Craft Brew Alliance (NASDAQ:BREW):
Just the slightest buzz for BREW shares despite a sizzling hot M&A sector.
- The recent DOJ settlement with Anheuser-Busch InBev (NYSE:BUD) ("ABI") clears way for the SABMiller deal while it also "prohibits ABI from instituting or continuing practices and programs that limit the ability and incentives of independent beer distributors to sell and promote the beers of ABI's rivals, including high-end craft and import beers" according to the Justice Department release. This is a significant development as prior programs limited payments to distributors who had higher sales of competing products thereby likely restricting sales of CBA's products to some degree. With these programs terminated in the DOJ settlement, all CBA brands will likely benefit to varying degrees going forward as distributors can sell the brands they want without concern that their ABI incentive bonuses will be reduced as they promote competing brands. I would anticipate the greatest impact on KONA sales given the size and relative growth of the brand.
- Channel checks reveal KONA brand continues to grow at a record pace, and I was told point of sale data suggests growth in the low 20% range in Q2. One independent distributor (large market) informed me that the KONA brand is growing in the "high twenties" currently. I believe continued significant growth in the KONA brand is the key factor in determining if / when CBA is acquired. In 2Q15, KONA sold 105K barrels- a 20% growth would indicate 126K barrels and represent not only an acceleration of growth but represent a big number for the brand. An update on KONA sales in Brazil is anticipated and will be in addition to volumes discussed above.
- Discussions with former and current CBA employees points to the shifting of personnel from the Widmer / Redhook brands to the KONA brand and required mandatory relocation to Los Angeles. I have been told several departed the company rather than make this transition. Another former employee related that a high level employee with responsibility for all major brand families departed after reaching a separation settlement with the company. Employee reductions are normal in all companies to be sure. However, the combination of eliminating personnel with "all brands" responsibility and the shifting of others to the largest and most profitable brand could hint at preparations to split the company as I have suggested. KONA is the largest and most profitable brand, and Widmer / Redhook would likely need to downsize were KONA to leave the fold.
- The Pabst deal at the Redhook Woodinville (RWB) brewery should provide some boost to Q2 results and beyond by significantly reducing SG&A as Pabst's production absorbs overhead at this facility. The specifics of the deal have not been released, other than brewing started in early spring, but we anticipate there is a per barrel charge as well as a monthly fee to defray some of the operating costs of RWB. Regardless, increasing the production at RWB will reduce the drag of this facility on CBA operating results as Pabst defrays some of the high embedded costs of this brewery. Recently I was told that Pabst is making significant capital investments at the RWB and "making it their own" which suggests eventually the option on this facility will be exercised and a significant O/H burden lifted from CBA entirely. RWB has over 125 employees (34 in production) and is only being used to produce limited runs of CBA's products as the majority of production has been shifted to the larger more efficient Portland brewery. Under either scenario, the Pabst deal for RWB will be positive driver for CBA earnings going forward.
- ABI has two seats on the CBA BOD, but has been operating with just one since the resignation of R. Jozwiakowski on 8/26/15. Having passed the 11th month mark with ABI's BOD representation at one versus the two authorized, I performed a detailed analysis of all ABI BOD members and seat vacancy since FY 2000. The only other time ABI was short one director for an extended period was when A. Short resigned from the BOD on 11/15/10 and was subsequently replaced by E. Johnson on 7/1/11- a period of 7.5 months where ABI was down to a single director. I find it very interesting that during this same period, CBA announced the negotiation of the sale of its Goose Island investment to ABI on 3/27/11 and the ultimate closing of the transaction on 5/2/11. The majority of the BOD changes were made in very short order, a period of days or weeks of the ABI resignation of a sitting BOD member. Is this co-incidence or does ABI reduce its representation on the CBA BOD during negotiations with CBA to minimize its influence on the BOD? That's something we can all ponder over our next Big Wave, Castaway, Longboard or Lavaman beer.
- CBA's shares have had a slight jump since my first report but have given back recently as anticipated Q2 results come to the forefront. BREW stock trading is very thin and susceptible to significant moves on very light volumes. Since my initial report however, there has been a significant increase in outstanding call options contracts. In fact, adding August and November expirations, over 3,633 contracts are outstanding with a strike of $10, 2,553 with a $12.5 strike and 1,516 with a $15 as bullish bets have been made on the stock. Several owners of the $10 strike I have spoken with have indicated their intention to call the stock and mentioned the thinness of the share trading as having influenced their decision to initiate a position by buying calls. An exercise of this magnitude, should it occur, could have a significant favorable impact on BREW's share price.
- I continue to believe that shareholders' patience in BREW shares will eventually be rewarded. The increasing M&A in the space, including two MillerCoors deals announced this month (Hop Valley just last Friday), serve as a reminder that the big players are positioning themselves in the craft arena and paying significant multiples to better position themselves for the ongoing shift in consumer tastes to craft beers. Reviewing ABI's past conference call transcripts, it is clear ABI recognizes the need for more growth in high-end craft segment. As a long time observer of the space, I find it hard to imagine a scenario where the KONA brand does not eventually fit in the ABI portfolio as a wholly owned brand.
Tomorrow, CBA will be providing a critical update to investors on its performance with the filing of the 10-Q after the close. I anticipate significantly improved results and ongoing growth in the KONA brand. Employee departures and other initiatives should show positive trends in SG&A reduction. Given the significant M&A in the space, however, I believe investors should focus more on the growth of the KONA brand as the key to ultimately being rewarded in BREW. BREW shares valuation sit at a significant discount to announced private transactions as discussed in my June article, Is Something Brewing at Craft Brew Alliance?
I believe the biggest beer players are interested in securing strong growth brands in short order to compete in the fastest growing and most profitable sector of the beer market. We are witnessing a "land grab" in the craft beer segment and CBA's brands, especially KONA, should be of interest to many players.
It is suggested that readers should also reference my prior piece on BREW in addition to this pre-EPS review of new developments.
BREW: 08/01/16, $11.33 closing price.
Disclosure: I am/we are long BREW.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author is a former Director of the Redhook Ale Brewery (HOOK)and chaired its Audit and Corporate Strategy Committees, negotiating the merger of Redhook Ale Brewery and Widmer Brothers Brewing to form Craft Brew Alliance (BREW). Investors should do their own due diligence and seek professional financial advice before investing in any securities.