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Morningstar | Weak Domestic Volumes Drag on Molson Coors' Full-Year Results; Shares Undervalued

Narrow-moat Molson Coors posted weak top-line performance in the fourth quarter (declining 5%) that led full-year sales to fall short of our estimates, down 2% versus our roughly flat expectation. However, the firm's cost-saving initiatives, coupled with solid pricing (with net sales per hectoliter increasing 0.9% on a financial-volume basis), helped it withstand ongoing input cost inflation, with full-year adjusted EBITDA margin holding steady around 23%, comparable to our expectation. The firm also disclosed that it will be restating its financial statements for fiscal 2016 and 2017 because of errors in the tax accounting, with an understated deferred tax liability, for MillerCoors. We anticipate lowering our near-term sales expectations in light of ongoing softness in the domestic beer landscape, which should trim our $78 fair value estimate by a mid-single-digit percentage. However, we're holding the line on our longer-term outlook, which calls for roughly 1% sales growth and above 16% operating margin on average over our forecast. We continue to view shares as attractive, even at our revised valuation, given a 9% decline on the announcement.

In the U.S. (67% of sales), a 5% decline in annual volumes exceeded our expectations for a low-single-digit decline, as industrywide volumes continue to stagnate. Domestic beer volumes have remained roughly flat over the last decade, and premiumization trends have led above-premium (craft and imported) offerings to take share from more value-priced formats. Molson Coors has not been immune from this trend, as its premium light and economy volumes continue to falter. However, we're encouraged that Miller Lite gained share of the U.S. premium light segment (for the 17th consecutive quarter) and that net sales per hectoliter increased nearly 2%, an uptick from the 1% increase the year prior. In our view, this suggests that the brand intangible assets that underpin Molson Coors' competitive edge remain intact.

We expect U.S. pricing to remain solid longer term, averaging a low-single-digit increase over our forecast, as Molson Coors bolsters its investments in its above premium portfolio, which we estimate accounts for just over a fifth of its sales. Its plans include doubling its media spending on Blue Moon, expanding its reach in the hard seltzer category, and launching product innovations and line extensions within several of its brands. We view this as a prudent strategy, as we expect more premium offerings to remain a key driver of industry growth. Further, by innovating within its portfolio to develop products that better align with consumer tastes, we think the firm will be able to reinforce its entrenched relationships with wholesalers and on-premises establishments (which we believe smaller craft players would struggle to replicate) and enhance its distribution footprint.

From a capital allocation standpoint, we appreciate the progress the firm has made in deleveraging its balance sheet. We estimate net debt/adjusted EBITDA now stands just above 3.8 times, versus more than 4 times in 2017. After it meets its target leverage ratio of 3.75 times (expected by the middle of 2019), it plans to restore a dividend payout ratio of 20%-25% annual trailing underlying EBITDA. In this context, we're holding steady on our outlook for high-single-digit dividend growth on average over our forecast and note the firm's more than 2% dividend yield stands to enhance shareholder returns.