Description

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As of February 12, 2013:

Share Price: $44.22

Upside Target: $70+

Downside Risk: $40

Average Daily Trading Volume: 1.25MM shares or $55MM

• Basic Thesis
  • At under 10x 2013 FCF, TAP is an undervalued stock with significant upside leverage (via multiple expansion) to a rebound in US and Canadian “premium” beer volumes 
    • US “premium” beer volume has languished due to
      • Craft beer taking share of the beer category
      • A shift towards wine and spirits in the overall alcohol category
    • However, both of these trends should reverse over the next few year as:
      • The “Echo Baby Boom” will turn 21 and 20-30 year olds are target, higher volume consumers of premium beer compared to craft beer and wine and spirits
      • Unemployment has fallen hardest on blue collar males between 20-40, premium beer’s target market, and any rebound in employment should benefit premium beer
    • TAP is the most exposed brewer to US beer volumes
      • The US is ~45% of TAP’s EBIT and Canada is ~35%
  • Importantly, at 10x FCF vs. peers at 13-16x FCF, TAP equity is not currently discounting any improvement in US beer volumes
    • Thus TAP equity is an undervalued call option on a recovery in US employment
  • TAP has limited downside
    • Low multiple, low volatility “recession proof” business, and strong technical support at the $38-$40 level, which I view as realistic downside
  • I conservatively calculate upside at 13x a modestly bullish 2014 FCF estimate of $5.25, or ~$70 per share, vs. Street at ~$4.75
    • Essentially I believe as more growth comes US premium beer volumes, due to demographics and an improvement in employment, the earnings will go up modestly and the multiple will expand given expectations for stronger growth
  • I view TAP as a 1:5 risk-to-reward scenario
    • In particular, I view the downside as more probable (excluding market volatility in the event of a large plunge in the SPX) given TAP’s very stable business and very strong support at $38-$40
• Bear Case
  • Big bear case/why it is so cheap
    • Bear Take: TAP is a lower quality, low growth portfolio of brands  that is underindexed to the growing area of beer (craft beers, beer-alternatives) at the same time that overall beer consumption is under pressure from a mix shift towards wine and spirits
    • My Take: While under indexed to the current beer demand environment, TAP is actually overindexed to those who are un/underemployed and would increase their beer consumption if employment conditions improve AND is exposed to a key demographic shift
      • TAP’s key brands (Miller, Coors) target demographic (20-40 year old men, particularly “blue collar” men) that has been hit hardest by the collapse of US residential construction AND is probable to see a significant improvement from a rebound in construction as well as continued growth in energy (shale gas/oil) and manufacturing (benefiting from lower domestic energy cost)
        • For instance, beer sales to North Dakota, where unemployment is low and fueled by energy, were up 18% in 2012 vs. ~2% for the entire US
      • Further, as the “echo baby boom” the share gain of wine and spirits, which is largely upon demographics as older drinks prefer wine/spirits to beer, should reverse over the next decade and favor beer again
  • TAP use of cash
    • Bear Take: Management are poor allocators of capital, choosing to buy Starbev in April 2012 at 11x EBITDA instead of increasing dividend/buying back TAP shares which were trading 8x EBITDA
    • My Take: While the Starbev acquisition was done at a higher multiple than TAP’s stock, that does not make the deal illogical and I do not believe management is “empire building” at the expense of shareholders.
      • The deal was done at a reasonable multiple for a beer transaction (even with the caveat that PE could have been running the business at peak margins)
      • TAP is undersized relative to conglomerates such as a ABI or SABMiller, which leaves TAP with fewer potential transactions to grow their business, hence this was the first transaction >$50MM in ten years
      • Starbev is exposed to the growing Eastern European markets and TAP should be capable of achieving synergies as well as using the platform to cross market brands such as Carling
      • While the market would likely have rewarded TAP more for increasing the dividend/buyback in this yield starved world, Starbev makes sense for the longer term and, given the scarcity of viable deals which can move the needle for TAP, I do not penalize management for their decision
  • Weak portfolio
    • Bear Take: TAP has a weak portfolio of brands, with Miller’s decline over the past three years offsetting Coor’s improvement. TAP has little exposure to craft beer.
    • My Take: TAP’s brands relative size and the complexity of alcohol distribution in the US and Canada leave TAP with a strong moat.
      • TAP brands might not be hot, new, and exciting, but they have stood the test of time are likely to grow at least modestly in the future
      • TAP’s JV MillerCoors is 33% of US beer sales (admittedly TAP only owns 42% of this JV) and 40% of Canada. Excluding market leader ABI, the next largest US competitor, Crown Imports (STZ), is under 5%.
      • Beer and alcohol sales in the US and Canada are governed by complex regulations that make entry and distribution difficult
      • TAP’s brands have strong pricing power

Catalyst