Description

Because the Mr. Market has lost its mind due to CV, Becle now trades for less than 2.5x 2021 sales and less than 8x 2021 EBITDA. Even with the current turmoil, this stock should trade signficantly higher and is worth over Ps50 per shr in anything other than a prolonged depression.

The thesis here is very simple:

- Becle has no net debt and can withstand an extended economic slump and/or worldwide quarantine due to CV.

- Alcohol is a consumer staple and sales will weather the storms of a bad recession. 

- Blue agave prices will return to historical levels in 2021 and margins will expand to normalized levels

- The drop in peso is not being taken into account by the market.

The peso has gotten destroyed over the past month, and the market is not taking into account that revenue is 70% developed world (mainly USD) and profits are even more weighted away from peso. Meanwhile, a large slice of Becle costs are peso denominated. Thus, in terms of pesos, revenue will go up substantially and margins will soar.

First, let's step back and recall the history here in 3 steps:

1) IPO/Break with Diageo: The break with Diageo caused confuing results thru 2018 as sales did not match depletions due to slack in the channel. Further, cash flows were non-existent as inventory needed to be built as Becle self-distributed. This confusion cleared up in 2019, and there is a solid year of proof as to the stability and growth of sales.

2) Agave Prices. Normally, agave prices are not a large part of expenses, but due to the growth or tequila sales, esp 100% agave premium tequila, shortages arose. This started in 2016, where blue agave prices rose from the normal 1 peso per kg to several multiples of this. But it really hit in the summer of 2017, when prices rose above 10 pesos per kg. And then prices continued to rise into the low 20s per kg. When prices rise 20x, this has an effect on margins. Becle owns farms that produce about 70% of the agave they need, but it must buy the remaining 30% on the open market. 

Agave shortages have arisen before, and it will cure itself. The problem is that it takes 7 years for an agave plant to mature. Planting per year is publicly available data so we know when the shortage will alleviate itself. There is one wrinkle, and that is that some producers were using younger plants even though grossly inefficient. Depending on how widespread this practice was, the shortage could run a little longer, but we expect it to run its course in 2021.

3) Coronavirus. One-fifth of distilled spirits are drinken on-premises. Clearly, this fraction is going to go to zero during this time as restaurants, bars, etc are closed. However, we expect growth in off-premise (i.e. home) drinking to partially compensate for the loss of off-premise consumption. Liquor has always been non-cyclical and not suffered during recessions. We do not expect this time to be different. Expect a reasonable unit drop in 2020 but then a rebound in 2021 to above 2019 levels.

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Valuation:

Mkt Cap = 3.6bn shrs * Ps27 = Ps97bn

Net Debt/Cash is zero.

Revenue in 2019 was Ps29.7bn. So stock trading at about 3.3x 2019 Revenue.

*** However, this was at an exchange rate of 0.053. The current exchange rate is 0.040. 70% of revenue is from the developed world, and the lion's share of that is from the U.S. Thus, when we adjust for the current exchange rate, Revenue in 2019 was Ps36.5bn (TEV is 2.7x pro forma 2019 Revenue).

Margin is trickier because Becle still paying outrageous prices for agave. We expect this problem to rapidly evaporate in 2021 as agave plantings increased dramatcally in 2014, and it takes 7 years to harvest an agave plant. And we had expected EBITDA margins to rise to high 20's, 28%.

But now, we expect higher due to the fact that most of the costs are denominated in pesos. Note that COGS are about 50%, but about 10% of this is due to agave prices. So pro forma for normal agave prices, COGS would have been about 40% of Revenue in 2019, and a strong majority of COGS is denominated in pesos. A much smaller % of SG&A is denominated in pesos. Roughly, we model about 36 % of Rev in pesos and 36% in USD. Due to USDMXN move, revenue goes up 21% but costs only go up 10.5%, taking margins from 28% to 34%.

Frankly, this is probably a step too far as some peso denominated costs will inflate and USD prices for tequilla will go down or more likely, stop increasing for a while. But the point is valid that we now expect EBITDA margins in low 30s rather than high 20s. If we run pro forma 2019 #s with two assumptions (32% EBITDA margin; current exchange rates), we have an unlevered distilled spirits brand (pre CV, growing faster than the industry) trading at 8.3x EBITDA. This seems extremely cheap for a consumer staple with an unlevered balance sheet. 

Risk:

There is only one major risk here that keeps me up at night: CV dislocations causing Mexico to turn into a 100% failed state and taking down the size-able tequila/blue agave trade. There is a lot at stake here, and the various brands have a lot of money to protect their interests, but if Mexico were to fail completely, a few private companies trying to protect fields and facilities is going to be difficult.

Catalyst

The only clear catalyst here would be Becle getting acquired. There have been various rumors on this topic for a couple of years. I have no insight into the rumors except to say that they could sell in a heartbeat if the Beckmann family wanted to sell. This is a handsome set of brands in two growing categories: tequila and irish whiskey. 

Agave prices coming down and margins expanding as predicted would be a nice soft catalyst, but I would think market already knows this will happen so it could come to pass without more than a yawn.