While the market continues to shrug off the obvious implication of higher commodity costs on corporate profitability, we remain very cautious and skeptical that the current rally in 2011 has legs. Corporate profitability has recovered to the peak levels of 2007 and the current forward view of the market does not factor in margin decline from the ongoing surge in inflation.
Looking at the beverage industry specifically, the consensus call is for increased beverage industry profits in 2011, despite elevated input costs. Additional broader headwinds include weak consumer confidence and tepid job creation numbers. It also seems clear that the consensus believes that the consumer will absorbed increased prices, while companies are planning to focus on manufacturing cost controls, which are designed leave operating margins unharmed during 2011. We have reason to be skeptical that this scenario will play out as planned.
The first real “data points” will be coming from the annual Consumer Analyst Group of New York (CAGNY) meeting on Feb. 21-25.
Consistent with the overall theme of elevated expectations, SAM looks vulnerable. While alcohol sales remain relatively resilient through economic cycles, SAM seems like a prime example of how to play U.S. Stagflation. This will become more visible as we move progress in 2011. In the short run beer volume in 4Q10 look strong. According to IRI data, domestic beer and spirits sales were tracking about 2% higher in 4Q10 year-over-year.
Boston Beer is a company that fits our profile for a consumer short idea; revenue slowing, costs rising, and unpredictability surrounding operations and the competitive landscape in 2011. SAM is currently a short idea in the Hedgeye Virtual Portfolio for all of these reasons. Below I show four charts detailing the lay of the land for SAM from a top line and margin perspective.
Revenue growth is a concern for Boston Beer looking into the next few quarters and it will be interesting to learn, when the company next reports on March 9th, of the company’s progress on driving sales and competing against a rapidly growing number of competitors. On the last earnings call of November 4th, management warned that initiatives being taken to “further address the increasing competitive activity and to grow our brands…it is possible that these decisions might result in slower earnings growth in 2011 as we forsake earnings in the short term in order to build our organizational capabilities and support our brands at appropriate levels.”
In the first three quarters of 2010, SAM experienced year-over-year depletion growth of 14%, 13% and 7%, respectively.
Looking at the chart below, detailing revenue growth, it is clear that even without the aforementioned initiatives slowing growth, difficult comps may be difficult to hurdle as the company moves through 2011.
Probably the most concerning aspect of the outlook for SAM is in their costs. In November, management stated that they would provide an update with full year results in the middle of Q1 but, even then, won’t “have a really good view as to all the costs and benefits and trade-offs”. While management anticipates full-year revenue per barrel increases of approximately 1% through minor price optimizations, it is clear that from an earnings standpoint, there is likely a considerable amount of pressure coming down the tracks. This is illustrated below in a chart of SAM EBIT margin versus an Enhanced Grain and Oilseed Index.
On a year-over-year basis, it is clear that the melt up in grain prices is not good news for SAM’s margins and, while implementing the new sales initiatives may grow market share (or at least preserve it), the unfavorable impact on margins may be occurring at an inopportune time, as the chart above shows. Margins seem ripe for a correction.
As we can see from the chart below, over the last number of months, sentiment has not been very negative on the stock. Per Bloomberg, there are only five analysts offering ratings on the name.