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Sam Adams: Love the Beer, Not the Stock

- By The Science of Hitting

I love this time of the year. The weather has started changing, bringing an end to the sweltering heat of summer (at least if you live in the southeast U.S. like I do). The holidays are fast approaching, which means time with friends and family. But most importantly of all, this time of year means Sam Adams Octoberfest will be back on store shelves - beer fans rejoice!


The only people happier than the beer drinkers are shareholders in Boston Beer (SAM), the company behind Sam Adams (as well as other brands like Twisted Tea and Angry Orchard).

In 2015, Boston Beer reported $960 million in net revenues, compared to $238 million in 2005 (10-year CAGR of 15%). This reflects significant volume growth (barrels sold increased from 1.36 million per year to 4.26 million per year, a 10-year CAGR of 12%), as well as higher average net revenues per barrel (cumulative increase of roughly 30% over the decade). The company reported $155 million in pre-tax income in 2015, compared to $26 million a decade earlier (10-year CAGR of nearly 20%). The stock has responded accordingly: since October 2006, Boston Beer common stock has climbed from ~$36 per share to a recent ~$165 per share - good for a compounded annual return of more than 16%. Even after accounting for the pullback since early 2015 (down nearly 50%), long-term shareholders have been handsomely rewarded.

Boston Beer's success is partially attributable to catching a huge wave. According to data from the Brewer's Association, craft beer had 12% volume share of the U.S. beer market in 2015 (and 21% dollar share). That's a sizable increase since 2008 (first year of reliable data that I can find), when craft beer had 4% volume share and 10% dollar share in the U.S. beer market. Since that time, annual craft beer sales at retail have more than doubled, from $10 billion to $22 billion (seven-year CAGR of 12%). Craft beer has accounted for all the growth - and then some - in the U.S. beer market in recent years. In absolute terms, craft brewers produced 24 million barrels in 2015 - a cumulative increase of roughly 240% since 2006.

Unsurprisingly, continued strength in the craft category (double digit growth in eight of the past 10 years) has created intense competition for Boston Beer at both ends of the spectrum.

Let's start with the little guys: in 2015, the number of operating breweries in the U.S. increased 15%, to nearly 4,300 (the most at any time in American history). By comparison, there were roughly 1,400 operating breweries in the U.S. in 2006. While many of these players are quite small (microbreweries and brewpubs account for roughly 20% of craft beer industry production volumes), there are roughly 180 regional craft breweries around the country that account for the other 80% (producing fifteen thousand to six million barrels a year); the number of regional breweries has increased nearly 4x over the past decade.

Now onto the behemoths: double-digit growth in craft beer has attracted the industry leaders - companies like AB InBev (BUD), Molson Coors (TAP) and Constellation Brands (STZ). They have grown their stable of brands through a combination of acquisitions and internal development. Wherever growth surfaces (hard sodas, ciders, or elsewhere), the industry leaders will continue to use their competitive advantages (access to dominant distributor networks, deep pockets, and so on) to fight for share against smaller rivals.

Competition is taking its toll on Boston Beer. Through the first nine months of 2016, key metrics like depletions and net revenues have decreased mid-single digits (after accounting for new product/category launches in 2015, the results are less discouraging). As CEO Martin Roper noted on the third quarter call, recent results have been below management's expectations. Based on the early projections for fiscal year 2017, investors shouldn't expect a return to double-digit growth in the coming year (up low single digits after accounting for the 53rd week in the current year).

For consumers, the rubber hits the road at retail, where beer companies fight for shelf space. Availability and visibility are instrumental to long-term success. The picture shown below is from a recent visit to Publix; Boston Beer accounts for 13 of the roughly 100 products shown (six-pack or twelve-pack). Note that this is only half of the beer selection, with the remainder full of legacy / non-craft products (like Bud Light). There's a lot of competition in the beer market.

Conclusion

As noted in the introduction, I am a big fan of Sam Adams (and a big fan of chairman Jim Koch as well). They have been a major player in the craft beer revolution of the past thirty years. Long-term investors in Boston Beer are sitting on astounding returns. But despite this attractive track record, I am not interested in owning the business at today's prices. While I think craft beer is likely to continue taking volume/dollar share in the years ahead, I worry about the competition for shelf space and consumer's attention.

Jim Koch understands this well; in a 2001 interview, he told the story of his father's cautious outlook when his son started in the beer business:

"His view of it was, if you're a little guy, you can't compete with the big guys," recalls Koch. "My view of it was, exactly right. I won't be competing with them. I'll be making something better. And there are drinkers who will drink that."

There's a lot of competition in making better beer these days. In addition, there's a component of craft beer that's a "variety seeking" business - a willingness to experiment - as opposed to a "brand driven" business. My concern is that this may continue in the years ahead.

For that reason, I'm not comfortable buying Boston Beer common stock at roughly 25x forward earnings (to be clear, I certainly would not short the stock either). For now, I'll stick to buying my six-packs of Sam Adams Octoberfest.

Disclosure: No position in the companies mentioned.

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This article first appeared on GuruFocus.


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