TPX.B:CC - Molson Coors: Still One Of My Favorite Buys

2023-11-08 17:29:14 ET

Summary

• Molson Coors Beverage Company has outperformed Anheuser-Busch InBev SA/NV in terms of total return and market performance in the past 18 months.
• Molson Coors has benefited from Bud Light's public relations issues, but its recent fundamental performance is worth examining.
• I maintain the craft beer market is peaking and Molson Coors will be a big beneficiary.

When I last wrote about Molson Coors Beverage Company ( TAP ) for Seeking Alpha in April 2022, there was a much different vibe surrounding both Molson Coors and its primary competitor Anheuser-Busch InBev SA/NV ( BUD ). When I wrote that piece, the core thesis was that Molson Coors would benefit from consumer down-trading as a result of price inflation. Given trends in the craft movement and Molson Coors' lack of a strong craft presence in its brand portfolio, I felt Molson Coors had the least to lose in consumer down-trading because of inflation:

This isn't to say that Anheuser-Busch can't work well in an inflationary environment as well. But I think you could argue that TAP has bled market share as a result of craft beer growth to a larger degree than BUD has. So a potential reversal of the craft trend could have the reverse effect and be better for TAP than for BUD.

In the 18 months since that article was published, not only has the total return from holding TAP (+14.6%) been better than that of BUD (+1.8%), but TAP has outperformed the broad market as well while BUD and Boston Beer Co ( SAM ) have both lagged the index:

The TAP call has worked out well. However, the elephant in the room is that Molson Coors has obviously benefited from the self-inflicted wounds resulting from Bud Light's public relations meltdown earlier this year. In the chart above, we can observe a large divergence between TAP and BUD shares that started in April right around when the Bud Light controversy began. The question now is, can this continue?

Earnings Reaction

Molson Coors reported Q3 23 earnings in early November, and I see a lot of positive signs. First, the headline revenue number for the quarter came in at $3.3 billion. That was up 12.4% year-over-year against a cost of revenue figure that was essentially flat.

While Molson Coors is still trailing peers, the company has improved gross profit margin from 33.5% a year ago to 40.8% in the last report. This was also the company's most profitable quarter by gross margin since Q1 22, and the long-term quarterly gross profit margin trend in Molson Coors is better than that of Anheuser-Busch.

At $1.99 per share, Q3 was Molson Coors' best quarter from a basic EPS standpoint in the last 2 years. The company is growing share in its Miller Lite and Coors Lite brands, and I don't think this is over. Citing data from Circana, CEO Gavin Hattersley didn't leave much doubt about the stickiness of that brand growth on the last earnings call:

In fact, Bud Light's actually getting worse. The brand's dollar share loss over the last 4 weeks was more than any 4-week period this year. And as I said, these aren't -- I mean this isn't a pole or a possibility, right? This is the fact as laid out in Circana, and we believe that the strength is going to continue into 2024, and we're very confident in the position of our core brands in both the U.S. and obviously, in Canada. We've got a very clear plan on keep these share gains. We presented it to our distributors at our 4 national distributor convention. We showed our plans. And honestly, the energy around our plans is something I have not seen, not only for Miller Lite and Coors Light, but for everything. We had a 95% positive score from our distributors. That has never happened.

Sometimes it's better to be lucky than good. While I still think Molson Coors has a favorable macro setup, the fact that the company's core competitor in the U.S. market hurt itself to the degree that it did earlier this year has clearly been an unforeseen catalyst in driving sales for Molson Coors. My read on the situation is that it is going to take Bud Light a long time to come back from this. And I maintain that the "decline of craft" catalyst that I laid out in my last TAP article is still in play.

Craft Breweries Are Already Struggling

Look, I know personal anecdotes aren't necessarily great metrics for assessing a macro thesis. Furthermore, anecdotes can even sometimes send the wrong signal, but I'd like to share one anyway. Back in late 2020, I bought what were essentially debt notes in two small craft breweries through a platform called Mainvest. One of those breweries is in South Bend, Indiana and the other is just outside Columbus, Ohio.

While they're in the same region, they're in different states and different markets. Within the last month, both of these businesses have paused profit share payments and provided updates that are concerning and possibly indicative of broader struggles plaguing the industry. The CEO of the Ohio entity said this in an investor update on November 6th:

The last few months have been rough. We went from a +6.2% above YTD projections to -3.35% below YTD projections as of November 5.

He went on to say the brewery's owners are looking for suitors and are trying to stay open for a buyout. Things aren't much better at the Indiana entity where debt holders are voting on a revenue sharing agreement amendment that would see repayments paused for a year. That brewery's CEO said this in a late-October update:

We started the year well, seeing an increase in overall sales from January through April at just over 18%. Unfortunately, those increases stagnated as we got into the summer, which is normally our busiest time of the year. Things began to take a downturn once we got into August. From August 1 through the first week of October, we are down over 13% and sliding into the slower winter months with cashflow issues that make it difficult to meet weekly responsibilities.

These are sad developments for these small businesses. But unfortunately, I don't think these are isolated incidents, and I believe we're essentially at the end of the craft boom. If we look at the long-term trend in openings and closings data from the Brewers Association, openings peaked in 2018 and closings have begun to increase as well:

But the most important takeaway from the graphic above is the net difference between openings and closings. Last year, that figure was +213 and that was the lowest that number has been since the beginning of the data set in 2010. While I'm not going to re-write my April 2022 TAP article, it is my view that high consumer price inflation is pushing craft beer drinkers to cheaper alternatives. Consumer down trading will result in brewpubs, taprooms, and microbrewery closings and it will ultimately benefit companies like Molson Coors.

Valuations

What makes Molson Coors an even stronger buy for me beyond the craft market setup and the self-destruction of Bud Light is the company's valuation relative to peers. Even with what I view as improving fundamentals, TAP still trades at a discount to book value and lower multiples than BUD, SAM, and Heineken N.V ( HEINY ):

Source: Seeking Alpha

Molson Coors is cheaper than major brewing peers in the public equity markets by just about any metric. Seeking Alpha's Quant Factor Grades give TAP favorable marks across the board, and TAP is the only brewer of the four mentioned with a valuation grade above "D+."

TAP is also the only equity of the four mentioned that has a dividend yield above 2%, and it has the 2nd best debt to equity ratio after Boston Beer Co.

Risks

It's entirely possible that beer drinkers don't just down-trade - they could simply drink less. This would admittedly be the healthier decision to make, but I'm less convinced we'll see that decision happen at scale. Of course, consumers may not have a choice if the broader economic space deteriorates and layoffs increase. That said, alcohol sales have historically been a recession-proof segment and beer is a cheaper buzz than wine or spirits when times are tough.

Summary

This is still a very defensive name in my view. But I do believe the time is right to be defensive in equity investment portfolios. While the "magnificent seven" stocks have roared higher all year, in my view those gains have helped the S&P 500 (SP500) mask the carnage elsewhere in the broader economy. Consider what the Russell 2000 Index (RTY), which is actually down over 5% over the last twelve months, might be telling us:

This is not a great sign, and many stocks have underperformed the index to a considerable degree this year. With that said, it's all the more interesting to me that Molson Coors has actually outperformed the broader stock market. For me, the company is a lower-risk name than peers due to its more favorable debt to equity levels, valuation, and dividend yield. I believe Molson Coors benefits from destruction in the craft industry. Furthermore, Molson Coors' largest domestic peer continues to battle a PR nightmare. Molson Coors Beverage Company is still a buy and is one of my favorite stocks to ride out a downturn.

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