Boston Beer Company (SAM) appears once again on GuruFocus’ Buffett-Munger Screener. This screener can be used to find Buffett-style companies high quality businesses at undervalued, or fairly valued, prices, and that probably have a moat working in their favor. These kind of businesses are able to consistently grow revenue and earnings, maintain and expand profit margins while growing, and incur little debt during growth.
Let's take a quick review of the company to see why you might want to look a little closer at it and maybe add it to your shopping list for when the price is right.
What Do They Do?
The Boston Beer Company Inc. (SAM, Financial) is best known for its Samuel Adams brand of beer. The company was founded in 1984 by sixth generation brewer Jim Koch, and is the largest craft brewer in the U.S. It has the additional distinction of being the only domestically owned, publicly traded brewery left in the U.S.
SAM produces about 3 million barrels annually and generates roughly $600 million in sales. The craft beer industry (its fastest growing segment) represents just 7.3% of the U.S. beer industry volume today. Craft beer is taking share from "big beer" brands, such as Budweiser, Miller and Coors, in addition to wine and spirits. This shift is occurring as consumers seek out more variety, more flavor and better quality from their beers, similar to what the wine industry experienced several decades before.
Boston Beer is a category leader in craft beer, and the industry is expected to double in size in the next 5-10 years. SAM maintains the broadest beer portfolio in the industry, with fifty different varieties of Samuel Adams beer as well as recent introductions into hard cider and malt beverages. Though they are the biggest fish in the craft beer pond, SAM's overall beer market share is about 1.3% by volume. This fact represents a major growth opportunity as they gain wider distribution across the country and reap the benefits of recent, and continued, investments in sales and marketing. The company generates high returns on capital at its three brewing facilities, significant free cash flow and maintains an excellent balance sheet.
Industry Information
The American beer market is huge, roughly $99 billion based on 200 million barrels of suds a year. Just two companies command 80% of the market AB InBev and MillerCoors. Within this space, the American craft beer market commands a small 7.3% share.
There are over 2,500 breweries in operation in the U.S., all competing for shelf space and tap space. Out of this figure, the numbers are roughly evenly split between traditional brewery operations and brewpubs, a business model that brews on premise for on-premise consumption.
Although the craft beer industry has been around for decades, it's been receiving incredible tailwinds for years now, propelling it to double-digit growth in terms of both sales and volume. The industry is expected to double to 15% market share by the year 2020.
To understand the industry, however, is to understand its clientele and its industry founders. To help with that understanding, read my previous article Craft Brewing Industry Primer — Behind the Revolution. Lastly, the following industry update articles should also help put into perspective the industry's growth over the last few years: 2012-2013, 2011, and 2010.
Competition
While SAM is the largest independent craft brewer, they account for about 1.3% of the total U.S. beer market. But in the craft beer space, SAM maintains a 16% market share. This makes them a very big fish in a very small pond. Only privately-held Yeungling comes close to Boston Beer Company’s volume. Yeungling, however, isn't considered a craft brewer by the Brewers Association definition. Therefore, the next two largest brewers are Sierra Nevada and New Belgium, who's volume together is about half of SAM's volume. [Note: AB-InBev owns Goose Island completely, and has a 1/3-stake in Craft Brewers Alliance (BREW). The volumes of these companies aren't represented in the craft beer statistics, due to the BA definition.]
SAM’s main competition is not with the mass-produced, mainstream beers of Budweiser, Miller and Coors (the “Big Three”). Why is this? Craft beer consumers seek flavor, freshness and choice — they aren’t motivated by price. They will gladly pay the premium for a premium beer. For this group, a bland-flavored, mass-produced, lifeless beer simply will not do. To make an analogy: Craft beer is to gourmet burgers, as mass-produced beer is to McDonald’s.
SAM directly competes with other domestic craft brewers and imports for market- and mind-share, such as Hofbrau, Hacker-Pschorr, Ayinger, Heineken, Sierra Nevada, New Belgium, etc.
The $1 Test
Does a company create value, or destroy it? In Warren Buffett’s 1983 Owner’s Manual for Berkshire shareholders he described what I call the "$1 Test." In short, over long periods of time, each $1 of retained earnings in the business must, in the long run, deliver at least $1 of market value. It's a quick acid test, and certainly not infallible, but I use it as a general research guide to help answer the question.
How has SAM done over the last 15 years? From 1998 to the present, SAM retained $86.3 million in the business (from $25.5 million to $111 million), and the market cap changed from $172 million to $3014 million. Over this period, for every $1 retained in the business, they produced almost $33 in market value. By this metric, on net, SAM is a value creator.
Sales, Pre-Tax Profit and Earnings
For a mid-cap company, SAM is incredibly consistent and successful. It sports a "5-Star" GuruFocus Predictability Rating. A visual review of SAM’s sales, EBIT, and net income curves on a log graph illustrates the stability of its operations. SAM has a pretty steady sales growth curve.
Its EBIT is also consistent and rising, with the exception of the outlier year 2008. In this year, it completed its all-cash purchase of its new brewery in Pennsylvania, and of course took a short-term accounting hit.
Growth Rates
SAM has a long track record of double-digit growth, driven by volume growth and strong pricing:
Gross, Operating and Net Margins
Because brewing involves simple and cheap ingredients, SAM enjoys gross margins in the mid-50% range. As shown below, since their brewery upgrade in 2008, SAM also looks to be improving operating and net margins.
Balance Sheet & Capital Structure
It currently has $74 million of cash on-hand and little debt at $0.6 million, although it has access to a $50 million line of credit, which remains unused.
It is capitalized with no bonds, no preferred stock and 13.4 million shares of common stock, which is divided into a dual-class structure. Class A common stock is publicly traded and has no voting rights, except as required by law. Class B common stock is not publicly traded and has full voting rights. Each share of Class B stock is freely convertible into one share of Class A stock.
Although not the CEO since 2001, Jim Koch, founder and chairman, has considerable influence over the running of the company. Koch owns around 32% of the firm's stock, including 100% of the Class B shares, and is able to elect five directors to a board of just eight members. There’s a small risk that the interests of minority shareholders will take second place to those of Koch. However, I feel this places Jim in a position of having significant “skin in the game” since he has significant wealth tied up in the company and is clearly passionate about the company and its brand since 1984. He's craft brewing's first billionaire.
SAM doesn't pay a dividend; however, over the last decade, SAM has returned capital to its shareholders, reducing the net share count about 17%. Its buyback program recently approved an increase by the board of $25 million for a new limit of $325 million. The chart below illustrates its buyback history.
Cumulatively for the program, it has bought back 10.9 million shares at $299.5 million.
Management Effectiveness
SAM is led by CEO Martin Roper. The other key executives are William Ulrich, CFO; Thomas Lance, VP of Operations; and John Geist, VP of Sales. This group has a range of experience in the food and alcohol industries.
As Buffett has taught us, a CEO's main job is efficient capital allocation for shareholders, and it looks like SAM meets that test also. SAM handily exceeds an ROC of 15%. Their 15-year averages are: ROE = 18.4%; ROA = 12.6%; and ROC = 56.8%.
Valuation
SAM has been on a tear in the last year, gaining 109%. As of Dec. 6, 2013, it traded for $236. This chart shows the price multiples as of Dec. 6.
If we take a look at the history of price multiple bands, we'll get the following charts. Each chart compares the price graphed against the price it would've been at maximum/minimum price multiples. As you can see, SAM trades in the middle of it's historical P/E band, and near the upper ranges of the historical P/B and P/S bands. (Note: the max P/E in the chart is an astonishing 88).
SAM's earnings yield is currently 3.7%, and that's in relation to a Bloomberg AAA corporate bond yield of 3.9%.
What growth is baked into the current price?
- Gurufocus Reverse DCF calculator: with a 9% discount rate, a 25% growth rate is implied. At a 12% discount rate, implied growth is 29%.
- Ben Graham formula of V* = EPS * (8.5 + 2g): where V* is the market price, and g is growth, and solve for g, we arrive at an implied growth rate of 22.6%.
Morningstar also shows expected five-year growth at 20%. Using that rate in the DCF calculator (below), yields a fair value of about $167. Using the Graham formula above with 20% growth yields a fair value of $213.
Guru Ownership
As of Sept. 30, 2013, SAM is held by the following gurus followed by GuruFocus:
- Murray Stahl (new buy at an average price of $206)
- Ron Baron
- Ken Fisher
- Mario Gabelli
- Jim Simons
Bullish Points
Boston Beer Company has the following catalysts and winds at its back:
- Although there will be increasing competition in the craft space, SAM will benefit from relative strength in the category as the dominant brand. The craft beer industry is expected to grow at 10% CAGR, doubling by 2020, to give it an anticipated 15% market share of the US beer market
- Consumers continuing the longer-term trend of trading up, due to demographic changes and trends occurring
- Recent data confirms that their volumes are outperforming the overall beer category. Their depletions growth, normally in mid-teens, was 26% on their last quarterly announcement.
- SAM’s financial flexibility, and low debt status, supports growth over the long term by enabling capacity expansion and additional marketing efforts.
- Although there’s currently no mention of it, a brewery expansion project west of the Mississippi would help tremendously in penetrating the West easier and easing fuel costs. They could fund an expansion again in cash, easily paying for such a project out of one or two years’ worth of owner earnings at the expense of a short-term hit to reported accounting EPS, such as in 2008.
- The board of directors approved an additional $25 million increase to its existing $300 million repurchase program.
- Alchemy & Science: SAM's recently acquired subsidiary is a craft beer incubator that is slowly buying good, local craft brewery brands. To-date they've purchased 4: Angel City Brewery, Traveler Beer Company, the Just Beer Project, and Coney Island Brewery. They're currently eyeing a project in Florida named Concrete Beach Brewery.
- Canning line extension recently installed which provides access to new markets where bottled beer couldn't previously be sold, such as parks, concerts, airlines, etc.
- Hard cider market seeing revival in the US and represents about 2% of the market by revenue, but growing rapidly at an average of 27.5%/yr during the last 5 years. Cider is a line extension that's popular amongst women. It competes directly with wine and has the potential to take market share back towards beer volumes.
Bearish Points
Boston Beer faces the following business risks:
- They’re concentrated at the premium end of the beer industry, a category that has achieved strong growth in recent years.
- Increasing competition from the over 2,500 fledgling craft breweries could eat into market share
- Interest by the big brewers in craft breweries in establishing a presence in the craft beer space
- Change in consumer preferences for niche brands could hurt revenue and affect market share.
- Change in consumer preference for wine and/or spirits could also hurt revenue and market share.
- Margins could be squeezed by rising commodity and energy costs. SAM’s breweries are geographically concentrated in the Eastern U.S. exposing them to increased fuel costs for transportation of products to the West.
Summary
Boston Beer Company (SAM, Financial) has developed a nice leadership niche in the highly competitive American craft beer market since 1984. It appears on the GuruFocus Buffett-Munger Screener, which attempts to find Buffett-style investments igh quality companies trading at fairly valued, or undervalued, prices. SAM is incredibly consistent in its operations, successful, highly profitable, has created value for shareholders, and has a trustworthy and capable management team. It's the largest of the craft brewers, generates plenty of free cash flow, has little debt, and is in an industry that is expected to double in size by the year 2020. In short, SAM is a quality company, with good prospects for growth, worth consideration and buying at the right price.
Disclosure
Long SAM
Disclaimer
This review/analysis is provided for informational and entertainment purposes only and is the opinion of the author. The information and content contained herein should not be construed as a recommendation to invest or trade in any type of security. Neither the information, nor any opinion expressed, constitutes a solicitation of the purchase or sale of any security or investment of any kind. Conduct your own research and due diligence.
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