Boston Beer Company (SAM) appears on GuruFocus’ Buffett-Munger Screener. This screener can be used to find companies with high quality businesses at undervalued, or fairly-valued, prices. These businesses are able to consistently grow revenue and earnings, maintain and expand profit margins while growing, and incur little debt during growth.
For a small-cap company, SAM is incredibly consistent and successful, and has tailwinds behind them for continued future growth. They have a simple-to-understand business model, are highly profitable, have created value for the shareholders, and have a trustworthy and capable management team. They’re the largest of the craft brewers, generate plenty of free cash flow, and have no debt.
Let’s look into the company further to see why you may want to consider it.
Primarily through its flagship brand, Samuel Adams, Boston Beer Company is the largest domestic craft brewer, and the fourth-largest brewer in the U.S. They produce malt beverages and hard cider products at the company-owned breweries and under contract arrangements at other brewery locations. The company-owned breweries are located in Boston, Mass.; Cincinnati, Ohio; and Breinigsville, Penn. Sam Adams competes at the premium end of the beer market with imports and domestic craft and specialty brews. The U.S. accounted for 99% of SAM’s volume during the fiscal year ending Dec. 25, 2010, which totaled 2.3 million barrels (bbls), giving them a 22% share of the craft market for the year. They additionally brewed and packaged approximately 13,000 barrels under contract of non-core brands for third-parties. During fiscal 2010, the company sold over 20 beers under the Samuel Adams or the Sam Adams brand names, eight flavored malt beverage products under the Twisted Tea brand name, and one hard cider product under the HardCore brand name. As of the most recently available quarterly filing, shipment volume increased to 651K bbls for the quarter ending June 2011. YTD volume is 1.153M bbls.
SAM distributes locally through a network of 400 wholesalers and 265 sales people, who then sell to retailers such as pubs, restaurants, grocery chains, package stores, stadiums and other retail outlets. They also distribute in Canada, Europe, Israel, the Caribbean, the Pacific Rim and Mexico. SAM has almost no exclusive selling contracts or primary brand status with distributors, and must compete with other brewers for their attention. However, the higher margin potential of their premium products, the increased national marketing focus, the diversity of the product line, its top-three "better beer" ranking and leading craft beer status make the Samuel Adams brand very attractive to wholesalers.
Historically, SAM is brewed using a combination of company-owned and contracted facilities. In 2007 and 2008, they took steps to better control brewing on concerns about future availability and pricing as 33% of their production was produced under contract. Their initial plans called for constructing a facility at an estimated cost of $170 million-$210 million, but instead decided to purchase Diageo's (DEO) Pennsylvania brewery for $113 million — a completely cash transaction. The sale closed in June 2008 and the brewery is in full operation which now gives them the ability to produce 100% of their product. Although not used recently, SAM does maintain the ability to contract brew, if needed, at facilities in Rochester, N.Y.; La Crosse, Wis.; Eden, N.C.; and Latrobe, Pa. SAM remains under-penetrated in the Western states with respect to brewery capacity.
The company began in 1984 with an old family recipe that Jim Koch, the founder, discovered in his father’s attic. After home brewing the recipe in his kitchen and reviving it, Jim brought it to bars in Boston with the belief that drinkers would appreciate a complex, full-flavored beer, brewed fresh in the U.S. — he was right. This first beer was Samuel Adams Boston Lager which helped catalyze what later became known as the American Craft Beer Revolution. SAM went public in 1995.
To understand the craft brewing industry a bit more and what motivates the brewers and their consumers, see my previous article Craft Brewing Industry Primer — Behind the Revolution.
Having grown from nothing in the early 1980s, craft beer, also referred to as “better beer,” represents about 5% of the total U.S. beer market. The rest is dominated by Anheuser-Busch Inbev (BUD), Molson-Coors (TAP), and SAB-Miller (SBMRY). In 2004, craft beer’s market share was 3%.
While SAM is the largest independent craft brewer, they account for less than 1% of the total U.S. beer market. But in the craft beer space, SAM maintains a 22% market share. This makes them a very big fish in a very small pond. Only Yuengling (privately held) comes close to Boston Beer Company’s volume of 2.3 million barrels.
SAM’s main competition is not with the mass-produced, mainstream beers of Budweiser, Miller and Coors (the “Big Three”). Why?
To understand the craft beer category is to understand the clientele. They 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.
Because overall U.S. beer production has flat-lined in the last 30 years, the major brewers have spent 25 years trying to break into the craft beer market, with only one real notable success, Blue Moon, from Molson-Coors (TAP). Their interest has piqued again recently to this area of the market and have been buying complete, or partial economic interests, in craft brewers. For example, Anheuser-Busch InBev (BUD) purchased Goose Island Brewery, in Chicago, Ill., and have a 30% stake in Craft Brewers Alliance (HOOK), which gives HOOK access to their distribution network.
Although the number of craft breweries is on the rise, which will translate to an overall increase in competition in the craft beer market, it’s important to remember that roughly 66% of these brewers are brewpubs — which don’t distribute to market. Their market is local; to enjoy their beer you must go to them and consume it on premise. Brewpubs only represent about 8% by sales in the craft market. The other one-third (92% of craft sales), are breweries that distribute to market. Therefore, SAM directly competes with other domestic craft brewers and imports for market- and mind-share, such as Hofbrau, Hacker-Pschorr, Ayinger, Heineken, Sierra Nevada, Craft Brewers Alliance (HOOK), Yuengling, Gordon Biersch, etc.
There are a number of underlying reasons/trends that account for the rise of the craft beer market.
Generally, there’s been a shift in consumer preference over the last 25 years for niche and premium offerings in the Better Beer category. Consumers want choice and SAM brews innovative and unique beers, some seasonal, that have struck the right chord with American beer drinkers. A whole generation of beer drinkers grew up expecting choice and flavor, and SAM is there to provide it.
Consumers also want to customize and personalize their products. There was a time when there was no choice — you could only select from three types of beer. But today consumers can pick their favorite beer style and make a personal statement about themselves, similar to the way consumers can customize their coffee at Starbucks, or personalize their iPod and iPhone, or get body art.
Additionally, craft beers have been experiencing the attention that wine had in the 1960s and the 1970s — as a compliment to dining — and is being paired with menu choices. Events such as SAVOR, held every year in Washington D.C., celebrate this pairing of craft beer and food. As an anecdotal gauge of enthusiasm, this year’s SAVOR event was sold out in less than 24 hours.
If the wine story is any guide, then the growth trajectory of craft beer could be similar. Quality, affordable table wine was unheard of in the 1960s. Now the market represents roughly one-third of its industry by volume. Craft brewing, which exploded onto the scene in the 1980s and was also unheard of in the 1970s, has enjoyed steadily growing recognition and availability, and currently holds a 5% market share.
Lastly, the core demographic is expected to expand. The U.S. Census Bureau estimates the population of young males, age 21-35, will increase 4% by the year 2015. Additionally, the target market continues to grow beyond age 35, just at lower volumes.
The $1 Test
Let’s take a look to see whether the company creates value, or destroys it.
In Warren Buffett’s 1983 Owner’s Manual for Berkshire shareholders, he described the “$1 Test.” In short, on a five-year rolling basis, earnings retention must, in the long run, deliver at least $1 of market value for every $1 retained in the business.
As can been seen from the chart below, SAM has created significant value for their shareholders. For every $1 retained by the company they produced $19.89 in market value.
Balance Sheet & Capital Structure
As can be seen from the balance sheet snapshot below, SAM currently has $66 million of cash in-hand, and no debt, although they have access to a $50 million line of credit, which they’ve never used.
They are capitalized with no bonds, no preferred stock, and 13.6 million shares of common stock. Those shares are 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 all 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.
Over the last decade, SAM has returned capital to its shareholders, reducing the net share count about 17%. Their buyback program was recently approved an increase by the board of $25 million for a new limit of $250 million. The chart below illustrates their buyback history.
For the first half of 2011, they achieved an average buyback price of $84.83 a share, purchasing 266,400 shares at $22.6 million. Cumulatively for the program, they’ve bought back 10.1 million shares at $219.9 million, or an average of $21.77 a share.
SAM is led by CEO Martin Roper. The other key executives are William Ulrich, CFO; Thomas Lance, VP of Operations; David Grinnell, VP of Brewing; John Geist, VP of Sales; and Robert Pagano, VP of Brand Development. This group has a range of experience in the food and alcohol industries.
Mr Roper has been the CEO since 2001, and has the longest tenure of the current executives. In 1994, he joined the company as VP of manufacturing and business development, becoming the COO in 1997, and later president and COO in 1999. He holds a masters degree in manufacturing, as well as an advanced degree in business management. Before joining SAM, he was a strategy consultant and led small manufacturing companies in turn-around situations. His experience, both before and since joining SAM, provides strength in operations, strategy, finance, public company corporate governance and general management. Mr Roper also serves on the board of directors for Lumber Liquidators Inc.
Mr Ulrich became the CFO and treasurer in 2003. Before SAM, he was the CFO of Acirca Inc., a producer of organic foods and beverages, from 2001-2003. Between 1998 and 200 he was also the VP of finance and business development for United Distillers & Vintners, a Diageo Plc (DEO) subsidiary, and from 1995 to 1998 the VP of finance and treasurer.
Recent executive compensation has appeared reasonable. For each executive, the proxy statement calls out very specific, weighted goals related to company performance to determine additional compensation beyond base salary.
Lastly, the board of directors boasts a solid range of experience in the consumer products industry.
Sales, Pre-Tax Profit and Earnings
As mentioned in the overview, SAM distributes internationally to a small extent — 99% of their sales are in the U.S.
A visual review of SAM’s sales, pre-tax profit, net income and owner earnings curves on a logarithmic graph will quickly illustrate the stability of its operations. Owner earnings are additionally charted along with GAAP net income, as it is the cash that a business can actually generate for its owners.
A “wonderful” company with excellent business economics will have straight curves on this chart that parallel each other and rise to the right — a visual indication of excellent management, cost control, and the presence of a competitive advantage. A “not-so wonderful” company will have choppiness in these financial figures, and the curves will be erratic, bouncing up and down.
As can be seen, SAM has a steady sales growth curve. Their pre-tax profit is also consistent, with the exception of the outlier year 2008. In this year, they completed their all-cash purchase of their new brewery in Pennsylvania, and of course took a short-term accounting hit. (Note: log graphs don’t display negative values.)
Turning to growth rates, SAM has enjoyed double-digit revenue growth, driven by volume growth and strong pricing.
Revenue growth has averaged 10.6% and 14.2% (nine years and five years, respectively). Sales in the latest quarter were $134 million, compared to $124.5 million last quarter. Additionally, SAM has been able to pass along cost increases to the consumer, even during the recession, without long-term detrimental change in demand. The accounting EPS has grown 25% annually from $0.47 to $3.52 over the last nine years. Book value expanded 8.7% annually from $78 million to $165.6 million over the same period.
As a percentage of sales, COGS for SAM has normally stayed stable in the low 40%-43% range. However, it trended upward from 2004-2008, peaking to 53.8% in 2008, as a result of the brewery expansion and supply restrictions for input ingredients. Since then, it has started to trend downwards and currently sits at 41%.
SG&A, as a percentage of sales, has averaged 25% since 2001, and is currently at 39%. It has grown approximately 11% during this period, roughly in-line with their sales growth. Normally, there is a spread between the two where revenue growth outstrips SG&A growth because core shipment volumes increase at a higher rate than SG&A. However, SAM has recently increased expenses to advertise their brand. But the long-term trend is clear from the revenue and earnings visual analysis chart — the pre-tax profit line moving towards the revenue is an indication they’re reducing costs overall.
Lastly, SAM has no R&D expenses.
As far as margins, gross margins have held steady at around 59% in recent years, but fell to 46% in 2008 on a glass bottle recall, inefficiencies at its new brewery, and a world-wide hop shortage. Gross margins are on the rise again, currently sitting at 59% for the TTM, and should recover to their original values and beyond as efficiencies are realized at the new brewery. They expect 2011 gross margins to be 54%-56%. The 10-year average is 58%. Likewise, their operating and net margins are on the rise again after the brewery investment. Operating margin currently sits at 15.9%, while net margin is over 12%.
Up until 2008, SAM owned two breweries. Since they now own and operate three breweries, it’s worth estimating capex per brewery. As they grow and buy new breweries, this cost will need to be factored into future valuations as it will affect cash flow. SAM doesn’t distinguish maintenance versus growth capex in their 10-Ks. Looking at the two together from 2000-2007 tells us that average capex per brewery ran anywhere between $5.8 million (excluding 2007) to $8.3 million (including 2007), which gives us a suitable basis to estimate total capex for three breweries post-2008. This figure should be anywhere between $17 million-$25 million. In fact, their latest annual filing estimates this value at $15 million-$25 million.
The chart below summarizes a variety of metrics to illustrate management performance and competence in making money for their shareholders. It helps answer the question: are they efficient allocators of capital?
Their 10-year average ROE is 17.5%; ROA is 11.9%; and CROIC is 14.2%.
Cash return on invested capital (CROIC) tells us how efficient a business’ operations and management can allocate capital into the business to create even more cash. Over the long term, a business will generally grow at the rate it can generate owner earnings. This growth depends on how much cash it generates based on total cash invested by shareholders and bondholders. When assessed over multi-year periods, CROIC can be viewed as the sustainable upper limit to a company’s growth. CROIC has averaged 14% over the last decade, with the 2010 CROIC at 29% and TTM CROIC at 41%.
SAM clearly generates cash and has the management acumen to generate double-digit ROE & CROIC. For every $100 invested, SAM generated $14 in owner earnings, on average.
Basis of Competitive Advantage
Scale is important for a brewer. Although SAM is a big fish in a small pond, they are a very small fish in a very big pond that has a few whales swimming around: Anheuser-Busch InBev (BUD), Molson Coors (TAP) and SABMiller (SBMRY) simply dominate the industry. This means they have a tighter grip on distributor relationships and distribution channels, making it more expensive for any craft brewer, in general, to get their beer to market. Being small also hinders a craft brewer from exerting pricing power or fully controlling production.
In spite of these challenges, the craft beer industry has survived for the last few decades, with the Samuel Adams brand growing and thriving in mind-share in the public. They are recognized and known, and in some respects part of the language… go to an establishment and just say “give me a Sam” to see the effect.
What’s their competitive advantage built on?
Real Product Differentiation: They use traditional brewing processes, the world’s finest ingredients, and often take extra steps, like dry-hopping and krausening, to differentiate their beers. These are tangible differences that result in a tangible difference on the palette — which is what the craft brewing consumer is after. Additionally, their sales force is knowledgeable and large compared to their peers. This team is known for its high level of education and product knowledge, carrying ingredients with them to demonstrate the differences in their beer. They’ve promoted the company well past any other in the craft market, and it has allowed them to establish loyal and strong distributor relationships
Perceived Product Differentiation: The dominant brand in the craft space, they dwarf most of their craft rivals. Their distinct brand image translates to quality and superior taste at a price that’s not outrageous — better beer for some, or an affordable luxury for others. This has led to name recognition, press and clout, especially when dealing with distributors. The brand is also enhanced by Jim Koch’s personality and clever commercials. Additionally, they elevate the image of American craft beer by entering festivals and competitions across the globe. In the past five years, they’ve won more awards in international beer competitions than any other brewery in the world.
Driving Costs Down: as seen from the graphs above, SAM has been continually reducing costs. They have the scale advantage over their craft peers, but not over the very large brewers.
Locking in Customers: Technically, it costs nothing for someone to switch brands. However, craft beer consumers will generally stay with craft beer — this is good for the category as a whole. Additionally, SAM continually innovates new beers and provide them to market to attract new customers with new tastes, such as their collaborative effort with the world’s oldest brewery, the Weihenstephan Institute in Germany. This project, two years in the making, recently released last November 2010 a new beer called Infinium. These projects keep the brand alive, interesting, and create anticipatory demand.
Locking Out Competitors: SAM brews a full lineup of beers — over 21 styles, many of which are seasonal. Not only does this create anticipatory demand and a loyal following, but it presents a barrier to others entering the business since most new breweries will start with a lineup of a pale, red and dark beer, and then expand from there. Additionally, “the strength of the weak” (as Jim Koch puts its) keeps the really big brewers at bay to some degree. Small brewers are nimble which allows them to try new flavors, promotions, and allows them to be closer to, and in sync with, their customers compared to the behemoths of the industry.
As of Aug. 29, 2011, SAM traded for $80.61.
Price Multiples: The chart below highlights various price-based multiples. SAM currently trades under its 10-year average P/E and P/FCF ratios.
According to this Gurufocus chart, SAM is trading in the middle of its P/E band.
This next section derives fair values based on: DCF, the Graham Number, EPV and various yields.
DCF: This approach uses a two-stage discounted cash flow model based on owner earnings through time with a discount rate of 9%. Each stage is a decade with the initial growth rate assumption at 14%, tapering 10% every few years during the first decade. The second decade assumes a 5% growth rate. Intrinsic value using this approach is $94.61. (Note: according to Morningstar and Yahoo, consensus estimates for EPS growth are 16% and 22.7%, respectively.) According to this approach, SAM is slightly undervalued.
Graham Number: This approach uses Ben Graham’s formula based on average earnings power to arrive at an intrinsic value of $86.80. Using this view, SAM is fairly priced.
EPV: This approach uses the earnings power value approach to arrive at a zero-growth intrinsic value, which is $34.58. The net reproduction cost represents the per share price a competitor would need to duplicate the business, or $16.44. The difference between these two figures represents the value created/competitive advantage SAM enjoys — which suggests that SAM has a moat, or a moat in the making.
Owner Earnings Yield: this method uses the bond-parity principle and views the stock as an “equity bond” where the owner earnings are a steadily growing “coupon” over time. It’s then compared against prevailing bond interest rates to determine relative valuation and attractiveness. When viewed this way, the 7.8% owner earnings yield would be compared to the corporate bond rate of 4.8% (avg. redemption yield), indicating SAM is undervalued. The bond-parity price at 4.8% would be $130 a share. However, to achieve this price with DCF, SAM would have to grow at 20%, which I don’t feel is realistic.
Valuation conclusion: Taking all of the above into consideration, SAM is slightly-undervalued to fairly-priced as of Aug. 29, 2011.
Catalysts & Tailwinds
Boston Beer Company has the following catalysts and winds at their back:
- Although there will be increasing competition in the craft space, SAM will benefit from relative strength in the category as the dominant brand.
- Consumers continuing the longer-term trend of trading up, due to the demographic trends mentioned earlier.
- While the recession caused some consumers to seek lower-priced alternatives over the near term, strong branding efforts are reviving growth.
- Recent data confirms that their volumes are outperforming the overall beer category.
- SAM’s financial flexibility, and no 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 $250 million repurchase program. As of November 2010, SAM had approximately $30 million remaining under the program.
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 fledgling craft breweries.
- Interest by the big brewers in craft breweries.
- 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 costs
- SAM’s breweries are geographically concentrated in the Eastern U.S. exposing them to fuel costs for transportation of products to the West.
I have a long position in SAM at the time of this writing.
This 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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