Good Beer at a Cheap Price

03/17/2010 1:00 pm EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, equities strategist and editor of Morningstar StockInvestor, and analyst Ann Gilpin, say a major beer maker is worth investigating at current prices.

I’m willing to consider investing in narrow-moat stocks under these conditions: 1. a lack of wide-moat opportunities, 2. a great valuation, and 3. predictable cash flows. I found one opportunity that was compelling enough for me to pull the trigger this past month—Molson Coors Brewing (NYSE: TAP).

Molson Coors, the fifth-largest brewer in the world, was created by the merger of Canada-based Molson and US-based Coors in 2005. Major brands include Coors Light, Molson Canadian, Carling, Blue Moon, Killian’s, Caffrey’s, Worthington’s, and Keystone.

[It] falls short of a wide-moat rating because of its lack of scale relative to industry titans Anheuser Busch InBev (NYSE: BUD), Ambev (NYSE: ABV), and SABMiller (OTC: SBMRY.PK). Plus, sales volume of mass-market beers has been flat to slightly declining.

That’s the bad news. But there is plenty of good news! For one, the company dominates in Canada, where Molson has a market share in excess of 40%. Additionally, here in the United States, the company entered into a joint venture with SABMiller in mid-2008 that is boosting the bottom line.

The merger allowed the management team to develop a reputation for its successful cost discipline, as it captured significant savings on distribution, overhead, and marketing. By cutting substantial costs out of the system, the company expects to eventually save more than $200 million annually.

This equates to a little over $1 per share. This cost-cutting is a relatively certain source of profit growth that has already yielded results, and earnings growth from this source should continue for another two years or so.

What really interested me in buying the stock is the valuation—something that is relatively recession-resistant at just below 11x expected forward earnings, with a decent balance sheet (current assets roughly equal total debt), and there is only modest uncertainty. The company generates copious amounts of free cash flow that amounted to $3.74 per share last year, equating to a free cash yield on the stock near 9%.

Our fair value estimate is $59 per share, which implies forward fiscal-year price/earnings of 19x, price/cash flow from operations of 16x, and enterprise value/EBITDA of 15x. In the longer term, we forecast reported annual sales growth of 2%–3%.

Over the longer term, we think total operating income will increase in the 3%–4% range, with operating income in the Canadian and US segments increasing slightly [more] and operating income in the UK segment increasing [by less]. We forecast mid-teens operating margins for MillerCoors by 2013.

At [above $43 Tuesday, nearly] a 30% discount to our $59 fair value estimate, this seems like a good price for an opportunity where I do not see a lot of risk at the moment.

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