EUR 850.00 For Business Accounts Only

Morningstar | Boston Beer's Top-Line Accelerates in 3Q, but We Expect Growth to Slow Longer Term; Shares Rich

Narrow-moat Boston Beer's top line continued to accelerate in the third quarter, with sales growing an impressive 24% over the year prior, driven almost entirely by an increase in shipments. Depletions grew 18% (versus an 8% increase in the first quarter and 12% increase in the second quarter), and management raised its full-year outlook for depletions to 12%-15% (7%-12% prior). From our vantage point, these results reflect that the firm's efforts to reinvigorate its portfolio and develop products that better align with consumer tastes are continuing to a prop up demand. However, we don't expect this level of volume expansion to prove sustainable as the craft beer category matures (with overall craft volumes up just 5% in 2017, below the low-double-digit growth averaged over the decade prior). As a result, we aren't expecting a material change to our longer-term revenue forecast, which incorporates a deceleration to mid-single digit growth over the next decade (in line with our outlook for the overall craft category).

This robust top-line growth was partly offset by margin contraction, with gross margin falling 200 basis points to 51% (management accordingly lowered its full-year outlook to 50% to 52%, from 51% to 53% prior and against our 53% outlook) as manufacturing costs rose (driven by higher use of third-party breweries increased to meet demand). We plan to adjust our near-term outlook to incorporate further near-term volume expansion, which should be partly offset by gross margin contraction over the next couple of years and elevated capital expenditures in 2019, which should lift our $189 fair value estimate by a high-single-digit percentage. However, even with this revision we view shares to be substantially overvalued, particularly given a mid-single-digit uptick in after-hours trading, and suggest investors await a more favorable entry point.

Depletions growth continued to be driven by brands like Truly Spiked & Sparkling, Twisted Tea, and Angry Orchard, rather than the firm's core Samuel Adams franchise. While we were pleased to see Samuel Adams' seasonal offerings return to growth (and posit this fare may attract consumers to other offerings within the brand family), we contend Boston Beer will need to maintain substantial investments behind its brands (in the form of advertising and product innovation) to restore growth within its flagship brand. In this context, advertising, promotional, and selling expenses grew 38%, as Boston Beer ramped up its brand investments and supply chain expenses (particularly for packaging and transportation) remained elevated, leading operating margin to contract to 15%, from nearly 21% in the prior year. We surmise the firm's ongoing efforts to extract costs from its operations and adjust its supply chain to meet elevated demand (including at least $100 million in capital spending planned for 2019) should help profitability expand longer term. We model average operating margin around 15% over the next five years, comparable to its five-year historical average.

For further detail on why we believe the market to be overly optimistic about the firm's top-line potential in a maturing craft beer category, please refer to our September report, "Boston Beer's Improving Prospects Don't Justify Frothy Valuation."