There’s something about the sellers of alcoholic beverages that makes their shares effervescent. When times are good, people drink. And when times are bad … people still drink.
That consistency makes brewers and spirits companies particularly popular in a downturn. When the economy rebounds, investors typically forsake them and flock instead to more cyclical stocks.
There’s something funny going on in the current bull market, however. The shares of the brewers and spirits companies aren’t particularly cheap. And yet value-oriented investors are still putting them near the top of their list.
How so? Well, it turns out you can make both a growth and a value case for most of the shares. Increasing incomes in the emerging markets should translate into greater global consumption of beer, wine and alcohol. That’s the growth part.
And the value-oriented like to look at the healthy cash flows of these companies, combined with their resistance to economic decline. “One of the real attractions of spirits and beer is you’ve got pretty steady cash flows out of most of these business. Nothing too dramatic happens … you can be reasonably sure nothing’s going to blow up too materially,” says Ian Shackleton, a London-based analyst for Nomura Equity Research.
One of the best buys in the spirits sector may be its biggest name: Diageo PLC. The London-based company faces some uncertainty, as it will stop distributing Jose Cuervo tequila this summer after a failed attempt to buy the brand from its Mexican owners. Losing Cuervo will cut about £300-million ($466-million) in sales and £65-million in EBIT, or earnings before interest and taxes, estimates analyst Ann H. Gurkin of Davenport & Co. LLC.
Missing out on Cuervo may not be such a bad thing; the Grupo Cuervo beverages lost 10 percentage points of share in the United States in the last five years, dropping to 35 per cent from 45 per cent, notes analyst Pablo Zuanic of Liberum Capital. The “super premium” segment, priced above Cuervo, has seen most of the gains, while U.S. residents of Mexican descent have often chosen value brands such as Sauza, Juarez and Montezuma, Mr. Zuanic says.
Regardless, the Cuervo loss may be distracting investors from the other news at Diageo, much of it good. Davenport’s Ms. Gurkin notes the company has managed to increase prices in the United States by 2 per cent to 3 per cent, coupling that with unit volume growth of 5 per cent. The company also has a better mix, compared to the industry as a whole, of higher-priced brands in the categories of “premium” and above, she notes.
Mr. Shackleton has a “buy” rating and price target of £24, about 20-per-cent above current levels. (The company’s shares also trade in U.S. dollars on the New York Stock Exchange.) He says Diageo has a “portfolio of emerging markets” that isn’t overly concentrated in any one country. “You don’t have all your eggs in one basket.”
The company also has a healthy balance sheet, and gets about 40 per cent of its business from the United States, which is “one of the best places to be at the moment,” he says.
Indeed, the robust numbers for spirits in the U.S., coupled with one of the big current trends – the growth of whisky – may have led some of the other U.S. high performers to be fully valued.
According to Standard & Poor’s Capital IQ, Diageo has a forward price-to-earnings ratio of about 18, while Brown-Forman Corp. and Beam Inc. each sell for about 24 times forward earnings.
Brown-Forman gets about 48 per cent of its sales and nearly 60 per cent of earnings from its Jack Daniels brands, Mr. Shackleton estimates. Its “Tennessee Honey” flavour for the brand doubled its sales in the most recent quarter from the prior year. Ms. Gurkin sees “continued strong performance” from the company – which, she believes, is already reflected in the share price, leading to her “neutral” rating. Mr. Shackleton is also neutral, with a target price of $67 (U.S.), below recent trades in the low $70s.
Beam, the spirits division of Fortune Brands before a 2011 spinoff, owns Maker’s Mark and Jim Beam, meaning it, too, is riding the whisky train. Ms. Gurkin and Morgan Stanley analyst Dara Mohsenian each have “buy” ratings and price targets a few dollars above the recent $67 price. But Liberum’s Mr. Zuanic and Nomura’s Mr. Shackleton both believe the market is pricing in Diageo buying Beam in order to get its hands on the Sauza tequila brand – a scenario of which both analysts are skeptical.
In beer brewing, as with spirits, much of the investment story for several years was growth through acquisition, and in emerging markets; Anheuser-Busch InBev SA, Companhia de Bebidas Das Americas (AMBEV), and SABMiller PLC are all global giants worth more than $100-billion (U.S.) on an enterprise value basis (market capitalization plus net debt).
Among beer makers, it’s the largest of the small that may be the best pick right now. While the three giants trade for roughly 19 to 23 times forward earnings, Molson Coors Brewing Co. has a forward P/E of just over 12. Compared to the typical consumer-sector P/E of 17, it’s a “hell of a discount,” says Mr. Shackleton. (It is similarly cheap on the basis of enterprise value to EBITDA, or earnings before interest, taxes, depreciation and amortization.)
Mr. Shackleton says Molson Coors’ lack of exposure to emerging markets has held the shares back. After several major brewers or spirits companies have reported “choppy” or even “soggy” results from those countries, however, he suggests it may be a near-term virtue for Molson Coors.
In the meantime, it has one of the best cash-flow profiles among all the alcohol companies; Molson Coors produced roughly $800-million in free cash flow, or cash from operations, minus capital expenditures, in the last 12 months. With a market capitalization just over $9-billion, that’s a free-cash-flow yield of nearly 9 per cent.
Absent an unexpected global temperance movement, it looks as if the sector will continue to provide intoxicating returns.