Two more-than-usually interesting and detailed analyst reports appeared in last 24 hours, with sharply contrasting conclusions. One is a 50-page deep dive on ABI by Societe Generale’s Andrew Holland, which downgraded the stock to a “sell” rating, based on pressure against US margins.  The other is an initiation of coverage on Constellation by RBC Capital Markets analyst Nik Modi with an outperform rating largely based on “upside margin potential in beer.” 

AB Volume “Will Continue to Decline”; ABI US Margin Pressure “Unlikely to Diminish”  That’s not-so-cheery conclusion of Societe Generale’s Andrew Holland in 50-page  report on ABI. US EBITDA margins could grow for next 2 qtrs, but “we expect a return to decline thereafter,” said Andrew. Currently, he assumes 40 basis points of decline per yr, where previously he had estimated 50 points of growth.  Why?  Analyzing pressures on mainstream US beer, “slow reduction in unemployment, continued competition from other alcohol, further growth of craft beer” suggests that “volume will continue to decline for several years.” Contrary to ABI’s statements that declines are primarily economy-related, Andrew says ABI “is contributing to the decline with its above inflation pricing strategy” (which he described as 3% per yr with inflation 2% per yr).  While this boosts gross margin, it has “caused the EBITDA margin to decline as operating costs increase as a percentage of sales…. This margin pressure is unlikely to diminish,” said Andrew, “as ABI needs to increase innovation, implying higher sales and marketing costs.”  Interestingly, Andrew shows that ABI US EBITDA margin ex-synergy has actually declined since 2009 when it peaked at 31.6%.  In first half of 2013, ex-synergy margin at  27.6%. Synergies were actually achieved by 2011 and masked the ex-synergy decline 2009-11.    

His reduced estimates on US margins lead to l3% lower valuation based on discounted cash flows.   Here’s Andrew on his assumptions:  “We assume 2% organic sales growth, consisting of -1% volume and 3% price/mix (the -1% volume compares with a 5 year average of -2.1%). But we have cut our EBITDA margin assumption from growth of 50bp to a decline of 40bp (the average organic decline over the last five years has been 70bp, so our assumption is slightly generous). The consensus forecast for N America for 2014 – the only period for which a consensus forecast is available – is for 30bp growth.”

Constellation’s “Outsized Beer Growth” Is “Very Sustainable”  So concluded RBC Capital Markets Nik Modi.  “We see large opportunities” for Constellation’s beer biz based on “distribution of Modelo Especial,” “on premise, where several brands are underrepresented,” “increased presence in c-stores,” more biz in cans “where it is underindexed” and “pricing opportunities.”  Nik also sees margin enhancement oppys.  Constellation pays ABI about $2 per case on 40% of its volume that ABI still produces, according to Nik, which he estimates as 75 mil cases in current fiscal year. So Constellation currently paying ABI about $150 mil to make its beer.  But that decreases by 5 mil cases next yr and 10 mil cases the yr after that, he points out, which should lead to margin upside sooner than most on Street are anticipating.  So that would be down to $120 mil in fiscal 16, before disappearing in the yr after.  He also sees “meaningful cost procurement savings” particularly in glass, where Constellation already has a lot of purchasing power from its wine biz.  Put together its growth and margin upside and Nik believes STZ will grow its earnings per share by 45% in next 2 yrs. 

Just as scanner data softened in latest 4-wk period, taxpaid shipments turned negative again in Oct: -100,000 bbls, -0.7%, estimates Lester Jones at Beer Inst.  That’s 5^th mo of last 6 that shipments in the red.  For 10 mos, taxpaids down 2.6 mil bbls, 1.7%.  With reported import shipments down near 4% for 9 mos thru Sep (tho that figure hard to buy given what we know about strength of Mexican biz, and that import depletions up slightly), reported US shipments back in -2% range yr-to-date.  But state trends look a little better than that, Lester points out, so there’s disconnect.  Hopefully, when all Q4 numbers come in, state and total shipments trends will be in closer alignment.  

Lengthy article in UK’s Daily Mail yesterday excerpted The Good News About Booze, a new book from science writer Tony Edwards.  After “in-depth study of around half-a-million scientific papers about alcohol,” Edwards details extensive health benefits of daily moderate drinking.  They include lower risks for heart disease, diabetes, common cold, rheumatoid arthritis, osteoporosis, macular degeneration, fatty liver disease and a handful of cancers. He even notes a study that found female drinkers express higher sexual satisfaction than teetotalers. Despite the title of his book, Edwards suggests that “red wine may be one of the most effective ‘medications’ in history.”  The Good News About Booze follows a spate of similar positive press celebrating health benefits of moderation over last month in Huff Post, Boston Globe and even Times of India (largest-circulation English language publication in the world), as we’ve reported in sister publication Alcohol Issues INSIGHTS.  While Edwards seems to lean toward wine, Huff Post and Times of India focused on beer and mentioned many of same benefits detailed in Good News.  Globe quoted veteran alcohol/health researcher Eric Rimm who said “the evidence now is there’s no huge difference in beverage choice.”  It’s all about the pattern, Rimm and Edwards stress: steady, regular consumption.  And Rimm was definitive about at least three key benefits.  “There’s no question that people who drink moderately have lower rates of heart attacks, lower rates of diabetes and live longer.”  We can all toast to that this Thursday.      

Turns out that with so many smaller AB distribs in Indiana, a handful jumped and cut their own deals in advance of this arbitration, reportedly for 5.5x GP.  So the arbitrator was looking at in-state comps at this high valuation, even if they were for very low dollar amounts. 

“Share is the ultimate yardstick of success,” contended Heineken USA prexy Dolf van den Brink in wide-ranging talk at Beer Insights Seminar, and so HUSA is gaining a bit of share in 2013 even if its volume not quite even.  On depletions, HUSA outperforming the industry by the same 2 points as last yr, said Dolf, “but the market is not as healthy as it was.”  Next yr, HUSA expects to see overall mkt “come back slightly.”  HUSA has become far more of a portfolio company in recent years as the category changed to a “repertory category,” noted Dolf, where consumers have 10-12 brands they drink.  “You need to go to market in a fundamentally different way.” 

This has led to lotsa change at HUSA and Dolf shared a few of its successes in expanding its portfolio in 2013.  Strongbow depletions up about 50% (up 90% in Nielsen) even as HUSA “transitioned” and only took “very deliberate steps.” Next yr, “we are relaunching” said Dolf, with new packaging, new mktg and a line extension.  Beers of Mexico variety pack is now over 2 mil cases, noted Dolf and it’s still growing double digits, based on the insight that consumers looked at this as a “fiesta in a pack.”  (Beers of Mexico up 59% in IRI multichannel + convenience yr-to-date thru Nov 3, but more like 17-20% in more recent periods.)  And Tecate Light is a 3 mil case brand that is growing 40-45% month after month.  Even in LA, it still has less than 20% distribution.  So HUSA thinks Tecate Light has “legs to grow double digits for a decade or more.”  Last yr, Light was 8% of Tecate franchise volume, this year it’s 15%.  In Phoenix, it’s 50% and in Mexico 75%.

Of course, Heineken is still the mother ship and it should be “growing low to mid-single digits long term.”  While Heineken has made strides, it needs to become “more relevant with the younger generation” even though the majority of its volume “sits with the 35 and older consumer.” Tuffer 2013 for Heineken in part attributed to being “overexposed in Northeast” which was hard-hit and liquor stores the “toughest channel.” So next yr, Heineken will look to “grow faster in the convenience channel in the West.”  Dos Equis is a “growth engine,” up 15-20% per yr since mid-2000s, but still only at 59% national distribution.  Next yr, Dos will launch Dos-a-Rita in Sunbelt where brand already has over 80% availability and consumers have already been mixing Dos and Margaritas. 

Over 50% of HUSA volume is consumed by multicultural consumers, Dolf noted.  As usual, Dolf used demographic insights to emphasize some of his key points.  Spirits are winning with multiculturals, women and millenials.  To get beer back on a growth path, “we as an industry better win with those 3 core demographies.”  Hispanic population is expected to grow 20% over next decade, while Caucasian population remains flat.   

“The single largest issue that is constraining beer,” according to Dolf “is that we’re not resonating with females” which are half the population but only 20% of the consumption.  “Cider is the best chance we have as an industry to recruit female drinkers.”    

Angry Orchard took cider by storm in 2013.  In 2014, big companies are taking direct aim at Angry Orchard, including the biggest of ’em all.  AB just announced its own more mainstream cider named after American icon, Johnny Appleseed, designed to go head-to-head with Angry Orchard, and debuting next Apr.   When AB sales veep David Almeida complimented Angry Orchard’s success in his speech at the Beer Insights Seminar, seemed likely AB would compete in that space.  Not sure why this brand wasn’t announced at SAMCOM. 

AB is not the only competitor taking direct aim at A-O’s outsized overnight success.  Heineken will intro 1 new Strongbow extension in 2014, prexy Dolf van den Brink said at Beer Insights Seminar.   We hear that it will be a sweeter cider also aimed at Angry Orchard.  As for Boston Beer, it’s also moving fast to address competitive challenges/oppys, including expanding both Anytime IPA and House of Shandy brands from Alchemy & Science,  plus Rebel IPA and Twisted Lemonade.  And then there is MC’s big bet on Miller Fortune, Modelo Chelada and much more.  It ain’t even here yet and 2014 is already shaping up to be a very competitive year. 

After better sales in recent mos, scan data took a dip in most recent 4-weeks, down 1.5% in Nielsen all-outlet data thru Nov 16, including 1.9% drop in foodstores and 2.5% drop in c-stores.  Premium beers down 4% and subpremiums down 5%, but imports still up 2.8% and crafts up 11.6%.  FMBs and ciders still flying.  Above-premium segments gained 3 share of $$ last 4 weeks.  And pricing remains healthy; up 68 cents 3.3% on avg across all beers.  Large portion of that price increase is mix shift as premium beers still up less than 1.5%, near premium up 1% and budget up almost 2%.   

Mazzoni called them “happenstance” brands, i.e. ABI happened to own them and would much rather have them in its own distribution network.  But it’s not like Spaten and Franziskaner are getting a big push or anything.  Trends are soft enuf to make one wonder about these arbitrators’ valuations.  Nationwide, Franziskaner Hefe sold 45,000 cases yr-to-date thru Nov 3 in IRI multichannel + convenience. That’s down 21%.  Spaten Premium sold 37,000 cases, down 27%.  Spaten Optimator Dark also sold 37,000 cases and that’s down 25%.   

 In 2 arbitrations, distribs paid over $1 mil for brand rights for tiny volume of declining Spaten/Franziskaner brands. But consultant Mike Mazzoni (expert for AB distribs in KY) argues that total payment not nearly as high as it appears.  “By the time you factor in expert witnesses, legal fees and arbitrator fees, notwithstanding the aggravation for all parties involved, the true # is probably less than 4x GP,” said Mike.  “So,” he asks, “why don’t we wake up and start being more reasonable in the way we approach brand transfers?”  

Turns out, in a very similar situation in Kentucky, an arbitrator ruled that same Spaten/Franzikaner brands should sell for approx 5x GP from Beer House to AB network there. AB distribs will pay Beer House about $400,000.  That arbitration pitted consultant Andy Christon vs consultant Mike Mazzoni as experts.  Andy had argued for valuation of 6.6x, Mike for 3.5-4x.  The arbitrator said both consultants valuation methods had some credence and he couldn’t wholly reject either, but he afforded 1/3 weight to Andy’s methodology and 2/3 weight to Mike’s.