Perhaps it speaks to the strength of this nine-year bull market that I get excited whenever a good quality consumer stock trades below 15x earnings. Take brewing giant Molson Coors as a good example. Over the past two years the owner of brands such as Coors, Miller and Carling has seen its stock price slump nearly 40%. It owns a bunch of top brands, has not suffered a big hit to its business and yet throws off a 7.25% earnings yield.
The downsides, in so far as there are any, are that it has a rather stretched balance sheet and low growth prospects. In terms of the former we are looking at net debt of around $10 billion versus a profit machine churning out around $1.25 billion per annum. As for the latter, volume growth is rather sluggish to say the least. In the six months ended June 2018, for example, the company sold 1.2 million hectoliters less beer than it did in the equivalent period in 2017.
Ordinarily I’d get concerned at net debt stretching toward 10x annual profits. Even more so if we were looking at cash spent on stock buybacks or aggressive dividend hikes. In the case of Molson Coors, however, the story is a bit more nuanced.
You may remember that back in 2016 Anheuser-Busch InBev gobbled up SABMiller in a mega deal worth around $110 billion. Prior to this, SABMiller had a joint venture in the United States with Molson Coors in the form of MillerCoors. The former owned 58% of the business – which owned brands such as Coors Light – with Molson Coors owning the remainder. Offloading the 58% of this venture was essentially a necessary condition for competition regulators to wave through SABMiller’s merger with Anheuser-Busch. Molson Coors was the obvious destination for that asset given its starting 42% ownership stake.
The short version: an opportunity arose which the company duly took. The upshot is that Molson Coors is now a larger company with more clout in the global beer industry. Not only that, but the valuation is such that growth becomes less of an issue. For instance just consider the cost savings attributed to paying down debt. As it stands the company pays annual interest of around 3.5% on its $10 billion net debt load. Let’s call that $350 million in total interest expenses for fiscal year 2018. That alone is worth something like 20% of the current level of annual free cash flow generation.
The good news is that surplus cash is substantial. Annual shareholder dividends, for instance, only take up somewhere in the region of $350 million to $360 million. All-in-all that leaves the company with post-dividend free cash flow of around $1.1 billion as a starting point; enough to make serious progress on debt reduction.
The cost savings arising from deploying that cash to reduce debt then become significant for two reasons. First of all organic growth is hardly set to be exciting given the industry the company operates in. Realistically what can we expect from a multi-billion dollar global beer company? Maybe mid-single digits per annum? We can get a chunk of that just by using surplus cash to pay off debt.
Secondly, look at how low the starting valuation is, relatively speaking. As it stands Molson Coors stock offers an earnings yield of around 7.25%. How many large-cap consumer defensives are trading at that kind valuation? I mean you can basically map a very realistic route to double digit annual returns solely from its internal cashflow and starting valuation. Given the nature of the business – i.e. defensive, cash generative, stable – I think that has to stand out as an attractive proposition.