If you’re an Emperor client with a more conservative attitude towards volatility (risk), you might notice that your portfolio has quite a few ‘consumer product’ companies. These companies tend to be less volatile than the market, making them a natural fit for a ‘Conservative’ Emperor portfolio. But not all flavors of consumer product are created equal. Beer, for instance, is a product with much more brand loyalty than something like tissue paper. This advantage is one of the reasons why Molson Coors Brewing Co. has been able to make the cut and remain in our Dream Team of stocks for so long. The following is an analysis of the company by one of Emperor’s analysts, Eddy Elbatish.
Molson Coors came to be when Adolph Coors Co. and Molson Inc. merged in 2005. This merger led to the formation of the second largest brewer by volume in U.S. and Canada. Its brands include but are not limited to Coors Light & Banquet, Blue Moon, Miller Genuine Draft & Miller Lite, Carling, Molson Canadian, Belgian Moon and Creemore Springs.
These two companies weren’t the only ones to merge. The entire beer industry experienced a lot of consolidation over the past few decades. This resulted in a small number of large brewers controlling most of the world’s global beer production. The market share of the top ten brewers in 2000 was under 40% of global sales which crept up to 60% by 2012i. In contrast to global brewers such as AB InBev (the largest brewer in the U.S.) which derives most of their revenue outside of North America, Molson Coors derives most of its revenue and profits from North America with only some exposure in Europe.
Industry consolidation has historically been a positive for large brewers. They used cheap debt to acquire well known beer brands with predictable cash flows. These cash flows were higher than the cost of said debt which left acquirers with a very clear job. They slashed costs, increased efficiency, and relied on consumer habits and branding to maintain market share. Increased margins from efficiency and using debt for funding resulted in higher returns on equity and therefore higher shareholder returns.
Losing Market Share
This worked well for a while, but the key assumption underpinning that model started to crumble a decade ago. That assumption was that consumer habits are very resistant to change; consumers have their favorite beer and stick to it. That’s simply not as true anymore. A prime example of this is Budweiser which fell out of the top three U.S. beers in 2017ii. And Molson Coors was not exempt from these consumer changes.
The company’s market share went from 30% in 2010 to 24% by 2018. On its own, this figure doesn’t look good, but it’s valuable to examine what happened with the competition. Let’s compare with AB InBev as it’s the closest competitor to Molson Coors, targeting a similar demographic with similar products. During this same period, AB InBev’s market share fell from 50% to 42%. But something different happened in the Canadian market.
Molson Coors went from 42% to 32%, whereas AB InBev slightly increased its market share from 41% to 42%. This was aided by the acquisition of Grupo Modelo S.A.B. by AB InBev. Over this 8-year period, Molson Coors’ net debt grew from $742m to $9.43bn, invested equity capital grew from $7.8bn to $13.7bn, while adjusted Earnings Before Interest and Taxes (EBIT) grew from $907.4m to $1.85bn.
The key takeaway from this data is that Molson Coors’ management used $14.6bniii to increase adjusted EBIT by $948m. This means that they spent about $15.40 for every additional dollar of EBIT. AB InBev’s management was slightly more efficient, using $96bniv in additional capital to increase adjusted EBIT by $6.7bn. They spent about $14.33 for every additional dollar of EBIT. That equates to about a 7% return on additional invested capital for AB InBev and 6.5% for Molson Coors.
Overall, the company did well against the competition considering their global market share went from 6% in 2008 to 4.9% in 2016 compared to 26.2% to 27.3% for AB InBevv. But why did market share decrease at all?
Molson Coors, AB InBev and other large brewers have been losing market share to craft and private label beers. Regional craft brewery volume peaked in 2015 at 19 million barrels and fell to 18 million barrels by 2017. Microbreweries and brewpubs, however, continue to grow rapidly and are likely the cause of falling regional craft brewery volumes. In 1983, there were 49 breweries, whereas at the end of 2017 there were 5,648. In 1996, a typical distributor managed 190 unique SKUs (different types of products) in their warehouses. However, as of 2016, the average stands at 1,025 SKUsvi. Therefore, it is clear that beer consumers are gravitating towards small and local rather than large brands.
The question now arises, how much of the pie will be redistributed to craft beer from traditional light beer? Is this a permanent restructuring of the beer industry or a fad? I have struggled with these questions and have yet to figure it out completely. I am convinced that light beer has a future and that not everyone will want to consume higher priced craft beer. It is also likely that craft beer will continue to grow faster than the beer market for the next few years. This means that it might continue to take away market share from the traditional beer brands.
In addition to all of this, there are other reasons why the market share for beer has declined.
Under The Influence
Changing consumer tastes have caused beer to lose market share not only to craft beers, but to other alcoholic beverages. The market share of beer went from 55% in 2009 to 50% in 2017. Per capita beer consumption in the U.S. fell to 19.39 gallons last year, from 21.19 in 2010 and 21.98 in 2000vii. Wine and spirits have been gaining market share for a while now with wine standing out having finished its 24th year of consecutive volume growthviii. It is possible that beer will continue to lose market share in per capita ethanol consumption to wine, spirits and cider. That’s less important if the overall market for alcohol is growing, but is it?
Overall ethanol consumption per capita in 2016 was 10% lower than peak levels in 1977. However, as you can see from the graph above, it’s been on the rise since the 90s. Whether consumption will continue to increase is hard to predict since there are many factors that can contribute to changes in drinking behavior. I believe that per capita ethanol consumption is not likely to fall more than 10% in a worst-case scenario from current levels. And if it does fall then it will be a slow decline which should be offset by population growth of roughly 1%.
- Traditional beer giants such as Molson Coors and AB InBev will continue to experience significant pressure on sales and earnings due to:
- The movement of consumers to craft beer, brewpubs and microbrewers, and changing preferences towards local rather than regional and national brands.
- A decrease in the per capita ethanol consumption coming from beer.
- Molson Coors is faring well compared to its largest competitor, AB InBev. However, the larger company is managed slightly better as evidenced by better capital allocation and its ability to maintain market share.
- The nature of the beer business allows for consistent positive and predictable cash flows which allows such a business to use more debt than cyclical companies. Consumer products businesses are therefore worth more than cyclical businesses. However, Molson Coors debt load relative to its pre-tax earning powerix leaves it vulnerable if interest rates were to increase materially. To combat that possibility, Molson Coors is deleveraging and aims to get to 3.75x Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) by mid 2019. At this point it will reinstate its dividend policy which is to pay 20 to 25% annual trailing EBITDAx. This would translate into a per share dividend of $2.3 up from $1.64 per share currentlyxi.
Molson Coors’ earning power is likely to stay at where it is or decline modestlyxii over the next 5 years with minimal reinvestment of earnings. Given that, the company should trade at an enterprise value of 12 to 14 times pretax earning power. On earnings of $1.75 billionxiii, this should give Molson Coors a total enterprise value between $21 billion to $24.5 billion. Since the company currently has an enterprise value of $22.3 billion, it can be concluded that it is fairly valued.
To invest in Molson Coors and other dividend paying stocks, you can sign up for an Emperor account here.
[iii] Change in net debt plus change in equity
[iv] An additional $33.11bn in shareholder equity plus and additional $62.89bn in net debt over the same period as Molson Coors.
[ix] Over 5 times Adjusted EBIT
[xi] If they were to aim for the lower end of trailing EBITDA, this would probably happen over time with 10% to 15% dividend increases per year.
[xii] A 5-10% decline.
[xiii] Conservatively calculated, a 5% decrease from Adjusted EBIT of $1.86 billion.
Forward Looking Disclosure
Certain statements that we make above may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning future strategic objectives, business prospects, anticipated savings, financial results (including expenses, earnings, liquidity, cash flow and capital expenditures), industry or market conditions, demand for and pricing of our products, acquisitions and divestitures, anticipated results of litigation and regulatory developments or general economic conditions. In addition, words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “projects,” “forecasts,” and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” as well as any other statement that necessarily depends on future events, are intended to identify forward-looking statements. Accordingly, these statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Forward-looking statements are not guarantees, and they involve risks, uncertainties and assumptions. Although we make such statements based on assumptions that we believe to be reasonable, there can be no assurance that actual results will not differ materially from those expressed in the forward- looking statements. Our actual results could differ materially from those anticipated in such forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.
We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks described in any filings with the Securities and Exchange Commission from time to time, including the company’s most recent Annual Report on Form 10-K and subsequent Forms 10-Q, which are available on the SEC’s website at sec.gov. We expressly disclaim any obligation to update any forward-looking statement in the event it later turns out to be inaccurate, whether as a result of new information, future events or otherwise.