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Craft Beer Industry - Reading the Hop Leaves (Part 1)

December 07, 2013 | About:

Bill Smith

30 followers

I haven't written in a while. So in honor of breaking my silence, I thought I'd write about one of my favorite subjects: craft beer.

You see, I have a special affinity for the subject. Why, you ask? Well, it just so happens I'm also a brewer, and have been for 15 years. So when I added "value investor" to my list of skills 6 years ago, this particular combination of knowledge naturally drove me to select Boston Beer Co. (SAM) as an investment in November 2008. But that, I suppose, is the subject of another article. We're here to talk about beer in general.

As an extension of my periodic review of the industry, my goal is to assimilate and share my thoughts through the eyes of a brewer/value investor, which I'll rename "Reading the Hop Leaves." As a side benefit, I hope it springboards your research if you're interested in the industry--either big beer or craft beer.

Craft beer has been around for decades. During that time it has been slowly chipping away at market share. But in recent years, if you haven't noticed, craft beer has been gaining in unabated popularity. The last few years having been particular striking with a consistent trend in both sales and volume, as you'll see later. In fact, if you pull a Google Trends chart and compare the relative interest over time of the terms "craft beer", "Budweiser beer", "Miller beer", and "Coors beer", you'll see something interesting:

Since Google started charting trends in 2004, it seems the term "craft beer" rose from nothingness surpassing on-line interest for the Big-Three beers (BUD, SBMRY, TAP). Concurrently, the Big-Three have seen a steady drop in interest over the same time period.

So what's going on here? Let's start by taking a bird's-eye view of the market to gain some perspective and context.

US Beer Industry at a Glance

The American beer market is huge. In 2012, it was about $99 billion, all from churning out about 200+ million barrels a year. Just two companies command 75% of the US beer market--AB InBev and MillerCoors. However, despite the size of the market and their iron-fisted grip on American "Big Beer," the industry has seen an aggregate negative annual growth over the past few years. My favorite chart below illustrates this continued decades-old trend of relatively flat growth. A picture is worth a thousand words, as they say.

74130_1385940168pD1Z.png

Beer Continues to Lose

Since the late 1970s, beer, which is as old as civilization itself, has faced an uphill battle--increasing competition from wine and spirits. If we look at the alcoholic beverage market share, in 2000 beer's share was 55%. Now it's at 49%. Additionally, according to a recent Gallup Poll, American liquor consumers are just as likely to reach for a wine as they are a beer.

74130_1385940169oAEz.png

Source: Gallup, August 1, 2013

To add insult to injury, according to Demeter Group, US growth in servings for beer will decline another 3.1% in 2015. They expect spirits and wine to grow at +6.1% and +5.7%, respectively. From 2005-2011, spirits and wine grew at 15% and 13.1%, respectively, while beer receded 1.7%.

Much of this negative trend for beer can be explained simply...consumers are increasingly knowledgeable about their beverages and are trading up for higher quality and flavor. As a result, they've migrated from bulk domestic beer offerings, like Anheuser Busch and MolsonCoors, and towards finer products with more flavor diversity. With this changing landscape, the consumer is willing to spend the increased price on premium/luxury beverages, because it's seen as an affordable luxury. According to Tully & Holland, consumer spending is now reaching levels not seen since before the economic downturn in 2008-2009--the consumer is buying premium beverages again.

Clearly beer has been losing, is losing, and looks like it will continue to lose for some time. The macro-picture for beer looks bleak.

Or does it?

Craft Beer: The Silver Lining

Despite the overall beer market treading water, if you look closely, you'll see a small segment of the market that continues to see major, double-digit sales growth and development. This segment, known as "craft beer," has been around since the 1960s, and is gaining resurgence again.

But what is craft beer?

As defined by the Brewers Association, a non-for-profit trade association representing the majority of US brewers, a craft brewer is defined as:

  • Small: production less than 6 million barrels per year
  • Independent: less than 25% ownership by a non-craft brewer
  • Traditional: having either an all-malt flagship beer, or at least 50% of its volume in either all-malt beers or in beers which use adjuncts to enhance flavor rather than lighten flavor

Craft beer has done extremely well, growing at 10% CAGR from 2007-2012, and is expected to continue to do so for the forseeable future.

Craft's market share, as of mid-year 2013, now stands at 7.3%, up 28% from the last time I wrote on this subject in 2011 when it stood at 5.68%. In 2012, craft brewers produced 13.2 million barrels across 2,347 breweries. Stated another way, 98% of US breweries produce just 7% of the beer! Yes, this segment is small, but explosive.

74130_1385940168gad4.png

Source: Brewer's Association Data

As this sub-industry fuels growth, and consumers become increasingly aware of the major flavor differences between craft beer and domestic "Big Beer", it has led to the highest brewery count we've had in 126 years. The US now has 2,538 breweries in operation, as of mid-year 2013. Of this count, 2,483 are craft breweries. The states with the highest growth rates are Michigan, Pennsylvania, New York, North Carolina, and Texas. Since the 1978 trough, breweries in operation grew at roughly a 10% clip over the coming 35 years.

74130_1385940167Tkie.jpg

Source: Brewers Association

It doesn't stop there either. The Brewer's Association listed an additional 1,605 breweries in the planning stage, compared to 1,252 at mid-year 2012. Additionally, the Brewers Association (as of March 2013) was aware of 409 brewery openings in 2012, and 43 closings. There are lots of entrants elbowing their way into the game.

The ratio of brewpubs to breweries is also changing. In my previous writings, the mix was more like 60% brewpubs, 40% breweries. From the 2013 data, that ratio is a little more evenly split now: 1,165 brewpubs out of a total of 2,483 craft breweries, or 47%. This translates to roughly 15% total growth since 2009 for the brewpub format. Brewpubs, however, account for just 6.5% of craft market share.

It's the brewery format where the growth is. Since 2009, when there were 573 craft breweries, it's advanced a total of 130% to 1,318 craft breweries. Craft breweries account for the other 93.5% of craft market share.

Some states, like my home of Ohio, are relaxing laws to allow small brewers to sell directly to retail accounts without using the traditional 3-tier distribution model enforced after the repeal of Prohibition. In your state, you may see a brewery format with a 'tasting room'. While technically a 'brewery', it has elements of a 'brewpub' where the beer's produced, bought, and consumed on-premise. The new brewery entrants and the brewpubs tend to serve more of a local clientele. Since bottling/canning lines are prohibitively expensive for startup breweries, they're unable to put a 6-pack in front of your face at the store. Consequently, you must go to them.

Clearly, there is strong demand for craft beer. Beer drinkers nationwide want high quality, full-flavored, diverse offerings from American breweries. Recent data from the IRI Group showed craft's retail off-premise volume accelerating--up 18.7% in sales growth and 16.4% in volume growth YTD.

To give you a sense of just how strongly the craft beer industry has been growing, here's a snapshot of the mid-year 2013 data:

  • Sales increased 15%, vs. 14% in mid-year 2012
  • Volume increased 13%, vs. 12% in mid-year 2012
  • 7.3 million barrels sold, vs. 6.4 million in mid-year 2012

During the full-year 2012:

  • Sales increased 17%, vs. 15% in 2011
  • Volume increased 15%, vs. 13% in 2011
  • 13.24 million barrels sold, vs. 11.47 million barrels in 2011

Between 2007-2012, sales grew 50% from $2.1 billion to $3.1 billion. Sales projections to the year 2017 are anticipating another 30% growth to $4 billion. Additionally, the Demeter Group anticipates craft beer will reach 15% market share, or roughly double, by the year 2020.

As far as the consumers that are driving this growth, their data shows craft beer growth is coming mainly from current drinkers, new drinkers, and some cannibalization from imports and premium offerings (such as Budweiser, Bud Light, Coors Light, etc.).

74130_1385940168MeLo.png

Source: Demeter Group Data

The Grim Reality for Big Beer

So now that we have a little macro stuff out of the way, let's revisit the chart I opened this article with and ask 'what is the cumulative effect of craft brewing on the rest of the US beer market?'

If we graph total production and remove craft brewing production to see what's left, we get a chart that looks like this:

74130_1385940168Q7jm.png

Source: Brewers Association and Beer Institute Data

This steady erosion by the craft brewers is not welcome news for Big Beer and their US market share. In recent years, they've woken up to this reality.

Stay tuned for the second part of this article, where I'll continue to peel the veneer back a little bit more.

Summary

The craft beer industry continues to outstrip the growth of the aggregate beer market, by a torrid double-digit pace. This growth is marked by a consistency in both dollar sales and volume increases. Consumer demand for craft beer is strong and has been met by the largest quantity of breweries in operation the US has seen in 126 years. This sub-industry shows no signs of abating and is expected to double it's market share by the year 2020, even amidst the entire beer market having seen flat-line growth for the better part of a few decades. However you look at it, tailwinds continue to fuel the craft beer industry, and it's an oasis of growth in an otherwise dead beer market.

For Background Reading

Craft Brewing Industry Primer

2011 Craft Brewing Results

2010 Craft Brewing Results

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.

About the author:

Bill Smith
I'm an IT professional and a private individual value investor with degrees in electronic engineering and business economics. My major investment influence is Warren Buffett--finding "wonderful companies trading at wonderful prices".

Rating: 4.3/5 (6 votes)

Comments

The Science of Hitting
The Science of Hitting premium member - 9 months ago
Great article Bill; as a small time brewer of my own (just a few batches in my career), I must sadly admit that I watched SAM and was close to buying many times, only to never pull the trigger. I should've been buying the stock instead of more Octoberfest!

It's amazing to look at retailers (even one's that skew to lower end shoppers like WMT) and see the shift in shelf space to a growing number of small breweries; the big guys have done a pretty good job latching on to a few niche brands, and will likely continue to do so moving forward. That being said, it's interesting to see such a material shift in the industry.
Bill.Smith
Bill.Smith premium member - 9 months ago
Thanks, Science, glad you enjoyed it. I'm finishing up the second part and should have it out by next weekend. As far as SAM getting away from you...I've noticed over the years (started studying it in 2006, and bought in 2008) that it rarely trades below my estimate of fair value (which I'm still evaluating btw). My estimates usually tend to understate because I lump all capex (growth & maint) together in the owner earnings calculation. Separating the two is an ongoing project to dial in my estimates :) It'll be interesting to see how the future folds out and at what point there's an oversupply of craft beer production for the demand that's out there.
graemew
Graemew - 9 months ago
Thanks for an interesting article Bill. Would you consider that the success of craft beer is another example of premiumisation, which has been evident in the spirits market in recent years? What do you consider to be the market potential for craft beers in foreign markets?
Bill.Smith
Bill.Smith premium member - 9 months ago
Graemew: that's an interesting question, and I'll see if I can give the answer justice in the next part. But in general, I don't view it as premiumisation for the sake of premiumisation, where it's a marketing tactic--at least as far as craft beer is concerned. Craft beer's been around since the 1960s, so I wouldn't call it a "fad". Their success is directly attributable to consumers wanting choice and diversity, and of these same consumers willing to pay the price to have it--it simply costs more to produce one of these beers. Flavored spirits, which is a new thing, I think is an extension of the "we want choice" concept, but it'll be interesting to see how long that lasts. It'll probably go the way of Zima. Remember that one?

As far as foreign markets, I think it's possible for craft beers to have potential in foreign markets for the same reason imports do in the US. SAM sells about 3% of their beers overseas. The limitation is scale and access to distribution networks, so I don't think that'll be something that happens in a big way any time soon for your typical US craft brewer.
graemew
Graemew - 9 months ago
Bill, thanks for your reply. It would be interesting to know if there are any European or UK based small listed craft beer companies....the thought being to get in early on a European SAM. But is there a European or UK market for craft beers? BTW, I recently became more interested in the drinks sector generally, following the recent share price fall of Remy Cointreau (RCO).
riccstef
Riccstef - 9 months ago
Reading the hop leaves, but you need hop flowers not leaves to make beer
Bill.Smith
Bill.Smith premium member - 9 months ago
Graemew: the only non-US, publicly-traded equivalent I'm aware of right now is Big Rock Brewery (BRBMF) in Alberta, Canada. They've been around since the 1980s as well. http://www.bigrockbeer.com/

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