Grab Yourself Some BREW

By Eric Tommarello - July 10, 2012 | Tickers: SAM, BREW, SBMRY.PK | 0 Comments

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As summer scorches onward, it seems appropriate to stop and take a look at the beer industry.  Recently, Boston Beer (NYSE: SAM) has dominated the headlines with 3 consecutive earnings reports crushing expectations and an ever-increasing 52-week high.  Yet there could be a dark horse lurking in the form of Craft Brew Alliance (NASDAQ: BREW), one of SAM’s competitors in the craft beer industry.

First things first, let’s look at a broad overview of the company.  CBA was formed by the merger of Widmer Brothers Brewing and Redhook Ale Brewery back in 2008, and has since grown to encompass Hawaii-based Kona Brewing Company as well.  Headquartered in Portland, Oregon, CBA represents a conglomerate of distinctive west coast craft brewers that leave no stone unturned when it comes to discovering new styles and flavors.

So what is there to like about CBA?  First of all, craft brewing is taking off as an industry.  The five year CAGR is currently at around 7%!  Craft breweries only possess about 8% of the US beer market right now, so there is certainly room to grow.  Drawing from personal experiences, I can tell you that craft beers are immensely popular among young people, and that this will only be a catalyst moving forward.  On my college campus—typically a haven for cheap, mass-produced beers—I have noticed many students splurge on higher quality (and priced) craft beer at least once a week.  Millenials, in fact, already purchase 28% of all beer in the US and 29% of all craft beer, despite the fact that many aren’t even legal yet.  As this generation moves into positions of greater purchasing power, I am hard pressed to believe that their brew of choice will deflect from the craft segment.

This brings me to my next point; understanding the consumer-base.  What are craft brew drinkers all about?  The one word that comes to mind is curious.  They like to try a variety of unique beverages and constantly seek out new brands to further explore the preferences of their palate.  This has significant implications for the industry.  The more crowded it becomes, the more heavily it will weigh on each breweries sales and revenue figures as consumers have more and more to explore.

The dynamics at play behind the consumer-base also place an emphasis upon each breweries geographical reach.  Craft drinkers love breweries that represent a particular region.  Samuel Adams is Boston’s beer, Goose Island (acquired by Anheuser-Busch in 2011) is Chicago’s, Sierra Nevada is California’s, and it seems reasonable to believe that CBA’s Widmer Brothers and Redhook could come to be representative of the Pacific Northwest while Kona represents the islands of Hawaii.  However, this is dependent upon their distributive capabilities.  Any particular beer is destined to remain a local secret if it cannot be shipped across the country, no matter how high its quality.  Fortunately, CBA has breweries located on both coasts and is partially owned (32.2% of shares) by Anheuser-Busch, giving the company a strategic partner for increased geographic distribution.

Such distributive capabilities present CBA with its greatest opportunity for growth moving forward: the east coast.  According to CBA’s investor presentation, the east represents 33% of all craft beer volume but only 15% of CBA’s volume.  As mentioned previously, craft drinkers are extremely receptive to new and unfamiliar brands, so the deficit is probably more a logistical than preferential problem.  Successful penetration of eastern markets could easily provide a catalyst for CBA’s top line.  Quarterly revenue growth for the company is already growing at an astonishing YOY rate of 19.2%, in comparison to SAM’s 10.9%.  The formula is simple: increasing distribution will increase revenue.

Of course, every stock has its cons as well. CBA’s profit margin is roughly half of the Boston Beer Company’s; currently sitting at about 6.7% (SAM’s is 13.3%).  Even more alarming is their miniscule 2.7% ROA (SAM’s is 20.6%).  Furthermore, craft beers are obviously more expensive than mass-produced domestic beers such as Miller and Budweiser.  If a recessionary economy were to develop once again, this could negatively impact consumers’ purchasing power and thereby provide headwinds for the industry as a whole.  That being said, investors must appreciate that CBA’s market is entirely domestic, sheltering it (at least slightly) from the chaos that is the global economy.  It goes without saying, however, that macroeconomic forces must always be considered before investing.

CBA’s lackluster profit margin and ROA could be viewed as red flags for the company as a whole, but they might also present opportunities for improvement.  I believe they represent the latter, particularly because of the strength of the company’s management.  In 2011, CEO Terry Michaelson brought on Andy Thomas—former CEO of Heineken USA—as president.  To put it simply, these guys just “get it” when it comes to their consumer base.  At the end of an interview with Modern Brewery Age on May 8^th, Andy summed up CBA by saying “we remain true to who we are—we are not selling out—but we want to replicate the local experience of drinking our beers all over the country.”  And that is exactly what craft drinkers are looking for.

SOURCES: craftbrew.com, CBA Investor Presentation, Yahoo! Finance

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