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Morningstar | Pricing and Cost Savings Help Molson Coors Weather Challenging Industry Dynamics in 2Q

We think narrow-moat Molson Coors' second-quarter results indicate improving top-line trends, as net sales decreased just 0.2%, versus a mid-single-digit decline in the first quarter. While continued weakness in the U.S. and Canada led worldwide brand volumes to fall 2.4%, we were pleased to see volume recovery in the Europe (up 2.9%) and international (up 0.6%) segments. Despite these lower volumes, and subsequently deleveraged manufacturing costs, as well as further cost pressures (freight and aluminum), gross margin expanded 40 basis points to 42.6%. We continue to think the firm will be able to offset these headwinds through its efforts to take pricing (net sales per hectoliter grew 1.9%) and extract costs from its operations, allowing for modest margin expansion longer term. We may reassess our near-term outlook for volumes and margins in the U.S. and Canada, but we don't expect a big change to our $82 fair value estimate. Our outlook for low-single-digit revenue growth and operating margin averaging close to 17%, about a percent above 2017, over our forecast period also remains intact. Shares remain at a double-digit discount to our valuation, even with a 5% uptick after earnings, indicating an attractive entry point for patient investors.

Weak demand in the U.S., which accounts for roughly two thirds of sales, continued to weigh on results, with domestic sales-to-wholesalers volume declining 3.6%, driven by declines in the premium light segment, which includes core brands Coors Light and Miller Lite. However, we largely attribute this performance to industrywide challenges rather than a material shift in the company's competitive positioning, as evidenced by the mid-single-digit volume decline wide-moat AB InBev experienced in the U.S. in its second quarter. In this vein, we estimate domestic beer volumes contracted by 1% in 2017 and that beer's share relative to wine and spirits (based on supplier gross revenue) fell to 46% versus 50% a decade prior.

While we appreciate that U.S. net sales per hectoliter grew 1.6% (excluding the impact of a new revenue recognition accounting standard), we would still prefer to see volumes recover, which would bolster our confidence that the firm's revitalized core brands and innovative new product offerings are resonating with consumer preferences. While our outlook for domestic volume growth remains muted (averaging just 0.5% after 2018), we contend that further pricing improvement coupled with a growing contribution from above premium brands (which contribute around a fifth of sales-to-retailers volume) should allow for low-single-digit annual improvements in revenue per hectoliter over our explicit forecast.