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Executive Summary

As volatility returned to the market in late June, investors are recommended to sell or hold Boston Beer Company (SAM) at current market price of $563.83. Our models assign the company an intrinsic value of $501/share, or a 11.14% downside from the stock price at the time this article was written. The company has been slightly affected due to COVID-19, but has managed to increase beer shipments in the first quarter. However, there could be temporary setbacks as the business is met with further uncertainty, mostly arising from the global pandemic’s situation, the potential of further lockdowns, and the upcoming US Presidential election in November. Several of our indicators imply that the stock is currently overpriced by the market. In the short run, we see the probability of a correction that drives the stock back down to the $510–520 range. In the long run, however, the company’s growth is likely to continue, making Boston Beer a good asset to most portfolios.

Background

Market Conditions

In the first half of 2020, economies around the globe have been severely affected by the COVID-19 crisis, and the US has certainly not been an exception. The largest economy in the world has suffered from extreme uncertainty as the back and forth struggle between the virus and the US government’s stimulus policies put businesses into complicated situations in which they can neither operate normally nor completely fire workers and file for bankruptcy. In mid-March, the market tumbled due to large sell-offs as the spike in coronavirus cases troubled investors. The legendary Warren Buffett cleared all airline stocks from Berkshire Hathaway’s holdings, predicting a difficult near future for the airline industry. The market, however, has recovered to near its pre-crash highs. The Fed’s policies of buying corporate bonds and pushing trillions of dollars into the economy have also contributed to the stabilization of the market.

However, we are concerned that the current market is excessively detached from fundamentals, as the unemployment rate is still high and the looming threat of COVID-19 remains existent. This is shown through the unexpectedly good performance of bankrupt or extreme speculative stocks like Hertz (NYSE:HTZ), J. C. Penney (OTCPK:JCPNQ), or AMC. Many fear that a second crash will happen in the second or fourth quarter, on top of which the presidential election is to take place. The market condition puzzle seems to remain unsettled until the end of 2020.

The Brewery Industry

Like many other industries, the brewery industry was impacted by COVID-19, but to a less severe extent. Revenues are expected to decline in the second half of the year due to the closure of clubs, bars, restaurants, and other food services. Distribution and international shipments have been affected due to tightened travel control around the world. Economic hardship and uncertainty play a big role in determining consumption going forward. However, on a positive note, demand for alcoholic beverages remains high in international markets that were less affected by the virus and did not suffer from the subsequent shutdown.

In the past few years, craft beer has dominated the industry’s growth narrative, effectively becoming one of the biggest trends in the sector. However, it is unlikely for these small companies to challenge the market share of well-established market share. This is in part due to the fact that the small breweries lack geographical exposure hedges, which may be key if the domestic market experiences a deep recession.

The historical low revenue growth could also be a problem for the industry as it may prevent further investments, especially if an upcoming recession weakens the availability of investment capital. This is a mature industry which is projected to have steady annual growth outlook of 2.2% until 2025. This is a modest number unlikely to appeal to growth investors. Despite the mentioned challenges, the alcohol industry is, according to IBISWorld data, one with relatively low volatility, making it attractive to more conservative portfolios. Alcohol’s relative resilience (and even growth in some cases) during recessions also makes exposure to this industry an interesting play.

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Company Overview, Business Model and Risks

The Boston Beer Company is a high-end brewery founded by Jim Koch in 1984 after his grandfather’s legacy. It is a producer of alcoholic beverages, including malt beverages, hard seltzer, hard cider, kombucha, and tea. Notable brands that belong to the firm include Samuel Adams, Twisted Tea, and Angry Orchard – each corresponds to the beer, iced tea, and cider segment. The company owns nine subsidiaries, four of which (Boston Brewery, Cincinnati Brewery, Milton Brewery, and Pennsylvania Brewery) are responsible for production and R&D of bottled beer. The rest, which are small-scale breweries acquired from other owners, are mainly focused on retail sales on-site at taprooms and gift shops in the local areas where they are located.

Unlike its peers whose sales come from large scale production of less expensive canned or bottled beers, a large part of Boston Beer Company’s revenue is derived from their High-End beers and primarily from inside the US. This product positioning provides the company with a niche segment to operate within but also becomes a problem during times of economic hardships, such as the COVID-19 pandemic. Customers are discouraged from buying highly-priced alcohol as the possibility of furloughs and layoffs threatens their income security. This, coupled with the closure of on-site bars and breweries, had affected the company’s earnings and performance in the first quarter. With the rising cases of coronavirus towards the end of June, it is uncertain when these establishments will resume their normal operation.

According to IBISWorld’s Industry Report, the two biggest players in the US domestic alcoholic beverage market are Anheuser-Busch InBev (BUD) with 41.5% market share and Molson Coors (TAP) with a 21.4% market share. The firm’s competitors include Constellation Brands (NYSE:STZ), Craft Brew Alliance (NASDAQ:BREW), and international brands such as Heineken N.V. (OTCQX:HEINY) (Dutch) or Diageo Plc (NYSE:DEO) (British). These are brands that compete directly with The Boston Beer Company for market share and could pose serious threats to the company’s financial success due to their greater financial resources, marketing strength, and distribution network. Besides the risk of competition, the brewery faces strict beverage safety and human health regulations from the USDA. The failure to comply with these regulations could lead to severe lawsuits and fines against the company. Its dependence on distributors for 96% of the beer sold is also a big source of risk that could hamper revenue should these distributors reduce the support for the company. Apart from the risks mentioned above, other risks worth mentioning include changes in public attitudes and drinkers’ tastes, disasters that affect production facilities, supplier dependency, and changes in regulation.

Company Valuation

The Boston Beer Company is valued using two methods: Discounted Cash Flows (DCF) and multiples valuation.

a) DCF method: The discounted cash flow method uses the following ten years’ unlevered free cash flows (UFCF) and the weighted average cost of capital (WACC) to determine the firm’s value, with 2020 as the base year (year 0). All data is based on Boston Beer’s fiscal year Financial Reports. This method is done with a more conservative approach to prevent overvaluation of the company’s equity. For year-on-year growth, barrel sales in 2020 are expected to be 6% lower than in 2019 due to the financial conditions caused by COVID-19. In 2021, the economy is expected to recover, leading to a 25% growth in sales. Growth then slowly depletes roughly 5% every two years afterward. Revenue per barrel is expected to remain unchanged, at $235.50/barrel, then increase at $3 every year. Other assumptions used in the DCF model include WACC of 6.38% and terminal growth of 2%, which is similar to the long-term growth rate of the industry. With 12.2 million shares outstanding, each Boston Beer share is priced at $500.43. The target price derived from the DCF model is $501/share.

b) Multiple valuation method: The multiple valuation method compares The Boston Beer Company with other publicly traded breweries on EBITDA margin, EV/EBITDA and EV/Million Hectoliter. Due to operating losses in some companies such as Constellation or Craft Brew alliance, EBITDA margin will be negative. This critically affects group average data of some metrics. Therefore, to avoid extreme outliers, group median is more suitable to be used to value The Boston Beer Company. Using Median EV/EBITDA of 13.9, the company is valued at $2.52 billion, and each share is worth $206.70. If the company is valued based on alcohol sales (EV/Million Hectoliters), group average data (640.9 x) results in EV of $3.99 billion and the median data (435.2 x) results in EV of $2.71 billion. Prices per share are $304.75 and $199.50, respectively.

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c) Target price: The multiple valuation method could be flawed due to influences of net loss from companies that had an unexpectedly bad year. As a result, we consider the DCF model to be more reliable in determining the company’s market value. At the time this report was created, The Boston Beer Company’s closing price at the end of June’s third trading week was $563.83. Both of the models indicate that the company is currently overpriced. In comparison with the DCF target price of $501, the company is overpriced by 12.5% at this price level. This price also lies 11.6% above the average analysts’ suggested target price of $505.17. The company seems to be slightly overvalued based on different sources of analysis.

Performance, Fundamentals, Financial Health and Strategies

a) Performance

In the first-quarter earnings release, The Boston Beer Company stated a net revenue of $330.6 million, that is an increase of $78.9 million, or 31.4% from the same period last year. Net income per share was $1.49, which decreased by $0.53 from 2019’s first quarter. The impact of COVID-19 on Boston Beer’s shipments is not as severe as the impact on other industries. However, this situation could change rapidly in the next few months, since the pandemic in the US did not reach its peak until late April (and perhaps the real peak is yet to come). The consequences of this could slowly become more visible as the lagged impact is finally reflected in the economy. In fact, just like many other companies, Boston Beer withdrew its financial guidance for the fiscal year 2020 due to the inability to accurately forecast future impacts of the pandemic.

Before the market crash in March, the stock fluctuated around the $350-425 range. After the big drop, the company has seen an extremely bullish trend arising with an impressive 87.94% gain since its low, and a Year To Date gain of 49.22%. For now, there seems to be a resistance level at the $560 price point that prevents the stock from going higher. The stock could potentially reach a double-top and eventually reverse back to the $500-510 target price range. The potential reversion is signaled by the massive insider sell-offs within the one-week period from June 8 to June 16, noteworthy by Chairman James Koch and Director Cynthia Fisher with prices ranging anywhere from $507.83 to $560.21.

ChartData by YCharts

b) Fundamentals and Financial Health

The Boston Beer Company is a growth firm with high growth prospective. However, the company’s fundamentals indicate that investors might have been over-optimistic about future returns. Trailing Price-to-Earnings ratio is currently 73.11, while forward P/E ratio is 43.05. While it is positive that Boston Beer is expected to see better earnings going forward, this P/E ratio is significantly higher than the group’s average and that of the mature and profitable companies in the industry. In fact, it has the second highest Forward P/E ratio in the group, only after Craft Brew Alliance, a borderline small cap firm ($300 million) that suffered a loss in 2019. The stock is also traded at nearly 9 times book value, with price-earnings-growth ratio of 3.14. To us, these metrics are evidences of overpricing.

Boston Beer mentions in the first-quarter earnings release that the company’s Q1 ending cash balance is $129.5 million, which along with the $50 million credit line and future cash flows will be sufficient for its operations. This is after a $100 million withdrawal from the company’s line of credit to manage the impact of COVID-19. It is also not highly-levered with low quick ratio (1.10), current ratio (1.80) and Debt/Equity ratio (0.14). The firm’s financial health is further tested using Altman Z-score and Ohlson O-score and based on Dr. Alexander Barinov’s distress risk puzzle research (Trading Strategies and Financial Models) to forecast probability of bankruptcy in the following year. All data used in the calculation is from fiscal year 2019. Formulas for Z-score and O-score calculations are represented below:

Elaboration:

WC: Working Capital; RE: Retained Earnings; EBIT: Earnings before interest & taxes; MVE: Market Value of equity (market capitalization); S: Sales or revenue; FFO: Fund flows from operations; CL: Current Liabilities; CA: Current Assets; TL: Total Liabilities; TA: Total Assets; NI: Net income (loss) at time t; NIt-1: net income (loss) at time t-1

Results:

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Based on the results of these calculations, a Z-score of 14.86 is much larger than the 5-point mark of a financially healthy firm. On the other hand, however, its O-score of -5.46 lies between -2.5 and -8, but leaning towards the -8-point mark, which suggests a low probability of bankruptcy next year, at 0.35%. Overall, there is no clear sign of financial distress spotted in the firm’s financial indicators. This is still a healthy growth firm that is suitable for investors who prefer long-term strategies.

c) Strategies

To evaluate the stock’s long-term performance, Boston Beer’s stock is regressed against the CAPM, Fama-French 3-Factor model, Carhart model and Fama-French 5-Factor model. The returns are tested in a 10.5-year period, from January 1, 2010, to May 31, 2020, on monthly basis. The monthly data for historical risk-free rate, market risk premium, value factor, size factor, momentum factor, operating profitability and investment factor from Kenneth French’s website in the Data Library section. Below are the results of the regressions:

i) Capital Asset Pricing Model (CAPM):

ii) Fama-French 3-factor model:

iii) Carhart model:

iv) Fama-French 5-factor model:

Elaboration: Intercept: monthly or abnormal return investor receives from holding the stock

RF: risk-free variable; Mkt-RF: Market risk premiumSMB: Small minus Big (Size effect) HML: High minus Low (Value effect) MOM: Winners minus Losers (Momentum effect) RMW: Robust minus Weak (Operating Profitability effect) CMA: Conservative minus Aggressive (Investment effect)

Results:

The models are represented through equations below:

CAPM: SAM – RF = 1.72 + 0.69 (Mkt-RF)

Fama-French 3-factor model:SAM – RF = 1.79 + 0.45 (Mkt-RF) + 1.21 SMB – 0.62 HML

Carhart model: SAM – RF = 1.66 + 0.52 (Mkt-RF) + 1.22 SMB – 0.39 HML + 0.46 MOM

Fama-French 5-factor model: SAM – RF = 1.49 + 0.54 (Mkt-RF) + 1.40 SMB – 1.03 HML + 0.73 RMW + 1.12 CMA

These results indicate that the company has the behaviors of a small growth stock. Over the last 10 years, on average, the stock has yielded an abnormal return of 1.49% to 1.79% monthly, depending on the respective model. This is the equivalent of 17.88% to 21.48% annual abnormal return. Despite the use of different models and factors, the alpha remains present in the regression results. As more factors are incorporated, the abnormal return does get smaller, but not at a significant amount. It cannot be explained by any of these well-developed models. If the abnormal return is compensation for risk, then the risk source is unidentified in this situation, and will take further researching efforts to explain where it comes from. If it is not a risk problem, then this is an impressive abnormal return that investors get on top of fair compensation for risk.

Consequently, there is no doubt that, in the last decade, this stock has been a great performer for investors who have held it. However, since the alpha is statistically insignificant in all models except for CAPM and Fama-French 3-factor, investors should take these results with a grain of salt.

Recommendations

Overall, we believe that while the long-term picture still looks positive, the stock is currently overvalued. As volatility returned to the market in late June, holding investors are recommended to sell the shares at the current price point. After a rather impressive run in three months, we believe the stock is unlikely to keep up the rally momentum in the near future. Investors seeking ownership of the stock should wait for further signals before buying the stock. A reversal event in which stock prices drop down to the $520 level could occur (it actually happened twice in June), bringing the stock closer to the true target price, and making it a better time for long-term investors to initiate their positions.

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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