Description

Molson Coors

Summary:

Molson Coors is a solid business (although exposed to a modestly shrinking market) that retains competitive advantages, most notably scale and strong brands, and it is currently available at a reasonably attractive price.  Although the price has appreciated since I began my research a couple weeks ago, the current price still appears to present a favorable risk/reward.

Key Issue:

First, the bad news: Molson Coors’ key categories (“premium” and “value” beers) face ongoing headwinds due to a secular shift toward high end beers (and flattish beer volumes overall).  Molson Coors’ volume mix (per Goldman, 11/2016) is ~60% premium, ~30% value, and ~10% high end—meaning that 90% of the volumes are exposed to a declining market. See the chart below—over the past 10 years in the US, “high end” beer has grown by over 31mm barrels while “premium and value” beer has declined by roughly the same volume — a volume decline of ~20%, equivalent to an annual volume headwind of about (2%).

• Counterpoint: although a 2% annual headwind in the industry volume (for segments ~90% of Molson Coors’ production) isn’t attractive, it’s also not fatal.  Molson’s key brands (Miller Lite & Coors Lite) have been gaining share as their segment has shrunk—meaning the Molson Coors headwind has been less than 2%.  Additionally, Molson Coors’ volume decline in “value” and “premium” sales may be partially offset by growth of Molson Coors’ craft/high-end products, a mix-shift toward these higher priced (and higher margin) products, and broader inflation-driven pricing growth (see chart below).  Even with an ongoing go-forward industry volume decline of (2%) in the “premium” and “value” segments, Molson Coors’ organic revenue might plausibly be flattish.

• Moreover, there’s reason to believe that the annualized 2% volume decline may subside as craft beer share plateaus.  In other words, the headwind for the “premium” and “value” segments for the next 10 years may not be as strong as it has been for the past 10.  An ongoing 2% headwind would suggest that “high end beers” become the majority of US volume in the next several years (they’re currently approaching 40% of volume, while the low-end “premium and value” beers comprise 58% of volume).  What seems more likely is that share gains by high-end and craft beers will eventually flatten. The trend toward high-end beers isn’t a one-way shift like the share-shift to touchscreen smartphones. Rather, the “statis” point for market share is likely to be balanced between low-to-mid-level beers (“value” and “premium”) and high-end beers. There is still a broad base of beer drinkers (the majority of volume) who prefer and purchase lower-priced value and premium beers.  (After all, a good chunk of Americans aren’t visiting an urban microbrewery but are instead buying beer in “Red America” at a Walmart or supermarket before the NASCAR race or football game). In-short, because the lower-priced brands are likely to retain meaningful long-term share, we might expect the 2% annual volume headwind to moderate, long-term.

Other Negatives:

Molson Coors had a bad first quarter, with Q1 2018 sales down nearly 5%.  [However, I’m not overly worried about the short-term here; the resulting decline in the share price may create a buying opportunity].

• Molson Coors operating margins, which have been in the mid-teens for the past few years, have long lagged those of Anheuser-Busch, which have been in the high 20’s and low 30’s (on the plus side, there is room for improvement).  [Note that this comparison is not apples to apples due to a variety of business differences; the broader point is that Molson Coors has long been viewed as operationally having room for improvement compared to Anheuser-Busch].

• Molson Coors’ product portfolio is somewhat concentrated.  (For example, Anheuser-Busch has a more diverse portfolio, including near-dominance of the growing super-premium beer category with Michelob Ultra and Bud Specialty brands.)

• Molson Coors has substantial debt (roughly 45% of the capital structure).

US Beer Consumption Volumes

Credit: BAML

Positives:

Molson Coors retains strong brands with high market share in the American, Canadian, and select European markets.  For example, Molson Coors has 25% of the domestic beer market share, and owns the #2 and #3 best-selling brands in the US after Bud Light (Coors Light and Miller Lite, which combined represent 18% of the domestic beer market).  

• Molson Coors also owns several leading craft beer brands and can benefit from the contribution of this growing and higher-margin (albeit small) segment.  For example: Molson Coors owns the largest craft beer brand in the US, Blue Moon. Molson Coors also owns Leinenkugel’s, a brewery known for sweeter beers and shandies (9/10 shandies sold are brewed by Leinenkugel).  

• Molson Coors top two brands—Coors Lite and Miller Lite—have gained share since 2015 (although declined overall) as the premium segment has shrunk.  Miller Lite in particular has been resilient, gaining share after a successful re-branding in 2014.

• Molson Coors has been investing in one element of its moat (more efficient production at scale.)  For example, in 2016, Molson Coors spent $30mm dollars to expand Blue Moon production in Milwaukee, and 50 million dollars were spent to expand Leinenkugel production.
  

• Molson Coors company has an opportunity to realize additional synergies from the MillerCoors acquisition (in October 2016).  

• Long-term, as craft beer growth moderates, the industry is likely to consolidate – scale (production costs, marketing/advertising, distribution) still favors the larger players (like Molson Coors).  Molson Coors has been effective at acquiring smaller brands (e.g. craft beers) and growing their sales/distribution.

Valuation:

On balance, the recent decline in Molson Coors’ share price provides an opportunity to purchase a solid, enduring business at a reasonable price.  

Currently, Molson Coors trades at ~13x estimated 2018 EPS of $5.10.  My target price of $82 is based modest EPS growth and an improved multiple as Molson Coors modestly grows top-line sales (due to price and mix), improves margins/realizes synergies, and accordingly, grows EPS.  The current fair value estimate of $82 is based on a 2019 valuation of 16x a normalized EPS of ~$5.50. This EPS estimate assumes 2018-2019 revenue growth of 1-2%, operating margin improvement to ~16%, and a go-forward tax rate of 25%.  Based on those assumptions, $11.35b of sales generates ~1.8b of EBIT and nearly $1.2b of net income, producing ~$5.50 of normalized EPS for 2019.

Risks:

• Overall beer volumes could decline as consumers shift to healthier drinks or if marijuana legalization provides a substitute.

Counterpoint: per the chart above, overall beer volumes have been relatively stable over the past 5-years and 10-years (through 2016)

• Craft breweries (that Molson Coors acquires) may be worth less in the hands of a large corporate owner. Customers may prefer to purchase craft beer from local, independent breweries (although they’re not always aware of corporate ownership).  

Counterpoint: Molson Coors has also made various acquisitions of small craft breweries throughout the country in 2016 such as Hop and Valley, Terrapin Brewing Company, and Revolver brewing, which have continued to grow sales post-acquisition.  Molson Coors’ scale may enable them to expand the reach of in-vogue (but small) craft brands that it acquires.

• Execution risk in realizing synergies at Molson Coors.

Counterpoint: realizing synergy targets always presents execution risk, but given the broader pressures on the industry/business, the organization is very focused on achieving these goals, which may improve their odds.

Conclusion:

Although there are risks, on-balance I like Molson Coors’ position (scale, strong brands, ability to cut costs and expand the distribution of craft brands that it has acquired.)  Given Molson Coors’ scale, its recent investments in more efficient production, and the opportunities to cut costs post-acquisition, Molson Coors has good odds of margin improvement.  Moreover, the share gains by craft/high-end beers seem likely to moderate, providing Molson Coors with the opportunity to return to top-line growth (thanks to favorable mix shifts and modest appreciation in selling prices).  At the current price (13x my estimate of normalized earnings), I believe that Molson Coors presents a favorable risk/reward.

Catalyst

• Return to long-term growth as share-shift to craft beer moderates.
• Short-term ability to improve operational efficiency and EBIT margin.