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The NCAA basketball tournament is underway and today is St. Patrick’s Day. For many, it’s a great time to open a beer. For investors, is it also a great time to open a position in the stock of a beer company?
Boston Beer Company (NYSE: SAM) is the nation’s largest craft beer company, with 2017 revenues of over $900 million. Since its days as a start-up in 1984, it has led the nation’s growing taste for craft beers. Shareholders have had tasty returns along the way, with its shares rising 16-fold from the 1995 initial public offering price of $20 to over $320 by early 2015. Gains for retail investors who bought IPO shares for $15 through coupons attached to Sam Adams six-packs had even better returns--over 21-fold.
So, why is The Turnaround Letter, which focuses on out-of-favor companies undergoing major positive changes, even thinking about this ostensible “growth” company? A few traits have attracted us. First, its share price has fallen 44% from its peak to around $180, suggesting that things haven’t been going well lately. Maybe some major positive change is needed.
Second, it is replacing its long-time (since 2001) CEO, suggesting that a catalyst for change may have arrived. Other appealing traits: Boston Beer’s balance sheet is pristine with zero debt and $66 million in cash. The company, not surprisingly, produces plenty of free cash flow, over $105 million last year, which it is using to repurchase shares. Its revenue and profits are stable, backed by a product that won’t be going away anytime soon nor is vulnerable to competition from Amazon. There is plenty to like with Boston Beer Company.
Shares aren’t much of a bargain currently
But does the company fully qualify as an out-of-favor turnaround? As our strategy focuses on the deeper end of the value investing spectrum, we’re not yet ready to step up to the bar with SAM shares. Despite the favorable traits noted earlier, we’re restrained by valuation.
The company currently trades at about 12.2x our estimate of its 2018 earnings before interest, taxes, depreciation and amortization, or EBITDA. While not particularly expensive, it isn’t much of a bargain either. Compared to other brewers, it is a bit cheaper than Anheuser-Busch InBev at 14.0x, but pricier than Molson Coors (11.0x). This doesn’t leave much room for a higher multiple.
Still, we like the changes under way
New leadership is freshening up Boston Beer. During the past two years, it replaced its Chief Financial Officer, Chief Marketing Officer, head of supply chain and head of Human Resources. As a long-standing board member, soon-to-arrive new CEO David Burwick likely approved these changes, so he arrives with a supportive team.
Burwick himself brings some real potential. Previously he was CEO of Peet’s Coffee, where he presided over impressive sales growth. As Peet’s is owned by privately-held JAB, a global food company recognized for its operational efficiency, he can also be expected to instill new operating and distribution efficiencies at Boston Beer.
Revenue growth may not be the best strategy right now…
Margin-boosting efficiency improvements might be the company’s best chance to grow its profits, as revenue growth looks challenging. Industry-wide, craft beer sales have flattened to below 3% from over 15% only four years ago. Competition from the 6,000 other craft beer companies (up from about 2,000 only seven years ago), combined with drinkers’ growing preference for local brews, adds to the pressure. Over the past few two years, Boston Beer Company’s net revenues have dropped 10% on an 11% decline in volumes shipped. It is not immune to stagnant industry trends.
In some ways, sacrificing revenue growth might be just the ticket for Boston Beer. From a single Sam Adams Lager offering at its founding, the company now produces a dizzying array of over 60 Sam Adams-branded beers, over 50 beers under the A&S Brewing label, more than 25 hard ciders and sparkling waters, and over 10 flavored malt beverages.
Industry estimates show that barely over half of the company’s 3.8 million barrels of output is now traditional beer. In addition to exposing the company to a potential downturn in the hard cider and flavored malt beverage trends, the cost of supporting this sprawl is rising. In its February 21 earnings release, Boston Beer said that while its 2018 gross profits would increase by as much as $20 million, it will spend all of this plus up to $25 million more on higher marketing and administrative costs.
While trimming its proliferation of brands could lead to temporarily weaker revenues, it could simplify its highly complex brewing, distributing and marketing processes, leading to cost savings and wider margins. Just returning to the 20.7% EBITDA margin from 2016, about a percentage point higher than last year’s margin, would boost pre-tax profits by over 5% without requiring any sales growth. It was another beverage company, Starbucks, that implemented a similar back-to-basics approach a decade ago that re-invigorated its fortunes.
A simplified offering might also trim Boston Beer’s growing capital spending. Management guided for a near-doubling of capital spending in 2018, mostly directed to its breweries, to $55-65 million, which “…could be significantly higher, if deemed necessary to meet future growth.” While Boston Beer’s free cash flow is generous, higher capital spending and higher expenses could dry up this spigot for shareholders.
… potentially producing an opportunity for a more attractive share price
While it could make a lot of long-term strategic sense to rationalize its product offering, the downward pressure on revenues would probably force growth investors to sell their shares. Assuming this is the primary cause of the selling, it could provide an attractive entry point for turnaround investors.
Other strategic options
Boston Beer’s new CEO could pursue a range of strategic options. The non-beer brands could be divested--no doubt there would be plenty of buyers looking to add this segment to their stables. Another option is to acquire other beer brands. A debt-free company like Boston Beer could potentially borrow $700 million for acquisitions, leaving it with a debt/EBITDA multiple of just over 4x, reasonable for a steady company. Alternatively, a similar amount of debt could fund the repurchase of up to a third of its shares.
Could Boston Beer itself be for sale? It’s not completely out of the question. Last year, Holland-based Heineken bought Lagunitas Brewing Company in a $1 billion deal, and Constellation Brands acquired Ballast Point Brewing & Spirits in 2015, also for about $1 billion. While a Boston Beer deal would be larger, at perhaps $2.5 – 3.0 billion, it would be easily in the range of giants like Anheuser-Busch InBev, Heineken, Diageo or Carlsberg. A major hurdle would be overcoming likely objections of its founder and chairman Jim Koch, who controls the majority of the board and has substantial influence over merger approvals through his ownership of 100% of the Class B shares.
So while there are potentially fascinating changes underway at Boston Beer Company, the valuation currently remains too high for our taste. But we’ll be watching, likely from the neighborhood pub, just over from the taps. Now, if only Ohio State could get to the Final Four.