Although the craft beer industry poses a major threat to its business, Molson Coors Brewing Company (NYSE:TAP) is likely to thrive despite competitive pressures.
The company is the second-largest North American brewer, with operations concentrated in mature markets. As a result of its relative lack of explosive growth, the company has developed an efficient distribution system and economies of scale. This has allowed Molson Coors Brewing Company (NYSE:TAP) to earn double-digit operating margins in each of the last six years.
One reason investors have shied away from the stock is due to the controlling stakes of the Molson Coors Brewing Company (NYSE:TAP) families. However, closely-held companies often focus on creating long-term shareholder value rather than pursuing strategies that boost the stock price only temporarily; as a result, capital allocation will likely be in the best interest of long-term shareholders.
Competition on the horizon
Molson Coors faces considerable competition from big brewers and craft brewers alike. The company’s long-time rival, Anheuser-Busch InBev NV (ADR) (NYSE:BUD), has a dominant share of the United States market. In addition, Anheuser-Busch InBev NV (ADR) (NYSE:BUD) has a large share of the beer markets in Brazil and Argentina, in addition to most of the other countries in which it competes. This enables the company to spread out its fixed costs across a larger number of units, leading to a lower unit cost.
However, beer market economies of scale are mostly regional. Even though Anheuser-Busch InBev NV (ADR) (NYSE:BUD) has a nearly 50% share of the U.S. market, Molson Coors Brewing Company (NYSE:TAP) can still compete because its operations are concentrated in a relatively small geographic area. This affords it economies of scale similar to that of Anheuser-Busch InBev NV (ADR) (NYSE:BUD) in many of the markets in which it competes. Therefore, Molson Coors Brewing Company (NYSE:TAP) will likely continue to fend off competition from other large brewers.
Craft brewers, on the other hand, could pose a more serious threat to Molson Coors’ business. The industry is growing quickly due to greater consumer awareness of the niche. For instance, Boston Beer Co Inc (NYSE:SAM) expects to double its sales volumes over the next decade — an impressive feat for a company that already boasts $603 million in sales, which is extremely large for a craft brewer.
Of course, the great rotation from bland beer to craft beer will take decades before upsetting companies like Molson Coors. Boston Beer Co Inc (NYSE:SAM), the largest craft brewer in the United States, has a 1% share of the domestic market; craft beer represents just 6.5% of all beer sales in the United States. Clearly, craft brewers have a long way to go before they start encroaching on Molson Coors Brewing Company (NYSE:TAP)’ profitability, which means the two may exist peaceably side-by-side for years to come.
Investment case
As with most stocks, Molson Coors has rocketed upward in price over the last several months. At the end of February, the stock traded just below $45; the stock now trades above $53 per share, or 18% higher than at the end of February.
Despite the run-up, Molson Coors Brewing Company (NYSE:TAP) trades at just 12 times trailing four quarters free cash flow. Although the company is not growing quickly, it will likely grow at least as quickly as the broader economy over the next several years. As a result, investors who buy at 12 times free cash flow will likely receive a double-digit annualized return over a long holding period.
The article A Rally Is on Tap for This Brewer originally appeared on Fool.com and is written by Ted Cooper.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Boston Beer and Molson Coors Brewing Company. The Motley Fool owns shares of Boston Beer. Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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