Boston Beer: Dogfish Deal Is No Dog

Boston Beer (NYSE:SAM) has been a name which I have watched with great interest in the past as I was surprised to learn that the company made a relatively interesting acquisition recently.

My latest article on the company was in the spring of 2016, some three years ago, as shareholders were having a hangover following increased competition in craft beer weighing on growth and margins. Shares traded around $150 with depletion volumes actually down. I noted that expectations have been low (compared to the past) as M&A and a strong balance sheet might act as triggers while the landscape was evolving in an uncertain way.

Shares have seen continued pressure in 2017 and hit a low of $130 that summer, only to rise spectacularly to a high of $330 in the summer of 2018, to consolidate in a $250-350 range ever since.

Trends Have Improved

After years of very impressive double-digit organic sales and volume increases, Boston Beer reported a 5% fall in depletion in the year of 2016 in early 2017, which followed just 4% growth in 2015. With earnings power of around $7 per share, shares looked cheap that summer, given that the company has traditionally operated with a net cash balance as well. The issue is that volumes were originally seen down by as much as 7%, or at best, grow by 1% at the start of the year, as limited price increases hurt margins a big way.

Depletion did actually fall by 7% in 2017, as shares recovered to $180 at the start of 2018 while the company guided for flat to positive 6% depletion growth in 2018. It furthermore became clear that cost cutting went a long way to preserve earnings power. Ever since, the company has regained some momentum again. Depletion growth was positive by 8% in Q1 of 2018, 12% in Q2, 18% in Q3, and 11% in the final quarter of the year. The 13% growth for the year was driven by improved marketing messaging and innovation as a transition from a founder-led business to a hired CEO seems to have gone extremely well in this case.

Some higher prices mean that full year sales were up by 15% with net revenues falling just a few million shy of the billion mark. Operating earnings were flattish around $116 million, as advertising expenses rose by more than 18%, and gross margins were under a bit of pressure. Net earnings of $93 million worked down to $7.82 per share as a net cash position of $108 million works down to nearly $10 per share. Upon the release of this earnings report, shares have bounced back to $300 already, implying a very ambitious multiple at 37 times earnings.

Part of this is driven by the outlook for 2019, calling for depletion growth of 8-13% and earnings to rise further to $8-9 per share, but even then, shares are by no means cheap. This remains the case even as a 11% increase in first quarter depletions triggered a hike in the full-year guidance, with depletion growth now seen at 10-15%.

The 11.6 million shares represent a market value of $3.4 billion at $300 per share and an enterprise value of $3.3 billion. With net sales seen around $1.15 billion in 2019, this values the company at 2.9 times sales, which is a very reasonable multiple for a beer company. Unlike (global) competitors, margins of Boston Beer are quite low, not benefiting to the same extent from greater scale in terms of distribution, marketing, and production.

A Very Interesting Tie-Up

To grow quicker in a big way, Boston Beer announced an interesting deal on May 9, a deal welcomed by investors who sent shares $15, or about 5%, higher in response to the deal announcement. Boston Beer is acquiring Dogfish Head Brewery in a $300 million deal, combining two pioneers under one roof. Dogfish has a heritage in this space as well, being strong in IPA and session sour brands. Investors like the tie-up of two special beer brewers and the fact that Sam Calagione will be involved in the leadership of the company as well as receive a big portion of the purchase price in the form of Boston Beer's stock.

Mr. Calagione will receive about $127 million in stock, and another $173 million in cash. In terms of valuation multiples, the deal looks reasonable with Dogfish expected to contribute $110-120 million in sales this year, for a 2.5-2.7 times sales multiple with sales growth seen in the high single digits. While Boston Beer will operate with a net debt load of $65 million upon completion of the deal, this remains minimal as dilution in the share count will be offset by the earnings contributor from Dogfish, not quantified at this point in time.

Given the modest multiple, potential for costs and revenue synergies, I understand why investors like the tie-up, although expectations have gone quite high already following the big recovery seen in the shares, mostly in 2018.

What Now?

Reality is that, while I have been a long-term fan of the company, the stock at times, this deal, and recent operating momentum, a current forward earnings multiple in the mid-thirties to nearly 40 times earnings is simply too steep for me to consider share currently.

I thus look forward to continued upbeat trends for the company and/or pullback in the shares before considering a position (again) but, for now, continue to enjoy the beer more than the stock at these levels.

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.

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