Waterloo Brewing: Plenty Of Upside For 2020

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About: Waterloo Brewing Ltd. (BIBLF)
by: Brant Munro CFA
Summary

WBR's efforts to seek new and expanded co-packing relationships and completion of the canning line expansion and the expansion of its facility in fiscal 2020 will further expand margins.

The company has secured its research license from Health Canada to begin developing cannabis-infused beverages (“CIB’s”) and will begin production as early as 2020.

Because of the above two mentioned catalysts, I believe there is plenty of upside for this stock in 2020.

All figures in CAD.

Background

In November 2018 I wrote an article on Brick Brewing Ltd. (OTCPK:BIBLF) which has been renamed Waterloo Brewing Ltd. (WBR.TO) called Brick Brewing: It's Time For A Brick Brew! As a refresher, WBR is Ontario's largest Canadian-owned public brewery. WBR produces, sells, markets, and distributes premium and value-priced beers, ready-to-drink (RTD) alcoholic beverages and has a growing co-packaging business. Shown below are the company's recognizable brand names.

Source: Company Website

Brick's products are mostly sold in Ontario with a few select beverages available in the rest of Canada. Within Ontario, distribution of alcoholic beverages occur primarily through The Beer Store and the Liquor Control Board of Ontario (LCBO), however, recently revised government regulations have allowed for the sale of alcoholic beverages in licensed grocery stores. The company expects the number of licensed grocery stores to continue to increase as additional licenses are granted throughout fiscal 2020.

WBR markets its premium products at prices that are comparable (sometimes 8-20% below) to the "mainstream" brands produced by its largest competitors. This allows WBR to recapture the higher costs of ingredients and processing that are involved in producing its various premium brands, as well as allowing the company to gain market share versus brands that are mass produced and heavily marketed.

Over the past several years, this pricing strategy has allowed the company to grow Laker brand sales at the expense of other value brand and "mainstream" competitors. However, up until the August 2018 decrease in the minimum retail price, annual increases have caused the gap between mainstream and value brands to become more and more compressed making it more challenging to compete based on price alone. The company’s largest competitors regularly promote their mainstream brands through limited time offers (“LTOs”). LTO prices are aggressive and the difference between minimum retail price and LTO price is very often less than 7%.

The company finished the 2019 FYE with $49.8 million in revenue (+10.2% versus the previous year) and EBITDA excluding one time costs of $9.0 million, continuing a five-year trend of strong financial performance and currently shows a respectable 8% ROE. These increasingly positive trends made it possible for them to offer an increasing dividend and the only Canadian craft beer stock to do so which is now at $0.019/share for a 3.3% dividend yield which puts it in line with the other major publicly traded brewing companies.

Chart Data by YCharts

Company Ticker Dividend Yield
Molson Coors Brewing Co. (TAP) 4.27%
Constellation Brands (STZ) 1.47%
Anheuser-Busch (BUD) 3.53%
Boston Beer Company Inc (SAM) -
Waterloo Brewing Company Ltd. (WBR) 3.22%

Source: Yahoo Finance

As we can see below this is a thinly traded small capitalization stock.

Chart Data by YCharts

The Waterloo family of craft beers grew by 10% with the support of redesigned packaging and a more attractive brand identity. Effective and timely responses in pricing and pack formats propelled the flagship Laker family of beers to grow by 7%, despite competitive activity in value beer. Landshark and Margaritaville, the newest additions to the brand portfolio, achieved growth of 45%.

WBR is now a single-source facility after five years of necessary consolidation. The co-pack business has grown by 28% on top of 20% growth the previous year, which further contributes to scale and efficiency. The addition this year of a high capacity canning line will yield further productivity and cost savings.

The company’s corporate head office and production facility are located in Kitchener, Ontario. In fiscal 2020, the company will be completing a 65,600 square foot expansion of its leased facility which will include an expansion of its warehousing and production facilities, and retail store, and construction of a taproom with a small batch brewhouse. The expansion will allow the company to improve capabilities, capacity, and efficiencies.

As of August 14, 2019, the company has secured its research license from Health Canada to begin developing cannabis-infused beverages (“CIB’s”). The company is continuing to prepare for participation in the CIB category when edible cannabis products are legalized in Canada. The necessary application documentation for a Standard Processing License has been prepared and submitted to Health Canada and is under review. Construction of the infrastructure to meet the requirements for licensing is currently underway and progressing as planned. WBR is on track to have CIB products sold in store for 2020.

This will be a lucrative revenue segment for WBR as the CIB market is expected to be valued at $1.5 Billion according to industry estimates. Company COO Russell Tabata has stated that due to technical infrastructure issues related to the licensing and commercial production of cannabis-infused beverages, WBR will be one of the few beverage production facilities capable of producing these products in Canada.

TBS Consignment

As we can see below, the WBR stock price has fallen ~29% post 2019 FYE which is January 31st of every year.

Chart Data by YCharts

During the first quarter of fiscal 2019, the WBR’s largest customer, The Beer Store (TBS), moved from a buy-sell relationship to one of consignment. This change impacted all brewers supplying product to TBS, WBR was no exception. On implementation, inventory increased YoY from 2018 FYE to 2019 FYE by $3.5 million to reflect inventory on hand at TBS. Further, there was a one-time reversal of gross profit. Net revenue decreased by $3.6 million, cost of sales decreased by $1.4 million, gross profit and EBITDA decreased by $2.2 million, and net income decreased by $1.6 million. At the time of change to consignment, the company was required to buy back inventory on hand at TBS, payable over a 26-week period. As at January 31, 2019, the company has fully paid the amount payable to TBS.

As a result of a one-time adjustment during the quarter ended April 29, 2018 associated with TBS’ change to a consignment basis, the annual results were impacted as follows:

  • Gross revenue decreased by $5.7 million;
  • production taxes decreased by $2.1 million;
  • Net revenue decreased by $3.6 million;
  • Cost of sales decreased by $1.4 million;
  • Gross profit decreased by $2.2 million;
  • Net income decreased by $1.6 million.

In essence due to this one time adjustment, the company appeared less profitable and revenue growth appeared to have stagnated. However, excluding the impact of TBS’ change to consignment noted above, net revenue in fiscal 2019 actually increased by 7.8% and owner brand net revenue increased by 1.1% according to the MD&A of the 2019 Annual Report.

Valuation

2019 Annual Report 2019 Q2 MD&A

In the table above from the 2019 Annual Report we can see that WBR typically has their worst quarter in Q1 and their strongest in Q2. The company’s revenue is influenced by seasonality. The second quarter, which covers the summer months, has historically been the strongest quarter for the company, representing approximately 33% of total net revenues in fiscal 2019, followed by the third quarter (approximately 28% of total net revenues in fiscal 2019) which covers the late summer and fall. The first and fourth quarters usually see a reduction in revenues as beer, cooler, and cider consumption is reduced in the colder winter months.

Below are EV/EBITDA valuations on other publicly traded breweries.

Peer Valuations
Company Ticker EV/EBITDA
Molson Coors Brewing Co. (TAP) 9.53x
Constellation Brands (STZ) 17.70x
Anheuser-Busch (BUD) 13.13x
Boston Beer Company Inc (SAM) 25.15x
Waterloo Brewing Ltd. (WBR) 14.24x
Median

14.24x

Source: Yahoo Finance

As we can see YTD financial performance is ahead of its level at this time last year, WBR has already had its best and worst quarters of the fiscal year in terms of revenues. As we can see gross and EBITDA margins have improved from their levels exactly one year ago. Margins have improved largely due to the decrease in total cost of sales which was driven by manufacturing efficiencies and improved material cost as a result of a decrease in the price of aluminum, and increases in marketing initiatives as the WBR continues to support its core brands.

Margins may also experience some tailwinds due to the decrease in the minimum retail price by the Ontario provincial government on beer with an alcohol volume of less than 5.6%. Annual increases in the minimum retail price have seen the price gap between value and mainstream brands reduced, creating increased competitive pressure. In August 2018 Premier Doug Ford lowered the minimum price of a bottle or can of beer to $1 from $1.25. The price also does not include a bottle deposit and does not apply to draft beer. Brewers are not required to charge the lower price and few in the province sell at the current minimum anyway as it is just unfeasible with the taxes, cost of ingredients, and aluminum tariffs from the U.S.

Annualized EBITDA is $10.06 Million, and using a 14.24x multiple would suggest that an EV of $143.3 Million and a price per share of $3.27 is not unreasonable.

EV $143.3
2019 Q2 Total Term Debt and Lease Liabilities $28
Implied Market Capitalization $115.3
Shares Outstanding 35.2
Price/Share $3.27

All figures are in millions except price/share.

This valuation is about in line with the current share price at $3.20/share as the market seems to have recognized that the TBS consignment policy should have minimal impact on the financial statements going forward. However, what is not being recognized is WBR's efforts to seek new and expanded co-packing relationships and completion of the canning line expansion and the expansion of its facility in fiscal 2020 which will further expand margins. The potential for increased revenues associated with CIB's that have the potential to be sold in stores in 2020 is also being ignored.

Conclusion

I maintain my stance on Waterloo Brewing Ltd. in that despite being in a very competitive environment that it is undervalued and is an even better buying opportunity now versus the time I posted my previous thesis on the company. I see very little downside unless the Ontario provincial government goes back to its old ways and starts increasing the minimum retail price which has a tendency to make value brand beer less attractive relative to "mainstream", but the Doug Ford administration seems to have little interest in doing that, meaning at the very least earnings should experience slow and steady growth. On the other hand, there is plenty of upside potential due to the completion of the canning line expansion and the expansion of the facility in fiscal 2020 which will further expand margins and the revenue generating ability of the CIB segment which will commence as early as 2020.

Disclosure: I/we 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.