Peak Beer: Time to Short Sam Adams

Boston Beer, also known by its core brand name Sam Adams, is riding the US craft beer wave sending its stock to an all time high this week. SAM is overvalued on every metric, absolute and relative, when compared to its peer and historical averages.

The company’s growth is driven by its Twisted Tea and Angry Orchard brands. The overwhelming majority of this growth is from distribution growth. Twisted Tea was first introduced in 2001, meaning it’s not a “new” product, but recently expanded more rapidly and reached full distribution in the US in mid 2012. While SAM should continue to have solid y/y growth in the 1H 2013, they will no longer have the distribution tailwind in the back half of the year. Its core beer portfolio is flat y/y at best.

Although beer/alcohol sales is a relatively stable and solid business, I believe for a short term trade you can easily earn 10-15% by shorting SAM stock at current levels ~$139. I think the stock may be a more attractive short on a fundamental basis in mid to late 2013. Although I generally avoid valuation/technical shorts, I think SAM can be used as a hedge to a long TAP, BUD, MNST position going into what could be a volatile few weeks with the fiscal cliff uncertainity.

Thesis
SAM reported 3Q earnings on Nov 1st and beat expectations pretty handily. However, they did not raise FY2012 guidance leading one to believe that 4Q would slow. On Dec 12th, SAM raised 2012 EPS guidance to $4.30 - $4.60 from $3.80 - $4.20 and also increased 2013 depletion expectations to 10-15% from HSD.

SAM is seeing depletion growth above what they are actually shipping to distributors, a trend which is not sustainable. This is expected to some extent since The Freshest Beer Program in essence is lowering inventory at distributors. I believe Angry Orchard helped contribute the most incrementally to the increase in expectations as investors had been modeling it as a very small component, but is likely closer to 7-10% of sales/EPS.

• One should note that Angry Orchard had a new product roll out this past summer and sales have been robust. SAM should continue to benefit from Angry Orchard in 1H 2013, but growth will become more challenging as they lap tougher compares in 2H 2013.

• Twisted Tea has been a growth driver for SAM recently and I think most people expect it to continue. The only growth driver in Twisted Tea this past year was their distribution growth as they expanded into 48 states (there are legal reasons why they won’t move into the other 2 states). In fact, Twisted Tea volumes are actually negative if you look at it on a SSS basis stripping out the distribution growth.

• In April Twisted Tea will start lapping tough compares.

Seasonals & Core Brand
• Seasonals have been and will continue to be a growth driver for SAM as long as they continue to innovate and release new products. This is a category that SAM has always leaned on so any slowdown in growth of Seasonals would mean trouble.

• As mentioned previously, SAM’s core brand is flat. If the trend in the Better Beer market begins to slow and SAM’s core brand turns negative, there is downside risk to my numbers.

The Freshest Beer Program has caused capex to increase significantly over the past couple of years and should continue to keep levels elevated over the next few years before normalizing. It is difficult to estimate how much of this increase is temporary vs ongoing.

Valuation
I am assuming normalized capex to be $50M after spending $19M in 2011 and an estimated $70M in 2012. I assume normalized depreciation of $20M for my DCF analysis. SAM’s EBIT margin is typically in the mid teens and peaked at 17.5% in 2010. It is expected to be 16.5% for 2012 and 16.75% in 2013. EBIT margin should remain steady over the next couple of years; however, I am assuming an 18% normalized margin for my FCFF calculation. I chose to use a 2 stage DCF which resulted in an intrinsic value per share of $113.05.

I felt a 10% discount rate is fair for a company in a steady low-risk business. I assume the craft beer craze continues for the next few years which is why I am using a 10% growth rate (in line with expectations) in years 1-5. As more competition enters the market I expect the growth to slow to 8%, and eventually 6.5% once the market is mature.

SAM’s depletion guidance for 2013 as well as consensus estimates for revenue imply revenue growth that is slightly faster than industry growth. SAM trades at 30x current year and 27.5x my $5.04 2013E and is only growing revenue ~10%. If you look at historical multiples SAM has averaged 25x while growing revenue at a faster pace. This seems awfully expensive when compared to other beer & beverage companies. BUD will grow revenue ~15% next year and trades at 17x 2013E. MNST trades at 22x 2013E and is growing faster than SAM as well. At 25x my 2013E of $5.04 vs consensus at $4.95 SAM is worth $126.11. My price target of $119.50 is a blend between DCF and historical multiple.