UNITED BREWERIES CO INC annual report, Q4 FY2018

Business Context and Reporting Period

Compañía Cervecerías Unidas S.A. (CCU; English name United Breweries Company, Inc.) filed its Form 20-F annual report for the fiscal year ended December 31, 2018. The filing is prepared under IFRS as issued by the IASB and reports in Chilean pesos (CLP). CCU is a diversified beverage company operating primarily in Chile, Argentina, Uruguay, Paraguay, Bolivia, Colombia and Peru, with Chile, International Business and Wine operating segments.

The filing is annual rather than a standalone 2018 fourth-quarter filing; fourth-quarter information is included within the full-year results.

Key Financial Metrics

Metric	2018	2017	Change
Net sales	CLP 1,783,282 million	CLP 1,698,361 million	+5.0%
Gross profit	CLP 923,271 million	CLP 899,622 million	+2.6%
Gross margin	51.8%	53.0%	Down 120 bps
Adjusted Operating Result	CLP 468,722 million	CLP 234,894 million	+99.5%
Adjusted Operating Result margin	26.3%	13.8%	Up 1,250 bps
Net income	CLP 322,085 million	CLP 148,108 million	+117.5%
Net income attributable to parent	CLP 306,891 million	CLP 129,607 million	+136.8%
Basic and diluted EPS	CLP 830.55	CLP 350.76	+136.8%
Total sales volume	2,853.0 million liters	2,602.0 million liters	+9.6%

Sales growth reflected 9.6% higher consolidated volumes, partly offset by a 4.2% decline in average prices in CLP terms, primarily because of Argentine peso depreciation. Cost of sales rose 7.7% and increased to 48.2% of sales from 47.0%. MSD&A increased 1.9%, but improved to 38.2% of sales from 39.4%.

Chile: Net sales increased 6.0% to CLP 1,109,574 million; volume increased 5.6%; Adjusted Operating Result increased 10.9% to CLP 202,662 million; margin improved to 18.3%.
International Business: Net sales increased 5.1% to CLP 483,926 million; volume increased 23.0%, including the consolidation of Bolivia from August 2018; Adjusted Operating Result increased 488.4% to CLP 266,345 million.
Wine: Net sales increased 1.0% to CLP 206,519 million; volume declined 3.0%; Adjusted Operating Result declined 7.6% to CLP 22,667 million; margin declined to 11.0%.

Adjusted Operating Result and ORBDA are non-IFRS measures and should not be viewed as substitutes for IFRS earnings or cash flow.

Cash Flow, Liquidity, Debt and Capital

Net cash from operating activities was CLP 429,313 million, compared with CLP 262,161 million in 2017.
Cash used in investing activities was CLP 199,002 million, including CLP 131,440 million of capital expenditures and CLP 65,325 million for acquisitions and investments.
Cash used in financing activities was CLP 52,964 million, including CLP 74,825 million of dividends paid, CLP 112,665 million of loan and bond repayments, and CLP 184,008 million of new borrowings.
Cash and cash equivalents increased to CLP 319,014 million from CLP 170,045 million. Including securities purchased under resale agreements and other short-term financial instruments, reported liquid investments were approximately CLP 254,708 million in the liquidity discussion, while the statement of financial position includes broader cash and cash-equivalent balances.
Total assets were CLP 2,405,865 million and total equity was CLP 1,389,116 million at December 31, 2018.
Financial liabilities reported on the statement of financial position totaled CLP 290,952 million, including bank borrowings, bonds, leases and derivative liabilities. Management separately described indebtedness, including accrued interest, as CLP 270,636 million; investors should reconcile these differing presentations.
Approximately 97% of debt was fixed-rate before swaps and approximately 99.8% after considering cross-currency and interest-rate swaps.
CCU reported compliance with all material debt covenants, including a consolidated interest coverage ratio of 23.85, consolidated leverage ratio of 0.56, financial leverage ratio of negative 0.03 and unpledged-assets-to-unsecured-liabilities ratio of 8.89.
Capital expenditures were CLP 131,440 million in 2018. Planned 2019 capital expenditures were CLP 212,982 million, subject to revision based on market conditions and business needs.

Material Changes Versus the Prior Comparable Period

The largest earnings change was the May 2018 transaction with Anheuser-Busch InBev. CCU Argentina terminated the Budweiser license and received cash, brands and related transition arrangements. The transaction generated a reported one-time operating gain of CLP 208,842 million and increased parent-attributable net income by approximately CLP 157,359 million.
CCU received US$306 million for early termination, obtained the Isenbeck, Diosa, Norte, Iguana and Báltica brands, and obtained licenses for Grolsch and Warsteiner. Additional transition payments may total up to US$28 million annually for up to three years, depending on performance obligations.
Excluding the transaction, hyperinflation effects and the Argentine tax-asset revaluation, management stated that net income increased 14.8% to CLP 148,797 million.
Argentina was classified as hyperinflationary under IAS 29 effective July 1, 2018. The first-time application generated a positive equity adjustment of CLP 92,241 million, a CLP 2,313 million gain in net monetary position and a CLP 6,087 million adverse impact on 2018 net income.
CCU increased its stake in Bolivian beverage company BBO from 34% to 51%, resulting in consolidation from August 2018.
CCU increased its ownership of VSPT from approximately 67.2% to 83.0% through a tender offer, paying approximately CLP 49,223 million.
CCU completed the sale of Nutrabien in December 2018 and exited the sweet-snacks business.
The company issued a 25-year, 3 million UF bullet bond in August 2018 at a 2.85% UF-linked rate and redeemed its Series E bonds in October 2018.
IFRS 9 and IFRS 15 were adopted in 2018 without material income-statement effects. IFRS 16 was scheduled for adoption in 2019, with management estimating approximately CLP 22,628 million of right-of-use assets and lease liabilities at January 1, 2019.

Guidance, Outlook, Commentary and Risks

CCU launched a 2019–2021 strategic plan focused on profitable growth, brand strengthening, innovation, efficiency through the “ExCCelencia CCU” program, employee development and sustainability. Planned 2019 investment includes construction of the new non-alcoholic beverage plant associated with the Renca project. The filing does not provide formal revenue, earnings or margin guidance.

Management expects operating cash flow and available liquidity to fund working capital, capital expenditures, interest, dividends and debt payments for the next 12 months and the foreseeable future.
Chile accounted for approximately 62% of 2018 sales revenue, Argentina-related operations for approximately 24%, and the International Business segment for approximately 27% of consolidated sales. This creates material exposure to Chilean and Argentine economic conditions.
Argentina remains a significant risk because of hyperinflation, recession, currency depreciation, dollar-linked input costs, potential price controls, tax changes and restrictions on financing or profit repatriation.
Raw materials, packaging and energy costs are exposed to commodity prices and foreign exchange movements. The filing states that approximately 61% of direct costs were denominated in or indexed to foreign currencies, while approximately 7% of sales were export sales.
Key business risks include competition from ABI and other brewers, dependence on license agreements, supermarket concentration, supplier concentration for cans and malt, water availability, logistics disruptions, cyber threats, environmental and labeling regulation, labor costs and catastrophic events.
The company is controlled by IRSA, which directly and indirectly owns 60% of the common shares. This may create governance and minority-shareholder risks.
The filing reports no material legal or administrative proceedings in its principal jurisdictions, but discloses labor, commercial and tax claims, indirect guarantees and provisions for litigation of CLP 893.6 million.
Contractual obligations totaled CLP 1,841,636 million, including CLP 1,337,560 million of purchase obligations, CLP 138,377 million of operating leases and CLP 337,832 million of long-term debt obligations including interest.

Investor Verification Checklist

Reconcile reported financial debt of CLP 270,636 million, statement financial liabilities of CLP 290,952 million and contractual debt cash flows of approximately CLP 365,699 million.
Separate recurring operating performance from the CLP 208,842 million ABI transaction gain and the CLP 157,359 million parent-attributable net-income benefit.
Assess the sustainability of International Business margins after transition payments and brand-transfer effects expire.
Review Argentina’s IAS 29 hyperinflation adjustments, currency translation effects and the sensitivity of dollar-linked costs.
Verify execution, timing and funding of the CLP 212,982 million 2019 capital-expenditure plan and the larger Renca project.
Review the terms, maturity profile and covenant calculations for the new Series J bond and other UF-linked debt.
Monitor wine volume declines, higher wine input costs and the pending Pernod Ricard Argentina wine-business acquisition.
Evaluate license-renewal conditions, especially for major international brands, and the effect of any termination or non-renewal.
Confirm the effect of IFRS 16 adoption on reported leverage, EBITDA-like measures, assets and liabilities.