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A Bourbon King with an Interesting Future

March 11, 2014 | About:
Patricio Kehoe

Patricio Kehoe

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As the U.S. spirits category steadily gains share of the average American’s yearly alcohol consumption, the largest spirit manufacturers continue to grow. Although some brands in the market enjoy particular financial health, such as Diageo Plc (ADR) (DEO) ($80 billion market cap) and Brown-Forman Corporation (BF.B) ($19 billion market cap), in the article below I focus on a somewhat smaller, but not less profitable company. The talk is of Beam Inc. (BEAM), which is set to be acquired by the Japanese firm Suntory by the end of 2014’s second quarter.

Now, since investment gurus John Keeley (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) added large amounts of this company’s stock to their portfolios last quarter, I’m curious to decipher why.

Of Power Brands and Rising Stars

As the fourth largest Western-style spirits manufacturer in the world and the No. 1 in bourbon, Beam has garnered a wide economic moat. In order to produce quality bourbon, the liquor must mature for several years in a company-owned warehouse. This aging inventory can be quite risky and expensive for a new market entrant, and therefore puts Beam and its three market rivals at a competitive advantage. Furthermore, the trend in spirit consumption has been tilting towards more premium brands with loftier margins, and since spirit drinkers are very loyal to their brands, aged spirits enjoy an advantage over beer and wine.

But in Beam’s case, its strong product portfolio in particular has earned it a wide moat rating. With the seven “power brands” – Jim Beam and Maker’s Mark (bourbons), Canadian Club (whiskey), Sauza (tequila), Teacher’s (Scotch), Courvoisier (cognac) and Pinnacle (vodka) – accounting for 60% of the company’s sales, these are also the main growth drivers in terms of profitability and cash flow. On the other hand, the “rising-star brands” Skinnygirl, Knob Creek and Basil Hayden’s (15% of sales) are expected to provide vast growth opportunities in the premium price sector. The fact that Jim Beam is the most sold bourbon worldwide remains, however, the firm’s pride and joy, and with rising demand in both the domestic and international market, investors can expect growth to continue.

Expansion and Valuation

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Beam’s management team has so far been successful at creating the most adequate business model for the company, having guarded shareholders’ capital and generating excess returns on invested capital of 22.6%, which should be sustained over the next decade. Despite 2013’s slow revenue growth of 4.7%, due to sales declines in Asia Pacific (-9%) and moderate sales growth of 5% in the U.S. and 6% in Europe/Middle East/Africa, the company is focused on expanding to emerging markets. While these currently only account for 15% of sales, the strong bourbon demand in Russia, India and China, as well as the vast Courvoisier volume boosts in China, should boost the firm’s growth significantly.

Furthermore, Beam’s value of about $16 billion, as estimated by Suntory’s offer to acquire the company for $83.50 per share, will be a good deal for its shareholders. The fact that Suntory recognizes this firm’s value is also encouraging, and with the current 24.2% operating margins, and 14.2% net margins in mind, it’s no surprise. Moreover, the company’s adjusted EPS grew by 10% throughout fiscal 2013, closing at a healthy $2.63. Therefore, I remain bullish about Beam’s long-term future. However, given the company’s current premium trading price of 37.2x trailing earnings, relative to the industry median of 19.2x, the firm appears to be overvalued. Thus, I would advise investors to await the next quarter, when Suntory is set to finalize its acquisition of the company.

DIsclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

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