News Analysis date published New: 
Tuesday, April 20, 2010 - 14:15
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Thursday, April 22, 2010 - 17:07
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Tuesday, April 20, 2010 - 14:15

This Leading Brewer's Prospects Are No Longer on Ice

Tuesday, April 20, 2010 - 2:15pm

The beer market is very mature in developed markets as has been around for hundreds of years. Case in point: Molson has been in operation since 1786 while Coors was founded in 1873. Legend has it that beer is as old as civilization itself, dating back thousands of years and contention as one of the oldest consumer goods out there. The unusually high level of mergers and acquisition activity has been one of the few ways for the major players to keep profit growth chugging along.

When Canadian beer behemoth Molson merged with the third largest brewer in the United States, the intent was to better compete with SABMiller and Anheuser Busch, the second-largest and largest brewers in the United States at the time of the merger. The result: Beer giant Molson Coors (NYSE: TAP).

Consolidation in the beer industry has been steady since SAB acquired Miller Brewing Company in 2002 to create one of the most dominant brewers in the world. To further strengthen its domestic clout, Molson Coors combined forces with SABMiller to create MillerCoors, a joint venture in the United States. Not to be outdone, Anheuser merged with Belgian-Brazilian behemoth InBev in late 2008 to create Anheuser-Busch InBev (NYSE: BUD).

Acquisitions can allow for entry into new markets, increased production scale, clout over suppliers and other related cost cutting measures. Molson Coors expects $500 million in total cost savings from the MillerCoors joint venture and achieved half of that in 2009 while posting $382 million in operating income.

Molson Coors is currently the second largest brewer in Canada, with a 40% market share, slightly behind Labatt's 44% share. Canada is a highly profitable market but growing about +1% annually. It is also the second largest brewer in the U.S. with 30% of the market, still well behind A-B InBev's 50% share. The U.S. market has also been growing about +1% a year, though growth fell by -2% in 2009 as a recession cut into sales at pubs and bars.

The United Kingdom represents MolsonCoors' third primary market where it is the third largest brewer with 19% market share. Though also highly profitable, industry shipments have been declining in the low single digits for more than a decade now.

Overall, Canada accounted for nearly half of total company profits last year, with the U.S. bringing in 40% and the U.K. about 10% of the total pie.

Despite the slow-growing nature of the beer industry, investors can do quite well by holding shares of Molson Coors. At a forward P/E below 13, the market is not fully appreciating the company's position as an industry leader with high barriers to entry. Free cash flow exceeded reported net income last year and that is used to support a current dividend yield in excess of 2% with the potential for steady share repurchases going forward. A combination of continued cost cutting at MillerCoors and improving demand in sympathy with a recovering economy bode well for the share price going forward.

The final consideration is that Molson Coors is considerably smaller than its two larger rivals and could be acquired at a hefty premium to the current valuation. Cash cow businesses are very appealing and offer plenty of downside protection for individual investors and strategic acquirers alike. Potential suitors include European-based Carlsberg or Heineken. Anheuser Busch was acquired by InBev for close to 23 times earnings, a +77% premium to where Molson Coors currently trades.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of TAP in one or more of its “real money” portfolios.