barriers to entry, as itrequires a strong distribution platform, SABMiller has been steadily inereasing directKomal Dion (420) T1343085 Komal ahllnemorgan.com Europe Baty Research J.PMorgan CAZENOVE distribution in LatAm. In Colombia and Peru, about 70% of SABMiller’s beer is sold directly by the company (in line with AmBev's beer operations in Brazil), while another ¢.20% is sold through “associated” or “complementary” distributors. ‘Therefore, around 90% of SABMiller's beer volume sold in Colombia and Peru is effectively directly distributed, Table 38: SABMiller has been increasing direct sales delivery, percentage of outlets covered direct FW Fis Parana Tie a Salodor 58% 3% Pen oe 1% Honduras a 75% comb ar ean Fsvator 30 0% ‘Sauce Company daa ‘SABMiller also has a very successful telesales function in LatAm, which augments top-line growth, An increase in direct distribution has led to higher top-line growth through more “up selling” as well as higher margins as distributors and wholesaler ‘margins are retained in house. ABI has similarly been successfully driving margin expansion through greater direct distribution in Brazil Strong cash flow and returns ‘Seven of SABMiller’s top ten global breweries (based on KPIs including sustainability, productivity, quality and costs) are located in Colombia and Peru, Operating cash flow in SABMiller's LatAm operations has increased materially in recent years with an average of nearly SI.Sbn per annum. In FY15, operating cash flow to EBITDA amounted to 60% in LatAm, We expect operating cash flow to have slightly deteriorated in FY16 given currency headwinds and lower profitability (EBIT margin -SObps and EBITDA -90bps).. Figure 38: SABMiller LatAm operating cash flow Figure 40: SABMiller LatAm retum on assets at ws os mm ‘ id fens ees ws epee eres a a a a Seu Congr la, Neg sina Soc Caner Strategy shift from value to volume Looking forward, SABMiller was aiming to increase focus on beer volume growth in the region through affordability (bulk packs, price restraint or reset) as well as inereased frequency of consumption. With low-income consumers being a key part of SABMiller’s market this strategy was starting to work and beer volume grew by 6% in FY16 ater three years of low single-digit growth. This focus on volume growth through limited price increases was expected to be largely offset byoral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE premiumisation of the portfolio through faster growth of international and local premium brands, boosted by innovation. Affordability remains a key issue for consumers in LatAm, SABMiller estimated in 2015 that, atthe lowest socio economic level, 6 hours of work was required to afford 500ml of beer in Honduras, 2 hours in El Salvador and 80 minutes in Colombia ‘versus 18 minutes in the U.S. While macroeconomic growth is leading to better living standards, the company expects lower socio-economic levels (D&E) to ‘comprise nearly 80% of the population in LatAm even in 2020, SABMiller has had success in its bulk pack strategy with less than 0% cannibalisation and sustained profit margins despite 20% discounts Table 34: LatAm population spit by socio-economic level Socioconanie Hi} as 7 73 cy 7 3% co % 5% ~ c % m 10% De 18% 19% 1% D 2h 2h 2% E 3 a 35% Tota 100% son 003, ‘soe Conan dala ‘The drivers of this leg of the strategy were increasing frequency for the same cccasion (through detailed tracking of consumer patterns across channels and ‘occasions), creating new occasions for beer consumption, increasing convenience of obtaining products and breaking dawn barriers by appealing to women. Women still account for well below a quarter of beer consumption in key markets in LatAm. SABMiller was striving to make beer more appealing to women through smaller packs, more choice, targeted marketing and mainstream pricing. Table 35: Female consumers are key target for brewers in LatAm County ‘Wren bear par Fe ‘eran 7 Params 2 Brat a ecco % Camila i Pon ® Agena v Eeieder 8 Honduras 3 Sahar 3 Premiumisation through international and local premium brands was a key pillar of growth in LatAm for SABMiller. The table below details the price ladder SABMiller used to help consumers “trade up”,oral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Table 36: SABMile LatAm brand price ladder 2 tr Supe retan Graseh NRE 50 255 Pom. RB 330 22 a NRE 358 190 Lal rium | Cosquena B20 v8 Cuscuena es t000 14 Upper aisteam Pisen Calo R620 110 ‘rouigena, San Juan, Tele Re20 15 Backs oe B20 103 Vsinsrean cist R650 +00 Cesta 5 1100 ae Crs 8 s000 ast sonar Fess 5620 a7 ‘Suc Company oe However, the premium and above beer segment remains small across most of LatAm, In the international premium segment, SABMiller concentrated its efforts on Miller Lite and Miller Genuine Draft (and broadly withdrew efforts behind Peroni) in the region. For ABI we would be wary of assuming material incremental revenue growth in COPEC as the initial push would be to replace SABMiller’s international premium brands with ABI’s premium brands, such as Budweiser and Corona. The real uplift ‘would come as ABI builds out the premium segment in these countries, which can take a few years as evidenced by gradual progression in Mexico and Brazil Figure 41 Premium and above beer remains small-scale in LatAm ‘20% 100% 20% 60% 0% 20% EOP P OPI SPOS ‘Economy Mainsveam «Premium & Supeprenium Sous Company deta Based on relatively low levels of per capita beer consumption (45 liters in Colombia and Peru vs 67 in Brazil), positive demographics, supportive economic conditions, and an emphasis on improving the affordability of beer, SABMiller forecast medium- ‘erm volume growth of 3-6% in this region at its June 2015 seminar with revenue per bi growth of 2-4% and margin expansion of 10-30bps. 7Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 Figure 42: Colombia beer pee versus GDP growth J.PMorgan CAZENOVE Figure 43: Peru beer pee versus GDP growth xf OP PPPEPIPOR PEER EES seu: Pia Lage FEOESOPPOEPOP PEER R RS Save Pes Lele ABI Beer Brazil and Mexico versus SABMiller LatAm ‘While margins are high across the region compared tothe rest ofthe group there is still a significant gap compared to ABI’s margins in comparable LatAm markets, which we think reflects the degree of maturity of the revenue pools, ABI's greater in ‘market scale (AmBev's Brazil beer business i 4x the size of Colombia), but mostly we think reflects the fact that AmBev/ABI has been ing margin improvement across the LatAm platform for longer. We see no “structural” impediments for SABNiller’s margins to reach AmBev's in Brazil with the posi of volume growth, pricing power, retumable glass-bottle markets, unconsolidated retail tiers and rho constraints on access. AmBev took a beer business in Brazil and across the region from EBIT margins in the mid 20° in 2000 to high 40%s today. SABM took a ‘margin in LatAm from the mid 20%s to now high 30%s, but there is more to go. In the table below, we have compared ABI’s Beer Brazil and Mexico operations to SABMiller’s LatAm business, We would keep a few things in mind. 1. ABI’s Beer Brazil business has greater scale, selling 85m hls of beer versus ‘SABMiller's LatAm business selling 46m hls and ABI’s Mexico business selling 42m bis, ABI’s Beer Brazil and Mexico businesses have greater scale in a single market ‘whereas SABMillers is split between Colombia, Peru, Ecuador and Central America 3. SABMiller’s LatAm business has a higher market share in its largest market (Colombia at 98%) and, indeed, in its other two major markets (Peru at 94% and Ecuador at 97%) versus ABI’s Beer Brazil at ¢.70% and Mexico at ¢.60%,oral Dion (aaa rise 580s formal cillonpnorgan com JPMorgan CAZENOVE ‘Table 37; ABI Beer Brazil and ABI Mexico versus SABMiller LatAm key financials, 2011 to 2015 calendarised Sion oi we mE 7 aS CAGRinargin parson Voki mi ‘Blbeer Srzt 6 a s o 8s 02% sont m a 5% 2 DBI Mois 38 3 2 45% gow a &% S220 Lata beer a 8 a « a8 1%. son o% os 1% cf Priclmix ‘beer Brezt 1 2 m 26 2 22% sown 108% o% e% 10% BI Meio 2 19 95 20% son a 20% S23 Laan ro 12 13 1m “16 23% som cf o% 1% 11% Sale ‘beer Brzt 15658 1598 18407 sa nat 2% sromh 28 5% 11% 10% BI Moi 4388, 458 asst 20% ont 1% 18 SAS Lala 0 580 5758 sie 5350 09% roms ‘0% 1% o% 7% ear ‘Bl beo Brack 7484 88 2.100 aan oe a margin 48% A154 404% 460% 4558 2 ABI Mis 557 17 670 38% magn 323% 88% 23% 2 ABH Lata sis61 19 2.067 ai “632 55% rain 302% 28% 169% 260% 361% ‘er EaiTDA ABI beer Brat ez sats 10228 sam 12038 00% nan 24% 29% 550% 528% 50% 0 ABI Mois 1940 2.188 2006 7% agin 418% 3% sas oe SAB Lata 201 2388 2502 2595 2306 22% margin 4m 419% 424% ae 43% 200 DBAto: ABI beer % 5% om o% ™% BIMonee o% om *% SASH alam 10% os ae m% ™% Sur: Crp dla Of the total $1.65bn of synergies, we estimate over $700m will be generated in COPEC, This reflects the scale of these businesses and the absence of constraints that ‘we see in SABMiller’s other regions on synergy capture, This level of synergy capture and with underlying growth would take SABMiller’s COPEC EBIT margin to 48.2% versus current 36.1%; implying 1200bps of margin expansion and taking it above AmBev’s Beer Brazil margin of 46.6%. We therefore believe there is limited to.no upside to our assumption, Colombia (5% of enlarged ABI) In Colombia, SABMiller has a near monopoly with over 98% market share in beer. In total alcohol, the market share is 66% with the local spirit, Aguardiente, ‘comprising over 20% of alcohol consumed in the countryoral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Figure 44: Colombia sleohol market share by volume, 2015 otter Fun ™% auartonta a ‘salir beet 35% Sess Company data ‘Skew towards mainstream SABMiller’s portfolio in Colombia is skewed towards mainstream beer, with brands such as Aguila, Poker and Costena, which account for nearly 70% of total volume, Upper mainstream brands such as Aguila Light and Pilsen, account for nearly a quarter of the portfolio while premium (Redd’s, Miller Lite, MGD, Club Colombia) is small at ¢.6% of total. Table 38: SABMiler Colombia brands by price index Sg rt rn Super Pea SH NGO, Pra Grek Pronum 14190 Redd’, Mile Lie, Ci Colonba Uppe: mainstoam wett0 ‘guia ight Pen Cesta Mainstream 100 ‘ula Poker, Costena Eeanary a ola Pea ‘Seon Company data Poker in the mainstream segment is the largest beer brand in Colombia with over 40% volume market share. Aguila, including Light, is similar in size. In the soft drinks segment, Pony Malta brand is key for SABMiller and accounts for ¢.12% of non-alcoholic beverage value in Colombia, Recently, the brand has been adversely impacted by negative publicity. Figure 45: SABMiler Colombia portfolio by brand tars wh Pieen ee Poker wh ‘aul Lone 24% ‘guia Classe 15% Soe Company dleoral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Ongoing premiumisation In recent years beer volume growth in Colombia has been driven by the upper mainstream and premium segment, while mainstream volumes have been in decline. By brand Aguila has ceded share to more premium Aguila Light while Poker has ‘maintained its dominance. This is in line with SABMiller's stated strategy of premiumisation in the region, Figure 4: SABMIllr Colombia beer trend by segment Figure 47: SABMiller Colombia beer trend by brand 0% 100% 0% co a ae " oe Premium 7 Pan 70% 20% om 50% = Aguila Light 50% aioe ean 10% am coe = Agila Clase oom canshean 20% Poker a 10% 0% 1% o% mo mame me ais 20 Sear: Crpny dla Sauce: Company sa Acthe premium end, SABMiller’s Club Colombia and Redd’s brands have lost share ‘o Miller Lite and Budweiser, At the super premium level, craft beer is gaining share in Colombia and now accounts for about a third of the segment, Miller Genuine Draft has gained share atthe expense of Corona, Heineken and Peroni Figure 48: Colombia premium beer by brand, 2011 s 2015 Figure 49: Colombia super premium beer by brand, 2011 vs 2015 we mer gromun om omer 0% oom ro = Buowsser 0% Peal oom oom =p soe smitorLe so on hen un sisioteo 30% 0% corona 20% cnn cotta 20% om o% aon 2018 at ans Sear: Carpal Sauce: Company a Distribution is largely direct SABMiller directly serves ¢.250k of a total of 365k outlets in Colombia. By 2020, SABMiller had intended to inerease direct distribution to 80% and reduce other third party distributors to 12% of outlets, nKomal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE AmBev currently directly distributes to ¢.70% of outlets in Brazil Figure 50: SABMiler Colombia distribution is moving more towards direct 00% so% 20% 70% oom 50% a0% 20% 20% 10% o an 8 Ey DSD =DSD compeeriary mOther Sess Company data Traditional retail dominates ‘Traditional on-trade remains the key channel for beer consumption in Colombia, accounting for over 70% of volume. Traditional off-trade comprises a quarter of beer consumption, but is growing in importance and expected to be a third by 2020. ‘Modern trade, both on and off, is small and while itis growing from a small base the ‘company expects it to account for only ¢.6% of total beer consumption by 2020. Figure 1: Beer channel volume mixin Colombia 7010 ws 00 Son Company dla Significant improvement in financial results ‘SABMiller as significantly improved the financial performance ofits Colombian ‘operations. Between FY 10 and FY 14, price/mix increased by 9%, which, along with reduction of costs, resulted in 640bps EBITDA margin expansion to $1.7% in FY 4. Lower capex and focus on reducing working capital led to FCF conversion of nearly 70%; marking 1200bps improvement between FY 10 and FY 14.Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 JPMorgan CAZENOVE Table 88: SABMiler Colombia summary financials indexed to FY10 Fig Fi Fiz Fi Fie FY change PRAT 0 7" 78 105 18 * Coste: Total etandard cost ‘00 8 6 a ® 51% Oistbvtnn cos ‘00 00 ® a a 3% Fuad costs 00 2 rs a 38 0% EBTDAmagin 463% 480% 109% 507% 517% tops EBITDA 00 a2 ” a ‘3 31% ‘cashflow (Cape cashfow 8 ® n @ “8 19% (indexed 0 #09) FoF / BMD 588 a oa 5% a 200s Sur: Crea dla Peru (4% of enlarged ABI) ‘Similar to Colombia, beer takes the largest share of alcohol consumption in Peru Nearly two-thirds of alcohol consumed in Peru is beer, while wine and spirits comprise 7% and illegal alcohol is an estimated third of total alcohol consumption. Figure 62: Beer has the largest share of alcohol in Peru egal cot 31% Bowe Wines 52% Ti Sess Company data ‘SABMiller has a near monopoly in the beer industry in Peru as well, with 94% ‘market share, Between FY07 and FY14, SABMiiller increased volume at a 6% CAGR, sales at 10% and EBITA at 14% in the country. noral Dion (aaa rise 580s formal cillonpnorgan com Europe Eau J.PMorgan CAZENOVE Figure 53: SABMiller revenue growth in Peru averaged 10% driven by beer volume growth 0% wh we wh 0% o% 6% % w% o% a Foe 8 Fro Fi Fa FI SBNABS mBeerprice/mix m Beer! Sue Company data Key brands ‘SABMiller’s key brands in Peru include Pilsen Callao (which accounts for over a third ofthe portfolio) Fiesta in the economy segment, Cristal in mainstream, CCusquefia in premium and MGD and Peroni in super premium. Table 40: Beer brands by price ladder in Peru Supa preva TMGD, Pare Pron % Budi, Cusquens Upper maisteam Backus le, Lowen Sau, Piken Callan Mainstream a Csi, Tuo, requpens San usn Eeanary <0 Feta, Gata ‘soso Company dala Shift towards upper mainstream ‘SABMiller has built out the upper mainstream segment in Peru from scratch through bbrands such as Pilsen Callao and Backus Ice. The segment now accounts for nearly a quarter of beer consumed in the country. Economy beer's share has fallen from 11% in FYO7 to 5% in FY14, while mainstream is down to 62% in FY14 from 87% in FYO7, Premium remains a small proportion of beer consumed in Peru at 9% in FY 14. ‘The super premium beer segment is de minimis in Peru,oral ilon Europe Equity (420) T1343085 so onoder 2016 Komal ahllnemorgan.com J.PMorgan CAZENOVE Figure 54: Peru beer volume evolution by segment ‘10% oe = Superrenin ao 10% Premium 0% 0% “Varsteon 0% sVairstean 20% * sconamy 10% o% Fr Fria Fv Fit Sous Company data ‘Traditional trade dominates ‘Traditional on- and off-trade continue to dominate beer consumption in Peru with nearly 60% market share, Modern trade is small at 4%, SABMiller directly covered "74% of channels, while the company’s associated distributor covered an additional 16% of outlets resulting in 90% of outlets effectively directly served by SABMiiler. Figure 55: Peru beer volume by channel, 2014 {ae & Cary. 2% Whales, 138 Trina orate, 3% Assad ddstibutr, 15% Evens, 7% Modem rade, 4% “rao on rade, 2a Son Compan dla High profitability with significant cost reduction in recent years ‘SABMiller’s margins in Peru are very high given the high market share and focus on costs in the past decade, We estimate EBIT margins are ¢.30%, The most significant mprovernent has been in fixed costs that declined by 1200bps as a proportion of sales between FY07 and FY 14, This led to 1000bps margin expansion. 8(ean risesaes ‘once! 2018 JPMorgan CAZENOVE omaldilondserongan om Table ét: SABI has increased Peru margins by 1000bps a arate cote a_i a ark 2% Marketing 1% Bw Camus sed cots ee ee ee Other fed cats % Maa EBITA 0% wea ‘Sse Company tala Figure 5: SABMiler cost breakdown in Peru, FY14 Mise Marina Vaile product cas ter fnad costs 2% om Vale sey cost Cunubave feed 2% cos ‘fer vt costs re % Soe: Compan dla SABMiller also focused on cash, with working capital now negative and operating cash flow growth of nearly 400% between FY07 and FY 14 with cash flow conversion improving from 24% in FYO7 to 53% in FY14.oral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com Africa (9% of profit) ‘© Affica will account for 9% of enlarged ABI’s profit in FY17E, on our estimates. Given faster growth as well as synergies in the region, we expect the contribution to increase to 11% by FY20E. ‘© SABMiller’s Affican business consists ofits dominant positions across much of the south and south-east of the continent. The largest profit contributors are South Arica, Tanzania, Nigeria, Botswana, Mozambique, Uganda and Zambia, The business also includes associate income from its 20% stake in Castel, which ‘operates predominantly in Francophone Africa. ‘© In recent years volume growth has been driven by soft drinks at high single digits, while beer growth has been lower at low to mid single digits, Price/mix has grown by mid single digits, resulting in overall net sales growth of 9% in FYIS and 11% in FYI6. ‘+ SABMiller’s organic EBITA increased by 6% in FY15 and by 11% in FY16. Margins declined by 7Obps in FY1S and by 40bps in FY16, ‘+ InFY16 (ending March), SABMille’s key associate, Castel, experienced very dificult trading conditions in its key market of Angola, where lager volume declined by 18% (otal beverage volume -19%) due to challenging macroeconomic conditions, 3% curency devaluation and lack of access to hard currency. Caste impaired its assets in Angola and scaled back materially in the country. Excluding Angola, Castel’s volume increased by mid single digits (in line with SABMiller's subsidiaries), driven by double digit growth in the Congo, Madagascar and Burkina Faso, Castel’ total beverage volume declined by 1% in FY16, which was offset by 7% growth in price'mix resulting in 6% net revenue growth, ‘+ InQLI7, SABMiller’s Affica organic volume growth slowed considerably to flat (ona 4% comp) post 6% in Q416 (comp 9%). Lager volume declined by 1%, while soft drinks grew by 3%. Lager volume decline was driven by a -16% fallin Tanzania and -12% in Mozambique, offsetting growth of 12% in Zambia, 36% in Nigeria and 2% in South Africa. SABMiller’s price‘mix growth remained intact at 6%, resulting in net revenue increasing by 6% (South Africa 6%, rest of Africa 9%). Caste’ volume declined by 4%, driven by Angola, excluding which volume, would have declined by 3%. Castel’s net revenue grew 1% (4% excluding Angola) implying price/mix of 59%. We expect challenging trading conditions to continue in key markets in Africa over the next 12 to 18 months. ‘+ We expect continued pressure in the short term, but, in the medium, term we believe the region can deliver mid single-digit volume and priceimix growth resulting in low double-digit sales growth. We expect underlying margin expansion to be subdued but synergies to result in 960bps EBIT margin expansion between FY15 and FY20E. This would take EBIT margin to 36.1% in line with ABI’s margins in North America, Background ‘SABMiller's African business consists of its dominant positions across much of the south and south-east ofthe continent. The largest profit contributors are South Africa, Tanzania, Nigeria, Botswana, Mozambique, Angola, Uganda and Zambia.Sane someone JPMorgan CAZENOVE Komal ahllnemorgan.com ‘The business also includes associate income from its 20% slake in Castel which ‘operates predominantly in Francophone Africa In South Africa SABMiller has @ dominant position in the local beer market (90% market share) and in soft drinks (through Coca-Cola Beverages Africa). ABI has agreed to sell SABMiller’s 27% stake in Distell Group, a spirits wine, cider and RTD producer, within three years, Within the South African Beverages division, beer accounts for ¢.80% of operating profit and soft drinks ¢.20%. In 2015, SABMille’s associate income from Distell was c, $50m, accounting for 3% of SABMiiller’s Arica EBIT (ic. of operating profit + associate income). SABMiller effectively has a monopoly in the mainstream segment and, with the disbanding of its sole competitor ~ Brandhouse, the joint venture between Heineken, Diageo and Namibian Breweries — in 2015, has further established its stronghold in South Affica. Brandhouse had a strong position in the premium beer segment with its brands Amstel (wihich was previously owned by SABMiller), Heineken and Windhoek. Brandhouse’s position was further strengthened by the inclusion of Diageo’s spirits brands in the joint venture, In South Africa Heineken now operates via a JV with Namibia Breweries SABMiller entered Tanzania, Angola, Mozambique and Zambia in 1994 as breweries ‘were privatized, In 2001, SABMiller formed a pan-Asican strategic alliance with Castel. More recently, SABMiller has expanded into Nigeria, South Sudan and North Africa via Castel Coca-Cola Beverages A rica (CCBA) began operations in July 2016 and covers nearly 40% of Coca-Cola bottling in Arica with operations in South AMfica, Kenya, Ethiopia, Mozambique, Tanzania, Uganda, Namibia, Comoros and Mayotte. CCBA, is currently (post Phase I) 54% owned by SABMiller, 34% by the Gutsche Family Investments and 12% by The Coca-Cola Company. Phase II is expected to be completed in the next 12 to 18 months and will include SABMiller’s soft drinks bottling operations in Swaziland, Botswana and Zambia, There are significant minority and associate partners in SABMiller’s Africa platform ‘The contribution of Aifica’s EBITA to SABMiller’s bottom line was partly offset by Castel’s 38% minority stake in SABMille's owned business. SABMiller’s Arica division included the fully consolidated businesses where SABMiller has equity and/or management control. Here there are some significant (20-40%) extemal ‘minority shareholders (and in some cases SABMiller was a minority shareholder but consolidated the asset by virtue of voting control, eg. Botswana, or Board representation, eg. Lesotho). In addition, SABMiller had associate stakes in bbusinesses in Zimbabwe as well as the direct 20% stake in Castel itself.Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE Table 42: SABMiler’s subsidiaries in Arca, FYI6 Soba County of neerporation a Sake Shae ca TNetbands oking company cas ‘SMe Botswana Nethtand Hokina company 2% ‘ew Boway Ue Brows son Cervas de Maganbique SA Brewing 20% raft Beverages Le Brewis Bo Iiematonal Brewers le Brewing B% Kgalged Stowe (Py Ls Browralsot eiks ne Nie Breweries ia Ugand Brewing 2% Tancania Sones Lis Taneania Brewis Bo ‘The Souh ican Breweries PyjLié South Aiea Brewing Holing company 100% Zanban rowers ple Zonbia Brow Set craks 8 eur: Carga We believe the incremental profit growth in recent years has been largely driven by ‘Nigeria, Mozambique and Zambia, SABMiller has rapidly gained market share in ‘Nigeria having entered the market with a regional and lower value approach only a few years ago. SABMiller typically had a target market share of 20-25% when it centered a new market. Given strong 30% to 40% growth for SABMiller’s brands in a market growing at low to mid single digits in recent years, we calculate SABMiller's market share in Nigeria to be nearing 20% now. After a few years of remarkable growth, SABMiller's associates (primarily Castel) in Africa have faced material challenges in the past 2 years and profit has declined by 19%. This was largely driven by significant decline in Castel's key market of Angola. estimated Afica EBIT spit by market FY16 South tia beer a Save dooney. Mogan sats SABMiller's associates in Affica are its investment in Castel, in which it effectively has a 20% stake, as well as Delta in Zimbabwe and Distell in South Africa. As part of the regulatory approval process in South Africa, ABI has agreed to dispose of the stake in Distell within three years. ‘Table 43: SABMiller associates in Aca, FYIS Faroe County of Hay ‘ake Incorporation ‘BH Srasaree latina Patg Dt ‘Gort tng eaipany fr subsicis prepaly oaedin Aca ae Soa des Brasaris at Glass Inlematonales SA Faroe Holing company for subsidiaries pray lrsedin Arca ax I SrasaneetarnabonaeHoteng (Argel) Lis Goratar Browralsot eiks a Data Coporsion Lis Zimbabwe Brewrgor einks 2% Dist Gu id ‘Sou Aiea Wings are sis 2% Source: Cry dts 8Sane someone JPMorgan CAZENOVE Komal ahllnemorgan.com SABMiller and Castel have complementary platforms across Africa In 2015, Castel beer volumes were 29.5m hls according to Plato Logic. The largest markets for Castel beer are Angola (which has been the key challenge in recent years) and Cameroon, with significant soft drinks and beer exposure also in the DRC, Ivory Coast, Tunisia and Ethiopia. ther major brewers on the continent are Heineken and Diageo. Heineken and Diageo are the incumbents in the key beer profit pool of Nigeria, where Coca Cola Hellenic Beverages is the Coke bottler. Heineken also has leading positions in DRC (beer and soft drinks) and Egypt and through its partnership in Congo. Diageo is a leading player in Cameron and Kenya (where SABMiller was aggressively fighting back after the breakdown of the effective East Africa “non compete” when Diageo entered Tanzania in 2010 with the Serengeti Breweries acquisition). Diageo and SABMiller also compete in Ghana and Uganda with Diageo now in beer in South Sudan and Ethiopia, while it has set up subsidiaries in Angola and Mozambique. Heineken and Diageo dissolved their partnership, BrandHouse, in South Africa in 2015 enabling SABMiller to gain market share (already above 90%). We note that Castel/BGI carries Guinness and other Diageo brands in West Africa, In the table below, we show key metrics for the major beer markets in Africa. The markets where SABMiller has a presence are marked in dark blue with Castel/BGI's ‘major markets marked in light blue and those where both companies are present in rey.(can rise sees J.PMorgan Scrat entonigogen.com Beer Forecstvolume Lites par’ GDP par GDP growth infiation ate ——_Popuation consumption growth CAGR capa capita 20156 000enis——_2015F-2020F 2aise ppp 2015E 20158 20150 2015, Tae Tar a TT Te Tr =r Tar a as 7 a aim Taz 4607 570%, mas 5 30% 103% 250 oaa7 a wT m8 cr 2 Ey as. say 52 25 sex 0.1% sea 438 sar 108 516 sm 66% 464 asr am 59 a eon 10% m3 seu 524% m 30 10% 56% 5 ett He 85 519 50% 52% ey) 2m 707% 03 mt eam, 30K maa Congo 2353 250% 205 a8 20% 20% 4 ote atvcire 212 90% 87 36 ea 12% ar hana 2160 9% a2 et 39% 172% a8 auund 700 00% 166 "a8 25% 56% 112 Tunisia an at 188 250 oy 49% ma Nambia 1599 4aD% 265 2a ers a 25 wanda 1469 516% 132 82 c 25% 18 ‘cabon 1500 203% ma 3Me 39% oa “7 Zimbabwe 1381 ra 45 oy 1% 28% 158 ‘Burkino Faso 1397 679% 13 ar 40% 10% 184 Zambia 1561 ses ‘00 x8 32% 101% 182 Algeria 4395 1.08% 36 340 39% 45% er Madagascar 1207 596% sa za 30% 14% m2 Ent 121 18% 1A 198 8% 0a a8 Benin 1098 550% 102 ar szH 03% 109 Moroeeo 734 20%, 24 sats 44%, 18% ua Botewans 6 ast ua 4403 3% anh 23 Togo oe 45% 7) x 55% 1% 13 cond os 0% SA mt 18% 36% uo Suter «0 055% 10 : 2% 169% 402 ‘South Sudan 54% 528% Lesotho s a7 2 519 36% 32% 2 Maurits ms 150% 251 aa 36% 13% 13 Maan 286 s70% 18 s1% 212% m2 Senogal a 320% 20 4% oa 181 ‘swanlind a 21% ns 25% 50% 13 Sea Leone 2 500% 3 16% 50% 65 Mali 10 58% 12 78% 1% 18 ines 460 595% 4 oy. a2 28 ‘Cental Aen 8 298%, 2 54% 49 Republic Niger 8 330% 05 = 3% 10% 9 ‘cambia eS 2a 16 a 6% 20 Seu: Pia Lae, CIA We Fetch Company JP Mogan eos(ean risesaes ‘eouoter 2010 JPMorgan CAZENOVE Komal ahllnemorgan.com Figure 68: SABMiller and Castel footprint in Africa sraene Castel SABMiller SABMiller/Castel SABMiller associate Sears: Company dla Castel is facing challenges Since 1995, Castel beer volumes have grown at an average rate of 8%. Castel is the world’s 10th largest brewer and is bigger than the beer businesses of Diageo and Anadolu Efes.Komal Dion (420) T1343085 Komal ahllnemorgan.com so onoder 2016 J.PMorgan CAZENOVE ‘The oil price decline in recent years has led to very challenging conditions for Castel in its key market of Angola, In FY16, SABMiller recorded an impairment charge of $372m against its associate investment in Castel in Angola and a further $110m ‘impairment as SABMiller’s share of Castel's impairment. The operations in Angola have been materially scaled down following significant devaluation of the currency and lack of access to hard currency. SABMiller also made a provision of $20m for Joan guarantees in Angola, Figure 59: Castell beer volumes 1992-2015 mis 000 15% sao 0% 3000 cao 5% +8000 ™ ‘oo00 too % 0 0% Se i age Very high market shares SABMiller’s market shares tend to be very high across the region. In its key markets, ithas quasi-monopoly positions in Botswana, Mozambique and Zambia and leading positions in Tanzania and Uganda, with market shares of ¢.75% and c.60% respectively. In Nigeria we estimate SABMiller now has nearly 20% market share. Volume growth opportunity Despite strong growth in the past, there still appears to be a material long-term volume growth opportunity across Africa outside South Africa, Per capita lager beer ‘consumption in Africa is only 11 Ipa versus the global average of 27. However, total alcohol consumption is comparable to other regions, with 80% of alcohol ‘consumption in Africa being of “informal” products. Figure 60: Significant headroom for beer in Africa 2 2 0 Y 6 8 2 < £ Es 8 ‘ a 2 5 ° 0 Ghd "Uganda Tnzaria—Nige ‘cao Boer er acct PCC Soe Company laoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com We therefore see an opportunity to trade consumers up from traditional alcohol into beer by making it both more affordable (through new products, often using local grains, and increased price compliance) and mote appealing (for example, increased cooler penetration). Beer consumption will also naturally benefit from rising disposable incomes, However, historically, geo-political volatility in the region has materially impacted growth in one or more countries. In the quarter to June 2016, SABMiller’s volume in ‘Tanzania fell by 16% and in Tanzania by 12%. Affordability is the issue As described above, aleohol consumption in Africa is not low ~ it just largely takes the form of informal alcohol, This is not due to a preference for these forms of alcohol, but rather to the lack of access to affordable lager beer. SABMiller was addressing this by: ‘© Increasing prices at less than local inflation on mainstream products, ‘© Pack innovation (eg. smaller packs to get down to accessible price points), ‘+ Increasing use of local grains (sorghum and cassava), and ‘© Promoting opaque beer (e.g. Chibuku). Figure 61: Hours work required to buy 800ml of ber, 2014 7 CS POPPIES CF Sess Company data Successful use of price ladders Castle and Carling Black Label are SABMiller’s largest brands on the continent; each accounting for nearly 20% of the portfolio. Castel Lite has been gai prominence since the early 2000s and now comprises 11% of SABMille’s African portfolio,Komal Dion (420) T1343085 Komal ahllnemorgan.com {0 october 2016 JPMorgan CAZENOVE Figure 62: Volume trend of SABMillr’s thre largest brands in Arca aoe oom 40% 20% o% 20% sayy | zis 2008 2007 2008 2ne «OHDOT aS OHS Costs ite | Caring lack Label (Aca) — Caste Lager So: ao Table 45: SABMiler price ladder in Atica TEtanang forint coaows Cass Ula Live, Cub handy, Fyng Fah >SiZ0 Promiam mie Coste Lie, Peroni Ndow, MSD, Caste Draught >$1.20 Core lager Her, lus, Saar, Casta, Konya sprts si0 ‘tory hve, Ima, Eagle $075 Henatrow 3150 ‘Ss Company ae With lager beer being an expensive product for the majority of African consumers (at average retail prices of around $1 per bottle), SABMiller has been further increasing the provision of alternative products. The closest substitutes are produets that look and taste very similar to lager beer, but in fact use local grains such as sorghum or ceassava (often with some barley to stabilise the product). The Impala brand, with its core market of northem Mozambique, is priced at only 75% of mainstream lager beer, bbut the margin is similar. This is largely because the product's 70% cassava content affords it favourable tax treatment. Further down the pricing spectrum is opaque beer, which is made of sorghum or maize, and where SABMiller’s major brand is Chibuku, This is available at only 50- 80% of the price of lager beer, but the margins are attractive (probably higher in percentage terms than on lager beer), and the returns on invested capital are very high given the low capex requirement. SABMiller has been increasing the range of products available in this category by using PET packaging. This is not only a more attractive package for consumers than the traditional eartons, but, more importantly, inereases the shelFlife of the product. Given the logistical challenges in African markets this increased the potential consumer audience for the product. Table 48: SABMile’s strategy for Chibuku in Africa eae a pgp Ser Dragn Ctr PET TH Caton iecatan os Super ‘wPeT oe ‘Sous Company data Investment level is stable Although some of these investments are ongoing, SABMiller has completed a large part of its heavy investment in Africa. Five years ago it was close to full capacityoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com across much of the business and at 85-90% utilisation overall. Ithas since invested in all markets and is now, we estimate, at around 70% utilisation, Moreover, its new investment has been designed to allow for further expansion at much lower incremental cost. Table 47: SABMiler capacity expansion plans in Africa, 2015. cc Ngora 20 Under Namba 40 Greet commissioned Sept Zaria, ‘ Commissionod gay 2015 Ugands [0 Conmssiond 013, hana 500 Gonmissoras Otis South Aiea ‘8 _Conmiseioned Jun 2015. ‘Sous Company dla New breweries are a big part of the regional capex bill Ata cost of $100 per hl, the intial size of African breweries is between 800,000 and Im hl, Four new breweries would therefore imply a total initial investment of between $320m and $400m. This compares to total capex average of ¢-$600m p.a. nce 2011. The remaining ($200-280m) capex would be a mixture of other expansionary production capex (ie. expanding the size of existing breweries, which is much cheaper than building a new breweries), investment in coolers to increase the availability of cold beer and drive topsline growth, and maintenance capex. Figure 63: SABMiler Africa a0 70 0 0 00 0 20 ‘00 ° apex trends rio FM FY FIG FY FYIS FYI copes —Caperto sles Source Company data Costs and supply SABMiller’s "Go farming” initiative has helped reduce the percentage of raw materials imported from 80% to 66%, with the ultimate objective being 46%, The main advantage here i often not cost, which (for barley) is broadly equivalent to imports. Instead, itis more favourable duty rates (eg. in Uganda), greater security of supply and greater stability (with forex volatility removed). Engaging local suppliers also helps politically with debates over duty levels, Some opportunities to move to local supply, for example for cans and glass bottles in Angola, are more about cost reduction, SABMiller was further improving efficiency in A\ffica by bringing the operations up to group standards, which was reducing costs and improving the effectiveness of functions such as marketing by moving to a more standardised regional approach.oral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Significant currency devaluation over the past 2 years has resulted in margin erosion though SABMiller has succeeded in containing this at -120bps. Figure 64: SABMiler Africa total costs as a proportion of revenue 19% 70% 71% 73% 13% 11% 70% me 1% 70% oo ro FFD FY@ YTS IG Sse Company a Mean sites We believe that there ultimately will come a point where economies of scale in the African business allow for margin expansion. This, we believe, will come when the cost savings achievable from expanding existing breweries outweigh the transportation cost savings of broadening out the brewery footprint. With the SABMiller breweries now at technical capacities of ¢.3m hl —and with SABMiller hhaving the ability to expand them easily and relatively cheaply — the economies of scale once it reaches this stage should be material. Around 2m hi (so roughly twice the size of the new-builds) is enough to reach an optimal seal. However, judging when this tipping point is likely to occur forthe division as a whole is very difficult given the large number of diverse markets within the region as well as ongoing macroeconomic challenges. Guidance and outlook In total, SABMiller reported total Africa volumes of 96.4m his in FY16, with lager beer volumes at 50.8m his, soft drinks at 37.8m hls and other beverages at 7.8m hls. ‘Total net producer revenue was $6.8bn (including associates share) and EBIT was $1.7bn, implying margins of 25%. On a reported basis, EBIT margins in Africa have been gradually declining in recent years (-120bps between FY14 and FY16), primarily due to very significant curreney devaluation, In early 2015, given macroeconomic challenges, SABMiller provided medium term guidance for Africa of mid-single-digit organic volume growth and mid-single-digit, revenue per HL growth (at constant currency) resulting in net revenue growth of over 10%. Annual margin expansion was expected at 10-40bps, Over the past two years, top-line performance has been in line with SABMiille’s ‘medium-term guidance with total (beer, soft drinks and spirits) volume growth of S- 6%, price/mix of 4-5% and net revenue growth of 9-11%. In FY16 (ending March), SABMiller’s key associate, Castel, experienced very difficult trading conditions in its key market of Angola where lager volume declined by 18% (total beverage volume -19%) due to challenging macroeconomic conditions, "oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE 33% curreney devaluation and lack of access to hard currency. Castel impaired its assets in Angola and scaled back materially in the country. Excluding Angola, Castel’s volume increased by mid single digits (in line with SABMiller’s subsidiaries), driven by double-digit growth in the Congo, Madagascar and Burkina Faso, Castel's total beverage volume declined by 1% in FY16, which was offset by 7% growth in priceimix resulting in 6% net revenue growth, ‘SABMiller’s organic EBITA increased by 6% in FY15 and by 11% in FY16, Margins declined by 70bps in FY15 and by 40bps in FY16. In QLI7, SABMiller’s Africa organie volume growth slowed considerably to flat (on 4% comp) post 6% in Q416 (comp 9%). Lager volume declined 1%, while soft drinks grew 3%, Lager volume decline was due to deelines of 16% in Tanzania and 12% in Mozambique offsetting growth of 12% in Zambia, 36% in Nigeria and 2% growth in South Africa, SABMiller’s price/mix growth remained intact at 6%, resulting in net revenue increasing by 6% (South Arica 6%, rest of A\ica 9%). Caste!’s volume declined by 4%, driven by Angola excluding which volume would have declined by 3%, Castel’s net revenue grew by 1% (4% excluding Angola) implying priceimix of 3%, We expect challenging trading conditions to continue in key markets in Africa over the next 12 to 18 months, Table 48: SABMiler Africa summary P&L. Snilon Fis Fis Toner ae Lager aaats 803 Soteinks seat 51788 (Other latate 718 171 beverages To saga 662 ‘rg oti growth 35% 49% eam 20%. 52% 59% Netrovene Subediaes seo este Associates 1981 ie Tota raat 1482 ees ‘gai growth 23% 107% est Subse 1478 san saw rp 211% 287% 28.4% desocats 4m ny 381 rg 240% nas 210% To ‘1908 “596 “600 rg 22% a 50% Dis tosales sz 5A 57%. ‘So Comp fe While we expect continued pressure in the short term, in the medium term we believe the region can deliver mid single-digit volume and price'mix growth resulting in ow double-digit sales growth. We expect underlying margin expansion to be subdued, but synergies to result in 960bps EBIT margin expansion between FY15oral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com and FY20E. This will take EBIT margin to 36.1% in line with ABI's margins in North America, Structural impediments to margin expansion in Africa It is worth noting that margins in A fica are relatively low versus those in Latin America. We believe the key impediments to margin expansion in Africa remain: © A larger number of smaller markets, ‘© Poor inffastructure, Poorer consumers, ‘+ Lower sales per hectoliter value, ‘© High input costs due to underdeveloped local farming and industry, ‘© High cost of brewery construction, with the same cost applying to the (usually German) equipment but a higher cost of transportation and construction, ‘© Higher cost of maintaining a “licence to trade” in South Africa with greater price restraint in South Africa for political reasons and greater degree of value leakage to wholesalers and distributors. ‘© Distribution structure with less direct and more wholesale,Sane someone JPMorgan CAZENOVE South Africa (5% of enlarged ABI) South Africa (beer and soft drinks) accounts for over half of SABMiller’s profit in the continent. In South Africa, SABMiller has a dominant position in both the local beer market (90% market share) and in soft drinks (through Coca-Cola Beverages Arica). ABI has agreed to sell SABMiller’s 27% stake in Distell Group, a spirits wine, cider and RTD producer, within three years, Within the South African Beverages division, beer accounts for ¢.80% of operating profit and soft drinks ¢.20%, In 2015, SABMiller's associate income from Distell was c.$50m, accounting for 3% of SABMiller’s Africa EBIT (ic. of operating profit + associate income). SABMiiler effectively has @ monopolist position inthe mainstream beer segment and the disbanding of ts sole competitor ~ Brandhouse, the joint venture between Heineken, Diageo and Namibian Breweries ~ in 2015 has further established its stronghold in in the premium beer segment in South AMfica, Brandhouse had a strong Position in the premium beer segment with its brands Amstel (which was previously owned by SABMiller), Heincken and Windhoek. Brandhouse’s position was farther strengthened by the inclusion of Diageo's spirits brands in the joint venture. SABMiller’s old soft drinks business in South Africa, Amalgamated Beverage Industries, has been bundled into the new Coca-Cola entity - CCBA. Amalgamated Beverage Industries previously accounted for 60% of South African Coca-Cola sales. SABMiller had over 90% market share in carbonated soft drinks in is territories in South Affica, with the remainder split between Pepsi and other smaller players. SABMiller also had leading positions in Energy Drinks and Water Beer: the battle in premium ‘SABMiller remains unchallenged in the mainstream beer category in South Arica (hence its 90% overall market share), and is engaged in a longstanding fight-back in the premium category following the loss of the Amstel brand in March 2007. ‘SABM’s share of the premium beer category, which was as low as 53% in FY10, increased to 62% in 2013. The decline of Heineken's Amstel brand has been central to the improvement in SABMillers fortunes within the premium category and the ‘wider beer market. We believe that SABMiller has continued to gain share in the premium segment post the disbandment of Brandhouse in 2015. Figure 65: SABMiler's shar of premium beer in South Africa 2% 2% 0% 8% 5% 3% 52% 0% 40% Fro Fro ett Fre eva Sous Company dataoral Dion Europe Equity Research J.PMorgan Cazenove (aaa rise 580s formal cillonpnorgan com Beer margins are already very high In the past a portion of the savings from the Business Capability Programme (BCP) in South Africa has been reinvested into marketing. Going forward, we expect the ratio of marketing support to net sales should increase only gradually given ‘SABMillers key brands have been getting the right level of marketing support. ‘SABMiller's beer operations in South A\fica already make very high margins of, we estimate, ¢.35% at the EBIT level. There are structural impediments to margin expansion in the country given the higher cost of maintaining a “licence to trade” in South Affica with greater price restraint in South Affica for political reasons and greater degree of value leakage to wholesalers and distributors. Additionally, ABL has agreed to not involuntarily cut jabs for S years asa result of the transaction, invest ZAR bn to support local agriculture and jobs, continue SABMiller's Zenzele share-scheme and keep the regional headquarters in Johannesburg,Sane someone JPMorgan CAZENOVE Australia (3% of profit) ‘© Australia will account for 3% of enlarged ABI’s profit in FY17E, on our estimates, ‘+ SABMiller acquired the Foster's beer business at end 2011, In 2015, we estimate Australia generated S1.Sbn of sales on 7m his of volume and EBIT was some '8430m; implying nearly 30% margin. SABMiller’s Australian business has been adversely impacted by macroeconomic challenges that have resulted in volume declining by 1% on average between. FY13 and FY16, Organic price/mix has been positive 2% on average pa. driven by premiumisation and some price increases resulting in 1% average annual ‘organic revenue increase, Despite this, SABMiller has successfully expanded ‘margins ofits Australian operations by over 1000bps over the past 4 years, ‘+ Importantly, given the significant intangibles ($5.4bn) recorded as part of the Foster's acquisition, amortisation charges are very high at over 10% of sales ‘© Inthe medium term, we expect volume to remain under pressure in Australia but priceimix to continue to grow by low single digits to result in some revenue growth. We believe most of the $115m of AsPac South synergies will be generated in Australia, This would take EBIT margins in the country to high 30%s by FY20E or above ABI's margin in North America Background (On 16th December 2011 SABM completed the acquisition of Foster's beer business Cation & United Breweries (*CUB"). Itpaid §11.5bn (including assumed deb) Based on profit forecasts prevailing atthe time this equated to 12.7x CY2012E EV/EBITDA (pre-synergies), which was atthe high end of prior mature market transactions inthe sector. SABMiller recorded significant goodwill of S8bn on the acquisition, In terms of profit contribution, SABM's Asian division’s subsidiary profitability consists largely of the acquired CUB business with the Indian business only. ‘marginally profitable. (SABM also disclosed its share of the CR Snow Associate in its Group EBITA breakdown). In 2015 we estimate Australia generated S1.Sbn of sales on 7m hls of volume and EBIT was $429m; implying a nearly 30% margin Post-SABMiller takeover headwinds ‘Since acquiring Foster's SABMiller has had to cope with a number of headwinds including: ‘© The loss ofthe Corona licence and other smaller brands which will have cost between $75m and $100m on our estimates. ‘© Weak trading conditions in the Australian beer market with CUB’s volume (excluding Corona) down by -3%'-1%imarginally up in FY 14/15/16. ‘© Currency headwinds with the AUD declining by -119%i+7%'+18% in FY 14/15/16.(ean risesaes ‘eouoter 2010 JPMorgan CAZENOVE omaldilondserongan om Figure 66: Australia GOP per cap versus beer pee PEPLESLIESE ELSES LES LEE ten ps com peren So lage Beer market ‘The Australian beer market is effectively a duopoly between Japan’s Kirin with a 48% share and SABMiller with a 41% share. Per capita consumption is high at 70 litres despite consistently declining from near 110 liters in 1991. Looking ahead, beet consumption in Australia is expected to marginally grow at 0%-1% p.a, based on, estimates from Plato Logie. Figure 67: Australia beer pec is high at 70 litres re09 Sous Fa oc ‘Traditional beer accounts for around a third of Australian beer consumption, while contemporary beer is ¢.20%. Traditional beer has been losing share primarily t0 contemporary beer, but also to domestic and international premium as well as cider. Mid strength beer has been relatively stable at ¢.20% of beer consumption, while Light remains small at 4% and has been declining,(ean risesaes ‘once! 2018 JPMorgan CAZENOVE omaldilondserongan om Figure 68: Australia beer market by segment, 2013 Light cat + Ma stengtn Premiom 10% sm Comemporary 10% Tadtional aoe SNM Premium (above 115 index) accounts for about a third of beer consumption in ‘Australia. This is amongst the highest in AsPac but still ower than New Zealand at 50% and Singapore at 35%. Figure 69: Premium beer asa proportion of total, 2015 0% 50% 40% 0% 2% 0% o% POPPA ELE ES OF EF Sor ten Despite the high share of premium, beer remains very affordable in Australia with only 12 minutes of work required to afford 500ml of mainstream beer. Figure 70: Minutes worked to afford 500m of mainstream beer, 2012 Mexico Poland Canada Spain. austala” UK Czech Germany US Soe Seeoral ilon Europe Equly Research J.PMorgan Cazenove (420) T1343085 so onoder 2016 Komal ahllnemorgan.com Even relative to other alcohol categories beer appears affordable in Australia both in the on and off premise. Figure 74: Austra off premise retal price per standard drink, AUD Figure 72: Australia on premise retail price per standard drink, AUD me ‘ie om ie tae sot te seu: SNe a 5 Seve Sir Rise of big retail As elsewhere, the big retailers in Australia continue to gain share from traditional trade. However, on premise share has remained stable at 30% of beer volume, Figure 73: National accounts gaining share in Australia "on premise "independent ‘Natonal secounts Fos | Fo) FOr FYB Fg FYIO FYI Soe Sue SABE SABMiller improved its volume share with national accounts from a trough of 37% back to near 40% by mid 2013. The company moved away from transactional and confrontational relationships and renegotiated terms through a move towards joint planning with 6 month activity plans. Commercial execution has also been improved with a revised category strategy, sales force has been optimized, key account ‘management teams are in place and a customer call center has been established to enable direct order taking. In-store category execution has been enhanced in the off ‘trade. In the on trade, SABMiller has educated staff and installed permanent point of sale material Brand investment SABMiller has brands across all price segments in Australia, Carlton Dry is a key brand in the contemporary segment, Carlton Draught in the classic segment and. Carlton Mid in the mid strength segment, Victoria Bitter, SABMiller’s key brand in the classic segment had been in decline since 2002. SABMiller revamped the brand iquid, packaging) post acquisition and introduced new marketing campaigns, which resulted in the brand getting back into positive teritory by the end of 2012. However,oral Dion (aaa rise 580s formal cillonpnorgan com Table 48: CUB price ladder Europe Equity Research J.PMorgan CAZENOVE over the past 3 years both Vietoria Bitter and Carlton Draught have been in dectine, driven by continued pressure on the classic beer segment, Segment Teaietve segment pie Index CUB ay rand cat ay atl ay Brent Co, Cascade Boia Co Prenien 0-0 Crown Perot MO, Balers Cortnporary 00-20 Carton, Pure Bene, Stengbow classe aco eto Ser, Catton Draught Mid Suergh Acca ca0 Caron Ne Ligt lone 0 Cascade Premium Lit Sur: Carpal Overall, SABMiller’s strategy has been to focus on reviving the core portfolio comprising Victoria Bitter, Carlton family and Crown, while using imports and cider to capture growth and investing in the growing craft segment. Strong profit growth in recent years ‘SABMiller’s Australian business has been adversely impacted by macroeconomic challenges that have resulted in volume declining by -1% on average between FY 13, and FY 16. Organic price/mix has been a positive 2% on average p.a. driven by premiumisation and some price increases resulting in 1% average annual organic revenue growth. Currency has been @ major headwind and has led to reported sales declining by -11% CAGR between FY13 and FY 16, or nearly -30% on a cumulative basis. Australia is amongst the highest revenue per hl markets for beer globally Despite revenue per hl declining by nearly -30% in USD terms (from $274/hl to '8200/hl) since 2012, it remains higher than in any major SABMiller or ABI market. ABI's average revenue per hl is $80. Australia’s revenue per hl is therefore 2.6x the average of ABI’. This reflects higher historical pricing and a high tax umbrella in Australia Despite macroeconomic and currency headwinds, SABMiller has successfully expanded margins of its Australian operations by over 1000bps over the past 4 years. SABMiller generated synergies ahead of expectations with AUD210m delivered by March 2015 (3 years post close) versus initial guidance of AUD 80m (USD190m) synergies over 4 years. SABMiller was expecting c.30% of synergies from supply, just over 40% from procurement and another 30% from commercial and back office. ‘The business now operates on 30% EBIT margin. Importantly, given the significant intangibles ($5.4bn) recorded as part of the Foster's acquisition, amortisation charges are very high at over 10% of sales. These have gradually decreased from 12% in FY 13 and FY I4 to 10.6% in FYI6. Depreciation to sales remains relatively low at 3%, with the Australian business operating through 6 breweries.oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE Table 50: SABMile Australia summary P&L $nilon ise ee Votre, 00H Tea 1) aga 7082 (igen grou % a4 1% 1% (rg prem “% oe 1% a Net producer revenue jo mga cxganic om 90% O% 2 6 Pximpset 1% 108% os 16% Reported om 108% 1% a 12% EBITDA 18 ma 7 ai meg a a a Depreciation ales ame a an 1% ama a oe en 5 image WI BB HTH Amorsstont as 17% 20% Hawt eon 450 a6 a as magn 20% KON Imag exansin bes si a8 ‘@ ma ‘Sooo Conpny sa LP Mogan ena In QLI7 SABMiller posted 4% organic beer volume growth in Australia on an easy ~ 5% comp that was impacted by the timing of Easter. Victoria Bitter and Carlton Draught continued to decline partly offsetting the strong performance from the premium and contemporary brands, such as Carlton Dry. Pricelmix increased by 3% resulting in organic net revenue growth of 7% on a -2% comp. In the medium term we expect volume to remain under pressure in Australia but price'mix to continue to grow by low single digits to result in some revenuc growth, We believe most of the $115m of AsPac South synergies will be generated in Australia, This will take EBIT margins in the country to high 30%s by FY20E; or above ABI's margin in North America, on our estimates,oral Dion (aaa rise 580s formal cillonpnorgan com Europe Equity Research J.PMorgan CAZENOVE ABI now controls 44% of global beer profit ABI: leverage in the biggest profit pools ABL is now present and, in many cases, is dominant in most of the largest profit lly. The market positions acquired by ABI through the SABMiller je attractive long term plays in Colombia, Peru and a number of African countries ‘© The US, including both domestic and imported segments, is sill by some way the largest global beer profit pool accounting for some 25% of total global profit ‘on our estimates. This includes the still very profitable imports segment, but in large part excludes the “distribution wholesaler” profit that brewers might typically expect to eam in other markets given the 3 tier system in the US. The level of profitability rose by nearly 40% between 2009 and 2015 driven by synergy capture by both ABI and MillerCoors. The total US profit pool is now at $836 per hl on our estimates. ‘© We think ABI secures around 66% of the domestic profit pool with 44% volume share. ABI also has high single digit volume share in the US import ‘market, and around 11% of the profit pool, on our estimates. U.S. industry volumes are currently improving and, with a rational pricing background, we ccan think of few better places to sell beer globally than the US, In 2015 SABMiller was the second largest player in the US domestic beer market through the MillerCoors JV, but its margins were relatively much lower than ABIs, and we think it took around 20% of the domestic profit pool. Margins have improved significantly over the past six years as the JV has delivered on synergies and fixed cost savings. Molson Coors will purchase SABMiller’s 38% holding of MillerCoors for S12 billion within the next few ‘weeks/months, providing the company with full ownership. ‘© Growth in Brazil has slowed since the World Cup in 2014, but after 3 years of contraction, our economists expect Brazilian GDP to grow by +1.4% in 2017. In 2018 ABI has a dominant position in the country with close to 70% volume ‘market share, The value of scale is clearly evident in the Brazilian beer industry with ABI controlling 94% of the profit pool with EBIT/hl of $34. Smaller players such as Petropolis make single digit EBIT/hl, and whilst 2015 saw Heineken gain share in the market, now with 10% of volumes, it has just 2% of industry profit with EBIT/hI of $4, on our estimates, AmBev's beer business in Brazil is the ‘most effective beer business globally in terms of margins, with EBIT margins of 4M. Inthe rest of LatAm, the profit pool growth in Argentina is more a function of the economic eycle, with high background cost inflation being passed on in pricing, but AmBev has maintained c,75-80% volume share, with 95% share of industry profits. In Colombia, the position ABI has acquired through the SABMIiller ‘merger has driven over 75% growth in the past 6 years in the profit pool through price increases and with impressive fixed and variable cost reduction through ZBB. Profit margins in the country are amongst the highest in global brewing. Colombia is the world’s 5" iargest beer profit pool, and ABI effectively has limited competition with 98% volume share and 100% profit share, on our estimates, Heineken is expected to enter the market in 2017oral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE with one brewery in Bogota and by utilising Postobon’s, the local soft drinks producer, distribution network, In the longer term demographies remain positive. ‘* ABI’s profitability in Canada (through Labatt run by AmBev) appears to ‘outstrip that of Molson Coors following cost reduction driven margin uplift and we estimate it takes 60% of the profit pool while Molson Coors takes just 25% despite only an 8% difference in volume shares for the two companies. ‘We would expect limited profit pool growth here longer term. ‘+ In Western Europe ABI is the dominant player in the declining Belgian profit pool (with 73% profit share) and is one of the more profitable brewers in the still fragmented German profit pool. We think profitability in the UK beer industry has increased in recent years driven by both Heineken and ABI, but remains below that of France, However, elsewhere in the region, in Franc ‘Netherlands and Italy, ABI's position and share of the profit pool is much smaller. The Peroni and Grolsch brands will take place in the next few weeks/months. We think meaningful profit pool growth in Europe, given the already very significant cost base reduction by all major players, is hard to envisage, ‘+ In Russia, the integration of Anadolu Efes’ business with SABMiller in 2012 did not go to plan. This, slong with stiff competition and an oppressive rogulatory environment against a difficult macroeconomic backdrop led to a significant fall in profitability for the combined entity. Profitability of the industry has halved since the recession given consecutive years of volume decline, and we estimate EBIT/hl is now just $6 for the industry. We would expect Carlsberg to maintain its dominance here but note that, on our estimates, Carlsberg's EBIT in Russia fell by -70% from $850m in 2009 to $270m in 2015, driven by regulatory, macro and currency headwinds. The market remains challenging, with per capita consumption decreasing from 74 litres in 2009 to 51 in 2015; although beer production data has shown some uptick in recent months. ‘© ABTis to sell SABMiller’s Central and Eastern European assets in the next few weeks/months, though no buyer has yet been announced. We think SABMiller took around §5% of the Polish beer profit pool, 73% in the Czech Republic and 48% in Romania in 2018, These profit pools are by far the largest in Central Europe. However, competition from European peers remains intense, channel mix trends are adverse, volumes are in decline and the pricing, environment is deflationary, We think future volume growth will be muted in these markets even with macro-economic recovery and we would be surprised if the brewers can squeeze out much more in the way of margins. Profit pool growth will have to come, we think, primarily from driving up revenue per hl through improving mix. ‘© The profit pool in China offers an attractive long term growth opportunity in global brewing, off what is still avery low base of $2/hl across the market. Historically, investment, inefficiency and aggressive competition have held back ‘margins, The level of profitability can vary significantly by provineeleity, by brewer and through time, Distribution ters eat up a meaningful part of the profit pool. ABI now has a very significant volume base (approaching 100m his) in China and a profitable premium segment strategy with Budweiser and Harbin Tee in our view. On our estimates, ABI commands 50% of industry profit. The market leader in volume terms, China Resources Beer is to buy backoral Dion (aaa rise 580s formal cillonpnorgan com so onoder 2016 JPMorgan CAZENOVE SABMiller's stake in CR Snow in the coming few weeks/months, for a sum of $1.6bn. CR Snow has the leading national brand (‘Snow’) and operates 220m, his of capacity across 97 breweries, with the most extensive geographical footprint of any brewer in China (spanning 25 provinces). Over the longer term ‘we Would expect the profit pool to expand significantly with CR Snow and ABI gaining profit pool share, particularly from the other domestic players. Current EBIT margins are very low at around 6% for CR Snow, and, we estimate, 11% for ABI © In Mexico, ABI, and to a lesser extent Heineken, has driven profit pool growth of almost 60% (nearly $900m) over the past 6 years. The industry is now controlled by ABI and Heineken with ABI taking 70% of the profit pool. We expect the profit pool will continue to expand albeit more gradually from here. In the medium term we forecast EBIT/Al of over $40 from $34 in 2015; ‘marking mid to high single digit profit growth p.a. ‘© The South African business that ABI has gained through the SABMiller acquisition controls .95% of the South Afriea beer profit pool, which is by far the largest in Afriea, There are ongoing macro-economic pressures on. demand in this market as well as competitive threat posed by Heineken in premium beer; although less so recently. With already high per capita consumption at 60 litres, we do see South Africa as one of the more “mature” of the “emerging” beer markets ‘+ Elsewhere on the African continent, ABI has gained a number of strong positions through the acquisition of SABMiller. On our estimates Tanzani the most profitable beer market in Afriea, generating $46/hl at market level We estimate that the business, now controlled by ABI, had 92% of the profit pool in Tanzania in 2015, with very high profitability at $59/h. In Mozambique, the position gained from the acquisition is also dominant, controlling essentially the entire profit pool, though this business is less profitable at $26/hl in 2015, on our estimates. In Uganda, the business now controlled by ABI had 52% market share by volume and by profit, generating $15/hl Heineken: control over its destiny In recent years, Heineken has consolidated its emerging market positions and now has dominant positions in fast growing beer markets of Vietnam and ‘Nigeria, and has a strong position in Mexico. We estimate EMs now account for about 60% of group profit. Teineken also has strong positions across Westem Europe overall and isin a strong number two position in the US import segment. Across its platforms it benefits from the richer sales mix afforded by the premium Heineken brand. ‘+ In Vietnam, Heineken has made significant progress since its takeover of Asia Pacific Breweries in 2013 and we estimate it now controls over 60% of the country's beer profit pool. Vietnam is now Heineken's second-largest profit contributor. Heineken has completed the repositioning of Tiger and Heineken brands, On our estimates, Heineken makes more money in Vietnam than SABECO, the volume market leader, and HABECO combined. We expect ‘competition to remain strong with Vietnam being an attractive market for the big brewers. ABI already has two breweries in the country, and Vietnam's government is accelerating privatisation plans for the two stat and the assets are of interest to all international brewers.oral Dillon Europe Equity (aaa rise 580s oon formal cillonpnorgan com Carlsberg: weak competi JPMorgan CAZENOVE ‘The African market where Heineken has the most enviable share of the profit pool is Nigeria, at some 70%. However, in recent years top line growth and profitability have been held back by intense competition leading to down trading in the Nigerian market. While the current low oil price is having a ‘material adverse impact on the Nigerian economy and consumer sentiment, we expect profit decline in the beer industry to be largely stemmed by more rational ‘competitive pricing behaviour in the medium term, while Heineken also has more pricing flexibility post the Naira devaluation, We estimate the position controlled by ABI post the acquisition of SABMiller is now c.20% of market volume and is profitable, and that Diageo would want to recover margins in the country. Demographics remain positive and per capita consumption is still low at 11, and we would therefore expect a return to MSD volume growth though there could be headwinds in the short term. ‘We estimate Heineken accounts for 30% of the Mexican profit pool, the fourth largest globally. Is profitability in 2015 in the country significantly lagged that of ABI at $24/hl versus S41 /hl, but we believe if Heineken is able to improve its cost base further (EBIT margin of just over 20% vs ABI at 42%), the absolute profit base could nearly double. Overall in Western Europe Heineken is the clear leader with, we estimate, 40% share of total profit across the region. We think Heincken is slightly ahead of Mahou San Miguel in the Spanish profit pool. Heineken has significantly improved profitability in the UK driven by cost savings, robust pricing and latterly input cost deflation, and now commands 42% of the profit pool with volume share of 24%, on our estimates. Itis the leader in Italy, Netherlands, France, Greece and Austria with footholds in other markets like Ireland, Belgium, Finland and Portugal. In C&E Europe Heineken has significant but not dominant positions in Russia, Poland and Romania. We expect these markets to continue to remain challenging. Despite the recession and very challenging consumer and retail environment (with continued shift from the on to the off trade), profitability in Europe has held steady or, in some cases even improved, largely duc to Heincken’s cost savings of nearly $1.Sbn in the region. We expect improving consumer sentiment and tight cost control to drive slight growth the medium term. ‘We think Heineken has around a 15% share of the US import profit pool with the absolute contribution in recent years under pressure due to falling Heineken brand volumes. However, in 2015 the Heineken brand stabilised, while the Mexican portfolio continues to perform well, having outperformed the US. market since 2012, Heineken’s strategy isto drive growth in the premium end with the acquisition ofthe fifth largest US craft brewer, Lagunitas (the largest IPA brand), another step in this direction, e position ‘We estimate that Carlsberg takes 67% of the Russian beer profit pool, down from 78% in 2014, This business represents around 15% of total EBIT for the Group; down from nearly 40% only a few years ago. Whilst we have no doubt that Carlsberg’s superior production, route to market and brand portfolio advantages should allow it to maintain its leadership of the profit pool tis is still, in our view, one of the least stable of the major beer profit pools in terms oforal Dion (aaa rise 580s formal cillonpnorgan com Europe Equity Research J.PMorgan CAZENOVE future long term revenue growth, competitive intensity and changes to the regulatory landseape. ‘Following -9% volume decline in 2014 and -4% in 2015, beer production in Russia has shown some improvement as 2016 progresses. Even if volumes in Russia return to growth and even if high background price inflation ean offset Jong term cost inflation we still have three international, and several domestic, brewers slugging it out in a market where per capita consumption is still relatively high (at 51 litres, though this has decreased from 75 litres before the financial erisis) and where retailers through time are likely to take a greater share of the category revenue pool. ‘© Outside of Russia Carlsberg has footholds in the profit pools in France and Greece and dominates in the Nordies. The brewer has proved adept in leveraging growth from these positions through cost cutting. However, we would not expect these combinations to deliver significant absolute profit pool growth cr present opportunities for share gain, ‘© In Asia Carlsberg has relatively small positions in China, South East Asia and India which could “move the needle” for the group in the longer term, ‘© Overall, with ©.70% of Carlsberg’s profit being generated in Europe (both East and West), where itis @ distant second to Heineken, we do think investors may be carrying more “fundamental” risk here than with the more diversified bigger brewers. Global beer industry profit of $36bn In 2015 we estimate the 54 markets of our profit pool accounted for 87% of the total global profit pool of $36bn, with the top 10 markets itself accounting for 60%. These ‘54 markets represented the entirety of ABI, 96% of Heineken and 92% of Carlsberg pro forma beer EBIT in 2015. In 2015 ABI, SABMiller and Heineken together accounted for 44% of global beer volume but took the lion’s share (62%) of global beer profit, on our estimates. ‘There are large profit pools, such as Brazil and Colombia, where European brewers still have quasi monopoly or dominant positions. There are also some large profit pools where the European brewers face competition from other large brewers such as ABI-Molson Coors in Canada (and now in the U.S.), ABI-Lion Nathan in Australia and ABI-Hite in South Korea. However, large scale consolidation in the past decade ‘means that the major European brewers are now competing directly against each other in key profit pools.