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Summary

  • Investors chasing growth have overvalued Craft Brew Alliance.
  • Even though craft brewing continues to grow, Craft Brew Alliance has lost market share.
  • Craft Brew Alliance's margins are very small, and improving its margins will be difficult without hurting growth.

Craft Brewing has been growing very quickly for several years now. Some investors that are looking for growth have taken notice. The problem for investors looking for high growth is that the vast majority of the craft brewers are not public. This leaves investors with Boston Beer (NYSE:SAM) and Craft Brew Alliance (NASDAQ:BREW). The former is more of a mix between a mass market brewer and a craft brewer, but is still well below the 6 million barrels a year craft brew threshold. The latter is the subject of this analysis.

Craft Brew Alliance Brands

Craft Brew Alliance has three core brands as well as a gluten-free brand. Kona Brewing Company is a Hawaiian-style beer brand that promotes a relaxing, drinkable beer. Widmer Brothers Brewing is its innovative, pioneering brand that focuses on creativity as well as collaborative partnerships. Its third core brand, Red Hook is described as "crushable." I'm not exactly sure what they mean by this, but it does not make me think of a craft beer. Omission is its gluten-free brand that was launched in 2012. They also have Square Mile Cider Company, which is its hard cider brand that was just launched last year.

Industry Analysis

In 2011, the top 10 craft brewers by sales accounted for 47.9% of craft beer sales. In 2012, this was down to 45.9%. This is a signal that the smaller craft brewers are taking market share faster than the larger craft brewers. Five of the top seven craft brewers lost market share from 2011 to 2012, and the two that did not remained stagnant.

Another troubling trend for Craft Brew Alliance is the increase of imported beer. Some beer drinkers who want a change of pace from the mass produced beer turn to imports instead of craft beers. According to S&P Capital IQ, in 2012 imports from Modelo Especial, Dos Equis, and Stella Artois grew 21.2%, 22.2%, and 19.9% respectively. Mexican beers have dominated the import market, mainly because of Corona's popularity but also because of the rise in the popularity of Dos Equis. This is a trend that is expected to continue due to the increasing growth of the Hispanic population.

Many of the larger brewers have recognized the growth of craft beers and have tried to get in on the trend. Anheuser-Busch InBev (NYSE:BUD) owns 32% of Craft Brew Alliance. The large beer companies are also trying to create beers that might appeal to someone looking for something different with a little more alcohol content than its standard beers. A-B did this with Bud Light Platinum. SABMiller is now trying a similar strategy with its Fortune beer that is 6.9% ABV. Also, Blue Moon of Molson Coors tries to market itself similar to a craft beer.

Competitive Problem and Market Saturation

The growth in the number of craft brewers over the past two decades is staggering. According to the Beer Institute, there were about 500 active brewers in 1991. In 2013, the record for active brewers was set at 3,699.

Craft Brew Alliance admits in its 10-K that within the craft brewing segment they are encountering strong competition from microbreweries, regional specialty breweries, and also national craft brewers such as Tenth and Blake from MillerCoors and Anheuser Busch's Goose Island and Shock Top brands. This leaves Craft Brew Alliance in an enigma. The microbreweries are able to focus more on the quality of its beer instead of the profitability of it since they do not have shareholders who obsess over every quarterly report. The national craft brewers have significantly more financial resources to promote its products.

Porter's 5 Force Analysis Not Encouraging

A quick look at Porter's five forces does not bode well for industry profits. There is always a threat of substitute products from the spirits and wine industry. The threat of new entrants is high because it is not that difficult to start a brewery. Dogfish Head Brewery, one of the more successful craft brewers, started off with a 12-gallon brewery. The bargaining power of customers is certainly high because of the vast array of choices consumers have. The suppliers do not have a lot of power because most of the supplies are commoditized. Craft Brew Alliance does use futures contracts to ensure the supply of its hops. There is also pretty intense rivalry amongst competitors vying for limited shelf space in stores.

CBA Financials

Craft Brew Alliance is the fourth largest craft brewer by revenue. In the last fiscal year, they had top-line growth of 11.5%. In their investor presentation in March, they gave forward guidance of 7%-11% top line growth for 2014. Their gross margin decreased in 2013, but is expected to increase in 2014. Their SG&A expenses are expected to increase in 2014, though.

Gross MarginOperating Margin

BREW

28.1%2.1%
SAM52.1%15.3%
BUD59.3%47.3%

Source: financials.morningstar.com.

It is certainly reasonable for a smaller growth company to have smaller margins than its larger competitors, but those margins are tiny and a little concerning. Especially since SG&A costs are expected to rise again this year. Craft Brew Alliance has made it a priority to reduce operating costs but there are some concerns there as well. First, a focus on reducing costs could be a hindrance to the company's growth. Secondly, most of their operating expenses are agricultural commodities, which they cannot really control.

Operating cash flow and net income both decreased from 2012 to 2013. They also lost market share from 2011 to 2012. They had 5.1% of craft beer sales in 2011 compared to 4.7% for 2012. Craft Brew Alliance also has a current ratio barely over 1 and a quick ratio slightly over .5. This is less concerning though since that is pretty much the norm for brewers. BUD has had a quick ratio around .5 for over a decade and they have been fine.

P/EPEGForward P/EP/CF
BREW140.82.345.232.6
SAM44.81.530.931.5
BUD12.51.618.913

Source: financials.morningstar.com.

These valuations suggest to me that investors are expecting more growth from Craft Brew Alliance than they will be able to deliver. Again, this may not be a completely fair comparison, but I think the growth of Craft Brew Alliance is more than already priced in.

Bottom Line

While Craft Brew Alliance is one of the only companies that investors can get in on to capitalize on the growth of the craft beer industry, I believe that the market is overvaluing the stock and confusing industry growth for company growth. Craft Brew Alliance operates in a very competitive and saturated market. It is going to be very hard for them to grow the top line while trying to increase its margins.

Source: Craft Brew Alliance - An Overpriced Stock In A High-Growth Sub-Industry