According to Anheuser Busch, Buffett has invested a large sum in the company. Buffett confirmed this at Berkshire's recent annual meeting. Anheuser's stock is trading for less than it was when Buffett invested in the company, so it is worth analyzing.

Anheuser Busch (ticker symbol: bud) is America's largest brewer, with nearly 50% of the market. SABMiller has about 20% of the market, while Molson Coors has around 10%.

Competitive Advantages:

Before we attempt to value Anheuser Busch, we must first determine whether it has strong, sustainable competitive advantages. If it does, it will probably be able to maintain its competitive position.

There are significant economies of scale in the beer industry, and with nearly half the market, Anheuser Busch's costs are far lower than its competitors. It is able to spread its marketing and administrative expenses over a larger revenue base, and is powerful enough to demand good terms from distributors. Its operating margins are over 20%, while Coors has 8% margins and Boston Beer (which makes Sam Adams) earns a 10% margin. Small brewers earn even less. Now this margin advantage has two important implications. This should allow the company to protect its market share. First, Anheuser's competitors can't afford to significantly lower their prices. This should allow the company to maintain its profit margins. Second, if there is a price war, Anheuser Busch should come out a winner. So Anheuser should also be able to protect its market share. Also important is the company's brand name, which is extremely strong. Beer drinkers are very brand loyal, and brand preferences change slowly. When Anheuser Busch starts to lose market share, it has plenty of time to respond.

Growth:

Now to calculate Anheuser Bush's value, we will need to estimate its future growth rate. To do so, we will need to break up the elements of Anheuser's sources of future growth. We will estimate:

• The change in per capita consumption if Anheuser's products in the U.S.
• The change in per capita consumption in foreign countries
• Population growth
• Profit margin changes
• Price increases due to inflation (or other factors)

According to the Beer Institute, an organization that lobbies on behalf of the Beer Industry, consumption of beer grew by about 0.7% per year between 1985 and 2004. Per Capita consumption, however, has been falling. Wines and Spirits have been gaining market share from beer, due to better marketing, changing trends, and an oversupply of grapes (leading to lower wine prices). In the U.S., population growth is about 1% per year. If preferences continue to move away from beer and toward wine, then consumption per capita will fall, and beer volume will grow at less than 1%. The total volume of beer sold does not drastically change year to year, so I would not expect beer consumption to fall at a high rate. I would say that 0.5% is a reasonable estimate for future volume growth. In some European countries, alcohol preferences have changed dramatically over the past few decades. So it's possible that beer volumes will decrease at, say, 1% per year (which corresponds to a 2% drop in per capita consumption). I think this is unlikely, given the huge loyalty that a lot of people have toward beer. But it is possible, and you should keep this in mind when valuing the company. Of course, it is also possible that, 20 years from now, beer will be more popular than it is today.

The company's growth should come primarily from its international operations and investments. The most important of these are in China and South America.

South America:

Anheuser Bush has a 50.2% economic interest in Diblo, which is the operating subsidiary of Grupo Modelo. Modelo produces Corona -- the number one import beer in the U.S. -- and is the largest seller of beer in Mexico. It has 57% of the Mexican beer market, while its competitor Femsa has 43%. These two companies control nearly 100% of the Mexican beer market. Modelo earned $788 million in 2004.

Anheuser has a 20% equity interest in Compania Cervecerias Unidas, the leading brewer in Chile.

China:

Anheuser owns The Budweiser Wuhan International Brewing Company, which owns a brewery,

Anheuser recently acquired The Harbin Brewery Group, which owns thirteen breweries, and sells about 10 million barrels of beer per year (about 7% of the company's total volume

Anheuser has a stake in Tsingtao, the largest brewery in China. Anheuser has a 9.9% economic interest, and has convertible bonds that, when converted, will raise Anheuser's ownership to 27%.

Beer is cheaper in China than it is in America, so these operations won't add much to Anheuser's bottom line. Now if China becomes a wealthier country, Chinese workers will be able to afford higher beer prices. This would lead to both higher revenues and higher margins. There is no dominant brewer in China. Anheuser Busch may end up becoming China's #1 brewer, which is pretty significant when you consider that China has 1.2 billion people.

Anheuser has other international operations, but they are less important than the ones I mentioned.

Overall, South America and China make up about 20% of Anheuser Bush's total volume. This calculation includes the company's ownership percentage of its international investments. If we assume 2-3% volume growth in these businesses, plus 0.5% volume growth domestically, our total expected volume growth would be about 0.9%.

Profit Margins:

Historically, Anheuser Busch has been able to raise its prices with inflation, while its costs have increased at a slower rate. Anheuser's operating margins were 11.6% in 1984, 15.8% in 1994, and 22.5% in 2004. Part of this is due to the company's market share gains, which allowed it to benefit from the previously mentioned economies of scale. Part of this is due to cost cutting. If a company is in a particularly competitive industry, the benefits of this cost cutting will be passed onto consumers. But companies that have strong brand names, like Anheuser Busch, Coca-Cola, and Wrigley, are able to keep the benefits for themselves. Over the past 20 years, operating margins have increased at a little over 3% per year. I don't think this can continue forever, so it would be wise to anticipate a lower growth rate. Perhaps 1% would be reasonable.

Recently, Miller has gained market share from Anheuser Busch, which has hurt Anheuser's margins. But its competitive advantage is huge. I doubt Miller will seriously harm Anheuser's margins or market share over the long term.

So, for our projection of Anheuser's future growth, we get:

• 2% growth due to inflation
• 1% growth due to population increases
• 0.9% worldwide volume growth
• 1% growth due to profit margin improvements

Valuation Analysis:

Anheuser's earnings yield (earnings per share / share price) is about 6.1%. I've looked through about 10 years of data, and Anheuser's free cash flow has been about 90% of its net income. However, during this period, the company was growing at a higher rate (leading to high capital expenditures) and spent a lot of money on cost cutting. In the future, I expect free cash flow to be slightly below net income. Perhaps 95% would be a good estimate. This would give Anheuser an earnings yield of 5.8%. Adding this to our 3.9% growth estimate, we get an expected return of 9.7%. Different growth estimates would lead to a different expected return, so let's look at a few scenarios:

• If profit margins only contribute 0.5% to growth, we get an expected return of 9.2%. If margins contribute 2% to growth, we get an expected return of 10.7%.

• Suppose preferences shift away from beer and domestic volumes fall by 1% per year. Profit margins would likely fall. Perhaps they would decrease by, say, 0.5% per year. Then, the elements of growth would be: 2% annual price increases, 0.5% growth due to international operatins, -0.75% growth due to volume losses (volumes would fall by 1% in America, which represents about 75% of Anheuser's volume, so the impact on growth would be -0.75%) and -0.5% growth due to profit margin decreases. Our expected growth rate would be only 1.25% per year, which would lead to a long term annual return of 5.8% + 1.25%, or about 7%.

• The company has gained market share pretty much continuously over the long term (although this trend has reversed itself over the past year or two). In 1990, Anheuser's domestic market share was 43.4%. In 2004, it was about 50%. This equates to roughly 1% in growth per year. Due to the economies of scale inherent in the beer industry, Anheuser's profit margins would increase more than otherwise. If marketshare gains add 1% growth, and profit margin gains add 2% (rather than 1%) to growth, then our expected return jumps to 11.7%.

• If Anheuser's international operations show only 1% volume growth, our expected return will fall by 0.3%, to 9.4%.

I'm not impressed with Anheuser's marketing strategy. Their commercials seem pretty juvenile to me, and contribute to the perception that beer is a low-class drink, that beer drinkers are less educated/stylish than wine drinkers, etc. Luckily, Anheuser is in a very strong competitive position, and has time to come up with a better strategy.

On the bright side, Anheuser's management is financially savvy. They avoid overpaying for acquisitions, and they acquired their Grupo Modelo stake at an extremely low price. This is especially important in the beer industry, as there will be an opportunity for large brewers to make profitable investments. As I mentioned, there are significant economies of scale in the industry, and brewers worldwide will merge to cut costs and to improve their competitive position. This will improve margins, which should generate wealth for intelligent capital allocators.

Conclusion:

I don't make buy or sell recommendations, but Anheuser Busch appears to be a good company trading at a reasonable price. As always, you should do your own research before making any investment decisions.