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Battle of the drinks giants

News of possible merger and acquisitions among the big UK-listed drinks firms will propel the sector to the top of the headlines, but what should investors be looking at?

SABmiller glass with beer in it
Source: Bloomberg

Shares in SABMiller spiked 5% after news that it had approached Heineken about a possible takeover. The attempt was swiftly rejected, but later in the day shares in the UK/South African brewer jumped further after fellow brewer ABInbev was reported to have made a bid for SABMiller. A classic case of the hunter becoming the hunted.

The rationale for these potential mergers is the same as ever – cost savings. With firms this size (SABMiller’s market cap is $89 billion, versus $44 billion for Heineken and $138 billion for ABInbev), the savings must be vast. Some analysts have suggested that a deal between SAB and AB could see a significant uplift in margins for the combined firms, pushing profit margins from their current level around 20% and boosting earnings as cost savings kick in. 

SABMiller’s African markets make it a compelling bid target. Growth in developed markets such as Europe and North America has stalled, but there is still substantial room in east Africa, an area where SABMiller has a commanding presence.

Assuming however that no deal of any kind takes place, it leaves investors with two choices when looking at the UK sector, SABMiller or Diageo (there is also Britvic, but its market cap is $2.8 billion or £1.7 billion).

On a current PE, Diageo trades at 18.8 versus a whopping 23.6 for SABMiller, while the dividend yield for the former is 2.8% versus 1.7% for the latter. Even on margins Diageo still has the lead over its rival, with an operating margin (operating income/net sales) of 30.4% versus 26.6% for its rival, while profit margins (net profit/revenue) for the two are 21.9% and 20.2% respectively.

On performance so far this year, SABMiller is the clear winner, even before today’s substantial rise. Excluding today, SABMiller shares are up 9.8% against Diageo’s 9.4% decline (compared to a 0.86% rise in the FTSE 100).

Thus on a fundamental basis, it would seem that Diageo shares offer the better prospect – margins are wider and valuations are lower, even if the share price performance has been dire.

However, those of a technical persuasion might still prefer SABMiller. Diageo shares have bounced impressively in August, but are now capped by the 50-week moving average. The retreat from the 2013 high of £21 continues and any drop lower should target £18 before focusing on the 2014 low just above £17.

SABMiller shares are firmly above their closing high for 2013, but prudence suggests investors should hold back for now and allow the 15 September gap to be filled. Even with this such a drop back, perhaps towards the £34 level, the uptrend is still in place, and a dip back to allow the shares to work off their overbought condition could provide an attractive entry point.

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