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 (TAP) as a good example. The owner of brands such as Coors, Miller and Carling has seen its stock price slump nearly 40% over the past two years. 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 $10b versus a profit machine churning out around $1.25b 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 1.2m hectoliters less beer than it did in the equivalent period in 2017.
Ordinarily, I’d get concerned at net debt stretching toward 10x annual profit – 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 recall back in 2016 Anheuser-Busch InBev gobbled up SABMiller in a mega-deal worth $110b. 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 that 58% stake was essentially a necessary condition for 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 $10b net debt load. Let’s call that $350m 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.
Free Cash Flow
The good news is that surplus cash is substantial. Annual shareholder dividends, for instance, only take up somewhere in the region of $350m to $360m. That leaves the company with post-dividend free cash flow of around $1.1b as a starting point. Suffice to say that is 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 – that has to stand out as an attractive proposition.
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