Description

Investment Recommendation:

I believe now may finally be the time for Cuervo. The Company is the largest tequila manufacturer and marketer in the world. Tequila represents 68% of Cuervo’s sales. Tequila margins have been temporarily depressed due to several years of elevated agave prices but the best cure for high prices is high prices and agave plantings have tripled over the past 6 years. It takes 7 years for agave plants to mature so agave harvests are already spiking and prices have come down 75%+. This will lead to substantial margin improvement over the next several years. Tequila is also (by far) the strongest alcohol category and Cuervo is a prime beneficiary of that continued shift. Cuervo is both the fastest growing and also the cheapest publicly traded alcohol company.

Valuation

Company Overview:

Cuervo is headquartered and trades in Mexico, but sales are predominately in the US and Europe. Julio Beckman (known as Don Julio) is Chairman while Julio Domingo Beckman is Don Julio’s son and Cuervo’s CEO. The Company owns 85% of shares outstanding with the balance trading on the Mexican Bolsa. The Company’s brands include Cuervo, 1800, Centenaro and Dobel in the tequila category as well as Bushmills and Proper 12 in the whiskey category. 

Key Investment Factors:

• Prices for agave (the only ingredient in tequila) have already come down and the market doesn’t appreciate the impact that will have on margins. Margins before agave price spiked were +60% (vs ~51% last year) and the agave price unwind will lead margins back towards prior levels.
  • It is important to note that there is no agave trading price that can be looked up on Bloomberg but conversations with industry participants have informed pricing my estimates and it’s possible the street just hasn’t been focused on the magnitude of the recent decline.
  • Tequila is made from Blue Weber Agave which takes 7 years to mature.
  • Agave farming and tequila making must be done in the Jalisco region of Mexico.
  • Tequila demand went vertical starting in the middle of the past decade but because agave plants take 7 years to mature, “feedstock” couldn’t adjust so pricing for agave shot up in a commensurate way

• • Agave growers saw those high prices and reacted by planting more agave but pricing is now crashing bc of that excess agave supply. We have visibility into “feedstock” and we can already observe pricing compression so it’s just a matter of this being reflected in financials.
    • Agave supply will grow at ~24% CAGR over the next several years vs volume projections in M/HSD so the market will remain oversupplied

• • Cuervo is ~80% vertically integrated (looking to move towards 90%) but the impact of that 20% “spot” market is still material
    • Every 10 Peso change in spot price leads to ~220 bps change in GM given Cuervo’s ~80% integration
    • So the recent decline in agave pricing is a ~700 bps tailwind to margins
  • This sensitivity is consistent with observed margins over the past few years as agave pricing spiked
• Tequila has been gaining share from other spirits and is the strongest spirit category so the demand environment remains robust. And tequila is still undiscovered globally (~2% share).

• The stock is the fastest growing public liquor Company and trading at the lowest valuation

• What is the stock worth?

Risks/mitigants:

• FX exposure
  • Cuervo’s costs are generally in MXN but +75% of revenue is mostly USD. The MXN was up ~13% in ’23 vs USD which was a ~400 bps headwind to margins.
  • This is obviously a risk worth monitoring and I don’t have a strong view on the FX cross but this could be hedged if desired.

• Shift towards super premium will be a headwind.
  • High end has definitely been growing faster than overall tequila market but even the lower end categories have seen reasonable growth (note also that half of Cuervo’s revenue comes from Premium brands)

• Entrenched family management poorly allocates capital
  • This is a fair observation and is a risk. They have made several acquisitions over the past several years and none of the acquisitions have been home runs. I would estimate Bushmills, Pendleton and Proper no 12 acquisitions had ROIC in the MSD. Clearly not good but not massively value destroying either. But clearly this is a risk
  • They have also mentioned a desire to delever from their current 3x so I expect that will be the primary use of FCF over near term which reduces risk of poor acquisitions.
• Alcohol share loss driven by GLP-1 uptake.
  • Early anecdotal reports from GLP-1 surveys does suggest reduced alcohol consumption. But most of this impact was observed in beer rather than liquor which could theoretically be a share gainer. But impact on volume trends from GLP-1 is obviously worth monitoring closely.
    • I’d also note this dynamic will effect all alcohol companies and could be hedged out.

Catalyst

Decline in agave pricing provides tailwind to margins