Molson Coors: Still Subdued

by The Compound Investor

I figure it is time for a periodic check-in on Molson Coors (TAP). The brewer has had a tough year, which is oddly not something you can currently say about the wider stock market. Corporate earnings and the economy may have tanked, but the S&P 500 is actually up year-to-date. Meanwhile, poor old Molson continues to languish in the $38 per share region. That is pretty much unchanged on when I last covered the name, and not much higher than its 2020 low.

With the above in mind, it would not surprise me if a lot folks had given up on this one. The stock is now down roughly 30% year-to-date, and circa 60% from its highs back in the later part of FY16 (excluding dividends). Suffice to say, it has been an incredibly disappointing performer in recent times.

The COVID-19 pandemic obviously explains part of that story, but not all of it. One area worth highlighting is the extent to which the valuation has been crushed here. For instance, four years ago Molson Coors’ enterprise value came in at roughly 14x annual EBITDA. That ratio has been pretty much cut in half as things currently stand.

Quarterly Results

Anyway, on to recent financial results. Molson posted its 2Q20 numbers at the back end of last month, and they came in much better than expected. The brewer sold 21.475m hectoliters of beer in the second quarter, down around 3m hectoliters on the equivalent period last year. The disruption to on-premise activity as a result of the pandemic obviously explains most of that drop. In Europe, where the on-trade takes a bigger slice of the pie than in North America, volume fell by over 20%.

(Source: Molson Coors 2Q20 Investor Presentation)

As a result of the above, company-wide revenue declined by just over 14% after stripping out foreign exchange effects. Somewhat counter-intuitively, profit actually rose at the same time. The firm posted underlying EBITDA of $692m, with underlying net profit clocking in at $337m; both figures were a couple of percentage points higher than last year. That came in large part as a result of temporary mega-cuts to things like marketing. The company spent around $1,200m on marketing and advertising activity last year as per its most recent 10-K. Though you wouldn’t normally like to see cuts here in a consumer company, the rather unique nature of a pandemic changes that. The marketing budget will return swiftly in the second half of the year.

Anyway, the company generated around $700m worth of surplus cash in the first half of the year. The dividend suspension in May means that mostly ended up reducing leverage, with net debt standing at around the $7,900m mark at the end of 1H20. I make that equivalent to around 3.4x last year’s EBITDA. Management declined to give guidance for the rest of year, which is hardly surprising.

Investment Case

I do not see that much has changed in regards to the investment case here. The stock remains incredibly cheap in my view, though as mentioned in the introduction it had its issues before COVID-19. The two headwinds most often mentioned are debt and non-existent growth. In terms of the latter, the firm posted underlying EBITDA of $2,500m back in FY17. That had dropped to $2,364m as of last year.

The debt issue manifests itself in a couple of forms. First and foremost, it ties up surplus cash while it is paid down. The company has spent a grand total of around $3,500m on debt reduction following its buyout of the MillerCoors joint venture in 2016. It has generated much more than that by way of free cash flow, but that is beside the point. Ideally that cash would be better spent on higher returning endeavors – investing in its brands to stabilize sales; expanding its business; funding stock buybacks, and so on.

The second reason relates to the stock’s valuation. Put simply, debt-adjusted valuation metrics are not as attractive as the headline earnings multiple suggests. That said, I still think it is pretty cheap on that score too. The firm’s current $16,100m enterprise value is worth around 7x last year’s EBITDA figure quoted above.

As I set out in the last piece, Molson now has room to reward new shareholders simply via longer-term debt reduction. Molson can reduce net debt by circa $500m per annum while paying out a 3.6% dividend based on the current share price. That can support double-digit annual shareholder returns, even under pretty conservative assumptions regarding valuation and profitability.

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