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A Look at the Profitability of a Boston Brewer
Posted by: Victor Selva (IP Logged)
Date: February 27, 2014 05:20PM

The domestic beer market is characterized by vast competition, as much as consumer preferences. While imported AB InBev and MillerCoors concentrate 80% of the overall market, Boston Beer Company Inc. (SAM) is most popular along the East Coast. In fact, not only is this craft brewer the fourth-largest in the U.S., but it’s also the largest publicly traded brewer nationwide. Under its flagship brand, Samuel Adams, the firm has achieved large scale, having sold 3.4 million barrels of beer in 2013 alone.

While craft beer still remains one of consumers' preferred beverages in the domestic market, competitors like Anheuser Busch Inbev SA (ADR) (BUD), which offered premium light beers, have been swapped for other craft brewers trying to imitate the Samuel Adams brand. And although the company enjoys a narrow economic moat rating, competition is heating up among privately owned brewers, like AB InBev, New Belgium and MillerCoors, which are planning to take over Boston Beer’s market share.

In the article below, I will analyze Boston Beer's past profitability, debt, capital and operating efficiency. In addition, I will take a look at which institutional investors have recently bought the company’s stock this past quarter. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings.

Profitability Analysis

Profitability is a class financial metric used to analyze a business’ ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues, in order to elucidate if the company is really making money.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets, in addition to giving us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.

I dislike the fact that Boston Beer Company's ROA decreased from 24.88% in 2010 to a current 17.52%, because this ratio is evidence of the company generating less from its assets than it did in 2010.

Quality of Earnings

Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies, such as inflation of inventory. In order to assess this brewery's quality of earnings we will compare the level of income with operating cash flows.

Boston Beer augmented its profits at a rate of 0.5%, but the growth of cash flows was higher, which is strong evidence of profits being earned through a boost in sales and cost reductions.

Working Capital

This ratio measures both a company's efficiency and its short-term financial health, indicating whether a company has enough short term assets to cover its short term debt. While the sufficient ratio should lie somewhere between 1.2 and 2.0, anything below 1 indicates negative working capital and anything over 2 means that the company is not investing excess assets.

In order to appreciate a company's working capital structure, we need to analyze its current ratio growth. Boston Beer's current ratio has decreased from 1.88 in 2010 to 1.57 in 2012, which shows that the company’s balance sheet is weaker today than it was three years ago.

Gross Margin: Gross Income/Sales

The gross profit margin measures a company's manufacturing and distribution efficiency during the production process, in addition to telling an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors — and overall industry — is more efficient and should be able to make a decent profit as long as overhead costs are controlled.

Furthermore, investors tend to pay more for businesses that offer higher efficiency ratings than their competitors. Over the past three years, Boston Beer’s gross margin has decreased from a solid 55.5% in 2010 to 52.1% in 2012. This indicates that the company is becoming slightly less efficient year after year.

Asset Turnover

Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue — the higher the number the better. It also indicates pricing strategy: Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.

The fact that this company’s revenue growth has outpaced the assets growth (-0.5% growth) on a percentage basis, indicates that the company is making money on its assets.

Institutional Sponsorship

I also evaluate which hedge funds bought the stock recently, so as to decipher if the stock is worth my while or not. In Boston Beer’s case, both Ron Baron (Trades, Portfolio) and Murray Stahl (Trades, Portfolio) invested in the company’s stock this past quarter at an average price of $159.02.

Analyst Outlook

Currently, many analysts have a good outlook for Boston Beer. While analysts at MSN money are predicting that the brewery will retrieve EPS of $7.58 for fiscal year 2014, Bloomberg is estimating revenue to reach $884.29 million in fiscal 2014. In addition to this, on April 11, 2013, Williams Capital gave the company a rating of "Outperform" with an astounding target price of $251.75, showing significant upside potential from this point.

Closing Argument

Despite a somewhat uneven balance sheet, I remain bullish about Boston Beer’s long term future profitability, especially while management is run by founder James Koch. The reality of the domestic beer market is that competition will continue to pressure operating margins, as well as revenue growth. Nonetheless, Samuel Adams’ popularity among craft beer consumers is not to be underestimated and while sales are up, investors can expect high returns on invested capital to remain around the 50% mark.

Furthermore, the 26.5% EPS reported in fiscal 2013 is promising and should help offset decreases in gross margins. However, I must warn investors looking to buy company shares to hold off until the trading price decreases, as it is currently boasting a 152% premium relative to the industry average of 19.20x.

Disclosure: Victor Selva holds no position in any stocks mentioned.

Guru Discussed: Murray Stahl: Current Portfolio, Stock Picks
Stocks Discussed: SAM, BUD,
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