Foam Can Only Hold A Bottle Cap Afloat For So Long; Boston Beer Still A Great Short

| About: Boston Beer (SAM)
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Boston Beer beat consensus estimates in the fourth quarter, but the quality of the upside was poor coming from a short-sighted slashing of marketing spending.

Depletion trends in 2017 are downright scary, down 15% to start the year; management's guidance for 2017 assumes an optimistic significant turnaround in trend.

With the shares down only 5% in reaction to poor guidance, the downside opportunity on a short sale of the shares remains compelling.

This is a follow-on to our Seeking Alpha article dated January 17, 2017, which makes a more detailed case for shorting Boston Beer (NYSE:SAM). Here, we analyze the company's just-released fourth-quarter earnings and 2017 guidance. Boston Beer reported better-than-expected earnings yesterday, but a deeper dive indicates the brand and company's troubles remain and may be getting worse.

In summary, Boston Beer reported net revenue of $219 million and diluted EPS of $1.75 in EPS in Q4, both better than consensus of $215 million and $1.25, respectively. Under ordinary circumstances, that would appear to be great news for a beleaguered company such as Boston Beer, but there is more (or less in this case) to the report than meets the eye. Peeling back the label and looking inside the bottle, so to speak, indicates trouble is still swirling and may be getting worse. Here are the highlights... or lowlights, depending on whether one is short or long the stock:

  • Revenue was up 2% versus the prior year, but benefited from an extra week, so on a sales per week basis, revenue was actually down an estimated 5%. Depletions (sell-through at retail) were down 1% in the quarter, even with the extra week. If one adjusts for the extra week it can be estimated that depletions were down 8% or so. We note the company did not adjust for the extra week in its reporting of the results.
  • The depletion trend has gotten worse in 2017, with reported depletions down 15% through February 11. Management suggested on its conference call that this was due to poor execution of its seasonal Samuel Adams Hopscape. Throwing Hopscape under the bus might deflect concerns by convincing hopeful investors that this is just a one-off problem easily fixed by the next seasonal release (Samuel Adams Fresh as Helles), but what if it is not? What if, as we suspect, the Samuel Adams brand has become viewed by craft beer consumers as a large, national brand and no longer a true craft beer?

    Management is hopeful that depletions will only be down 7% to up 1% in fiscal 2017, which would require a significant turnaround in trend. Note also that 2017 is a 52-week year, so for depletions to be up 1% at the high end of the range would actually imply being up 3% on a per-week basis. With a down 15% start to the year, rebounding to be down just 7% would imply the rest of the year is down only 3.6% (assuming the first six week's depletions of this year and last are representative of the full first quarter's weekly sales).

    To achieve the high end of the range, the remaining 46 weeks' depletions and sales would have to be up 4.9%. Both represent quite an abrupt turnaround from the -15% start. Hopscape may be a dud, but the brand's depletion trends were bad before its launch, so we do not believe it is a singular problem that goes away with a new seasonal launch.
  • Now let's turn to the earnings quality. Beating street estimates by $0.50, or 40% is laudable, to say the least, until one looks at the sources of that variance. The primary reason Boston Beer beat Street estimates is that it shipped less product AND cut marketing spending dramatically. Recall, when the company issued guidance on its Q3 call, it indicated that sales and marketing would be flat to down $10 million for 2016. Even at the low end (the down $10 million case), this implied sales and marketing for Q4 was to be $77 million (versus $64 million the prior year). Of course, this included the extra week and made some sense given that the company's major brands (both Samuel Adams Boston Lager and Angry Orchard hard cider) were in trouble and perhaps needed a Q4 marketing push.

    However, the marketing push didn't happen, and Boston Beer reported sales and marketing of only $58 million in Q4, down almost $30 million for the full year (compared to the guidance of being flat to down $10 million). This $20 million variance relative to the down $10 million case represented $0.99 in EPS after tax (and $1.50, had the company kept sales and marketing flat). Therefore, had management done what it said it would do with sales and marketing, EPS would have been a mere $0.25-0.76 rather than $1.75, and the company would have missed Street EPS estimates horribly.

    Of course, investors can only take management at its word when it comes to discretionary spending such as marketing, so it is hard to give management too much credit here for cutting back so dramatically on marketing to beat Street estimates. According to the company's 10-K, advertising and sales promotions were down $15 million in 2016 from 2015, an after-tax "savings" of about $0.75 per share. For a troubled brand seeing depletion declines, Samuel Adams is, it would seem, very short-sighted to cut marketing when the brand needs support... unless management has not figured out how to market its flagging brand yet. More on that below.

    In addition to the $0.99 "upside" created by cutting sales and marketing, the company also saved $3.6 million ($0.18 per share after tax) due to the early retirement of CEO Martin Roper, which gave rise to a reversal of non-cash stock compensation. Furthermore, Boston Beer enjoyed a lower tax rate of 35.4% in Q4, compared to 37.9% the prior year, which boosted EPS by $0.07 and resulted in a small gain on the sale of property of $0.01 per share. Thus, the $1.75 in EPS is not nearly as strong as it appears, in our view. Without the marketing cuts ($0.99) and one-time G&A savings ($0.18) due to the CEO's retirement, EPS would have been only $0.58!
  • Based on management's comments on Boston Beer's Q4 conference call, it appears it does not yet have a strategy to resume growth... and it is not clear to us that there is one. In its press release, the company indicated it is conducting a comprehensive review of its core brand strategies and activation activities. What it will find during this review is unknown, but based on Chairman Koch's conference call comment, the answer may not be welcome: "I think what we have seen in craft in the last, call it, two or three years is a momentum shift, which may well be a passing phase towards new, small and local, and Sam Adams has not been new for a long time. It's not local in most of the country, and it's not small."

    How, then, does one make a brand that is not new, not small nor local new, small and local? We don't think you can without a major retrenchment of Boston Lager to the Boston region (and given it was contract-brewed in Pennsylvania and elsewhere in the beginning, it is not even clear Boston-based craft beer drinkers hold it dear). That is the dilemma Boston Beer faces. Acquiring new, small, local brands could be a solution, but again, management's conference call comments suggest that nothing along those lines is in the works because craft brewery asking prices are too high.
  • Management offered a wide range of earnings guidance for 2017 of $4.20-6.20, well below prevailing Street estimates of $6.35 (but consistent with our January 2017 base case of $5.35). Even with this wide range, management felt compelled to offer the uncomfortable caveat in its press release that, "The Company's actual 2017 earnings per share could vary significantly from current projection."

    There is a lot of leverage in the beer business, with significant fixed brewery costs having to be absorbed by whatever volume runs through it. The lower the volumes, the more fixed costs impact margins. Of course, one wild card again for 2017 will be sales and marketing, which management projects will be up $20-30 million from last year (about $1.00-1.50 per share after tax). We would not be surprised if management elects not to spend all of that marketing increase.
  • The fact that Boston Beer share price is only down about 5% today is surprising. Obviously, investors remain hopeful that the Hopscape fiasco was a one-off, and that the company's dramatic loss of share can be abated. The price of that hope is very high, in our view, with shares trading at 13x our base-case EBITDA estimate and 30x our new base-case EPS estimate of $5.15 for 2017. At a more appropriate value of 20x EPS, shares would be closer to $100. We remain short.

Disclosure: I am/we are short SAM.

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.

Additional disclosure: There are many risks to shorting stocks including unlimited downside. For selected specific risks associated with Boston Beer please see our Pro Seeking Alpha article on Boston Beer dated January 17, 2017.