Molson Coors: Unexploited Opportunity or Infinite Stagnation?
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In the past few years, the alcoholic beverage industry has undergone massive consolidation. While huge companies with big emerging market exposure were being formed, such as SABMiller or Anheuser-Busch InBev (NYSE: BUD), Molson Coors (NYSE: TAP) was divesting itself of its international exposure by selling its Brazilian beer business, Kaiser. Molson Coors has suffered from this reliance on mature markets which is reflected in its 12x earnings multiple compared to the far more generous 21x for Anheuser-Busch InBev. Does this pessimism represent opportunity for the long-term investor?
The first question to ask is what have Molson's operating returns been over the past ten years? We can see that returns on operating assets are towards the bottom end of the past ten years but profits have increased dramatically in absolute terms. To get a clearer picture we have to break the return on operating assets down further to see what margins Molson is making and how it is using its assets.
While operating margins have improved any benefit from this has been canceled out as the company has achieved lower and lower sales per unit of operating assets. In 2002, Molson had sales that were 2.59x operating assets but by 2011, this had dropped to 0.51x. To put this in more understandable terms, while net operating assets have increased by around $7bn since 2002, sales have only increased by $1.3bn. The main reason for this was the 2005 merger between Molson and Coors which added about $5bn to the goodwill line. The company has made good investments outside of goodwill and the operating performance net of intangibles has improved from around 6% in 2002 to 16% in the LFY with a high of 35% in 2006. Due to the effect of the JV, of which more will be said later, we know that this problem with operating assets is somewhat overstated as the income statement no longer includes US sales. The conclusion at this stage is that the merger really didn't work out as expected.
So what will Molson be facing in the future? As mentioned already, the most important dynamic in the alcoholic beverage industry has been consolidation. In the 2001-2010 period, the combined share of the world's largest 10 brewers increased by 22 percentage points to 61% and this increase was achieved primarily, through M&A. Consolidation, combined with slowing consumption growth in Molson's major markets of the USA, Canada, and the UK, has placed Molson Coors in a rather difficult position.
If we look first to the problem of consolidation, a key element of Molson's strategy is the JV with SABMiller, formed in mid-2008, which combines their US operations. Molson has a 42% economic interest in MillerCoors and 50% of the voting rights. Due to the accounting, it is quite difficult to work out if Molson has benefited. It appears that SABMiller contributed most of the assets and that Molson's share of the JV's profit is higher than the profit it would have received from its independent US operations. The gross margins of the JV are about 17% better than the margins in the rest of Molson's business as well however; while it seems a great idea financially, is it really a long term solution? One problem is that the two main products in the JV, Coors Light and Miller lite, are competing for similar, if not the same, customers. In this sense, the JV is zero-sum as gains for one brand come at the expense of the other.
I don't quite agree with this view. Volume growth is not a realistic target for companies in the US market. The projected CAGR for the US market over the next few years is 2%. Therefore, it makes sense to try and compete on cost and efficiency. In SABMiller, Molson is getting an experienced partner and given their record on gross margins, is perhaps getting a partner with a better record on cost control. In addition, some analysts have mentioned that the JV dramatically improved distribution possibilities for both companies however; the US market is still dominated by A-B Inbev and in 2010, A-B Inbev held around 36% of the US beer market against MillerCoor's 16%. While there is potential for craft beers and targeting new customers the ultimate dynamic of an extremely competitive market dominated by a particularly formidable competitor has not changed.
The other major issue facing the company leads on from this: stagnation of Molson's traditional markets. As already mentioned, the projected CAGR for the US beer market is 2% while Canada may experience slightly faster growth around 3% and the UK may experience significantly negative growth around -2%. In 2010, Canada represented about 59% of sales ($1.93bn) and the UK about 38% ($1.2bn) with international sales making up the remainder ($81m). The JV had sales of $7.5bn in 2010.
The most serious problem for Molson is the UK. Its main brand there, Carling, has been losing ground to Carlsberg and Beck's as it fails to define itself as either a premium or economy choice. Molson has faced this across all developing markets as the standard lager market gets more crowded and competitive however; the UK has been particularly tough as demand for standard lager has dropped away more sharply than in other markets. The question has been how much growth can be achieved through marketing to new customers, especially women, or products outside standard lager, such as dark beer or premium lager? Growth is possible in these segments and should be pursued, which Molson is doing, but the numbers just aren't big enough. The basic fact is that Molson's specialty is in standard lager and growth in standard lager in the markets it serves isn't going to be substantial.
A more successful strategy has been to try and sub-contract or licence spare capacity. This has been most successful in the UK with the Cobra partnership (Molson also took a majority stake in the company that owns the UK and worldwide, ex-India, rights to the Cobra brand). Analysts have noted the potential to link up with SABMiller which has no local production in the UK and runs import-only operations.
Rather than selling to new customers or new products, it may make more sense to try and expand on its reputation overseas where standard lager markets are growing strongly. The company appears to have set sights on Vietnam, Russia, China, and India. The growth offered by this markets is substantial with CAGRs for standard lager often in the high single or double digits. China has the greatest potential as it is already large enough (volume of over 40,000 mm litres) to make a difference however; the other three present some significant challenges. India is the probably the fastest growing market but, despite the good relationship with Cobra, Molson probably cannot enter the market alone. The regulations involved present a serious barrier and it will probably need to partner with another company (again, SABMiller is a possibility). Vietnam has a young population and consumption is growing fast yet the market is not big incredibly large (around 1,500mm litres). While Russia is one of the biggest markets in the world it is approaching maturity. The potential here is significant but only the JV with Hebei Si’hai Brewing Company in China seems to have potential at the moment. One possibility is taking another look at South America, particularly Brazil, where the markets are large, well-developed, and still growing fast.
It is clear that Molson is in a difficult position. Growth in the countries it operates in is stagnating and growth has been hit worst in its core segments. At the same time, these segments are becoming more competitive as companies battle for slices of a shrinking pie. The JV with SABMiller was definitely a good move but it cannot address the fundamental problem of a shrinking market. Any upside from the JV is diminishing as the company runs out of room to improve costs and efficiency. The strategy for developing markets has potential but there is nothing that really suggests great potential. The reason for this is that the company doesn't have operations in South or Central America which, at the moment, offer the largest, fast-growing markets. So valued at just under $8bn is Molson worth it?
One way to value Molson is to look at the JV and the rest of the business separately. The JV had net earnings of roughly $1bn of which Molson's share was $450m FY11. Given weak expected growth we could put a 10x multiple on this so Molson's share is worth about $4.5bn. The rest of the business produced around $340m and again applying a multiple of 10x earnings, we have a total value of $7.9bn. I think this demonstrates best my general feeling that Molson, at the current price, doesn't really seem like a great opportunity however; the company's return on tangible assets is still very good which suggests it has some brand value. If the company gets cheaper or improves its international operations (in particular, opportunities for JVs or further mergers are still good) then this could be an excellent opportunity to pick up a somewhat misunderstood company.
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