Beam, Inc. (BEAM) has been the subject of takeover speculation since it started trading as a pure-play, standalone spirits company. Beam was formerly known as Fortune Brands, and changed its name to Beam on October 4, 2011, after completing a spinoff of Fortune Brands Home and Security (FBHS). A takeover bid would be a wonderful thing for shareholders, as it would likely cause the stock price to immediately increase by 20% to 30%, but if you plan to buy Beam stock, you should evaluate the underlying company to be sure you are comfortable with your investment in the case that a buyout offer does not materialize.
If you clicked on the ticker symbol above, the quote page would have shown you statistics about a company with ttm earnings of 5.83 per share, and a trailing P/E around 8.5. Seems like a bargain for the largest U.S. based spirits company with 10 of the world's top 100 brands. Unfortunately, those figures represent the results of the old conglomerate, including earnings from FBHS, as well as a golf business that Beam recently sold. We are interested in what Beam will do in the future, and for that, we have to dig a little deeper.
On the recent Q3 earnings call, Beam’s CFO spent some time discussing pro forma results, and those are the results in which we are interested. The pro forma results give a picture of how Beam would have performed if it were operating as an independent company, going back to 2010. Using the 2010 results as a baseline, we can see how the business has improved in 2011, and judge whether or not the price at which we can currently buy it is attractive.
Pro forma earnings for Q3 2011 were $.53, compared to $.47 for Q3 2010, for a growth rate of 13%. Management further explained that the company received a $.03 per share benefit from reduced interest expense due to the early retirement of approximately $900 Million in outstanding debt, funded by the sale of the golf business and a $500 Million special dividend Beam received as part of the spinoff of FBHS. Beam plans to retire another $800 Million in debt in Q4, which should lead to further interest savings and earnings increases, however, bear in mind that those earnings increases are due to changes in the company’s capital structure, and not due solely to strength in the underlying business. Beam’s Q3 earnings also benefited from a change in its Australian distribution model and the way the company records revenues based on sales to distributor Coca-Cola Amatil (CCLAY.PK). Previously, Beam recorded revenues when CCA shipped products to customers. Under the new model, Beam records revenues when it ships products to CCA. As the CFO explained, “This has the effect of pulling forward some peak Australia summer holiday season sales into Q3 at the expense of Q4.” Management was very clear and open about this, and it does not look like they are intentionally trying to use accounting gimmicks to boost results, but the fact remains that this is a low quality source of increased earnings, something investors need to consider before they invest.
For full year 2011, management expects the company to achieve “high single-digit” growth over 2010 EPS of $1.92. Assuming “high single-digit” means either 8% or 9%, we can expect 2011 earnings to be in a range of $2.07 to $2.09. Based on Friday’s close of $49.72, that gives a P/E ratio just under 24. Diageo (DEO), the company many are hoping will buy Beam, currently trades at a P/E of 17.5, making Beam look like not much of a bargain. Another way to judge the “cheapness” of a stock is to use something called the PEG ratio. This is simply the stocks' P/E divided by the growth rate in EPS. Stocks with PEG ratios under 1.0 are considered to be significantly undervalued, while stocks with PEG ratios over 2.0 are considered overvalued. Giving Beam the benefit of the doubt and assuming 9% growth still gives us a PEG of 2.67, which means the stock is expensive.
Investors who buy Beam at current levels are operating without a margin of safety, and their main hope for gains rests on a buyout offer. If the buyout offer does not come, investors run the risk of having funds invested for several years in a stock that does not appreciate. Worse, if the company runs into any trouble, the lofty P/E could contract, leading to permanent loss of capital. Beam is a great company, but the stock is simply not attractive at current levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.