Digging Into Boston Beer's Intrinsic Value

Nov.18.13 | About: Boston Beer (SAM)

As part of our process, we perform a rigorous discounted cash-flow methodology that dives into the true intrinsic worth of companies. In Boston Beer's (NYSE:SAM) case, we think the firm is overvalued. We think it is fairly valued at $167 per share, representing significant downside potential from today's levels.

At Valuentum, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in what we call our Valuentum Buying Index (click here for an in-depth presentation about our methodology), which ranks stocks on a scale from 1 to 10, with 10 being the best. Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors.

If a company is undervalued both on a DCF and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. Boston Beer posts a VBI score of 2 on our scale, reflecting our 'overvalued' DCF assessment of the firm, its unattractive relative valuation versus peers, and neutral technicals. We compare Boston Beer to peers Anheuser Busch InBev (NYSE:BUD), Diageo (NYSE:DEO), and Molson Coors (NYSE:TAP). In the spirit of transparency, we show how the performance of our VBI has stacked up per underlying score:

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Investment Considerations

Investment Highlights

• Boston Beer earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 42.7% during the past three years.

• Boston Beer brews handcrafted, full-flavored beers. Its Samuel Adams brand is the US' largest-selling craft beer, and it accounts for about one percent of the US beer market. The firm brews over 50 different styles of beer.

• Boston Beer has an excellent combination of strong free cash flow generation and low financial leverage. We expect the firm's free cash flow margin to average about 10.1% in coming years. Total debt-to-EBITDA was 0 last year, while debt-to-book capitalization stood at 0.3%.

• Although we think there may be a better time to dabble in the firm's shares based on our DCF process, the firm's stock has outperformed the market benchmark during the past quarter, indicating increased investor interest in the company.

Boston Beer continues to lead the craft beer revolution against full-calorie mass domestics. In 2012, the craft beer category grew roughly 12% and now makes up about 22% of all US beer consumption by volume.

Business Quality

Economic Profit Analysis

The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Boston Beer's 3-year historical return on invested capital (without goodwill) is 42.7%, which is above the estimate of its cost of capital of 10.8%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.

Cash Flow Analysis

Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Boston Beer's free cash flow margin has averaged about 9% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At Boston Beer, cash flow from operations increased about 41% from levels registered two years ago, while capital expenditures expanded about 385% over the same time period.

Valuation Analysis

Our discounted cash flow model indicates that Boston Beer's shares are worth between $125.00 - $209.00 each. Why such a wide range? Click here. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $167 per share represents a price-to-earnings (P/E) ratio of about 37.7 times last year's earnings and an implied EV/EBITDA multiple of about 13.2 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 13.1% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 11.8%. Our model reflects a 5-year projected average operating margin of 20.3%, which is above Boston Beer's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 5.5% for the next 15 years and 3% in perpetuity. For Boston Beer, we use a 10.8% weighted average cost of capital to discount future free cash flows.

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Margin of Safety Analysis

Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $167 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Boston Beer. We think the firm is attractive below $125 per share (the green line), but quite expensive above $209 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.

Future Path of Fair Value

We estimate Boston Beer's fair value at this point in time to be about $167 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Boston Beer's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $227 per share in Year 3 represents our existing fair value per share of $167 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.

Pro Forma Financial Statements

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.