The Risk of Small Beer Investing

Up until 2005 or so, investing in regional brewers was a stodgy way to build wealth. The investors would get a 2% dividend, 2-3% or so annual sales growth, and 2-3% annual price increases. By investing in the alcoholic brands that were cherished in your state, you would get 6-8% annual returns. Plus, given the industry’s history of mergers and consolidation, you would have the possibility of owning an acquired company and capturing a one-time 30% to 50% premium.

From about 1960 through 2005, the common risk for niche brew investors was that the brand would try to expand beyond its core market and customers wouldn’t have the same affinity in the new location (because it usually requires extensive advertising or marketing as a part of a brand roll-up to develop market share).

So, if a beer brand was thriving in Milwaukee, there would no guarantee that the brand could expand successfully into Oklahoma. If the company’s executives did try to grow into a new area, and didn’t develop the necessary advertising budget, there would be a debt/cash-flow issue. As debt got taken on to grow production, add new facilities, and expand into a new state, disappointing sales would stress the cash flows from the established locations as they would have to service the bungled expansion efforts.

Nowadays, the risk with small beer investing is that the brands themselves are not holding up well as the rise of new craft beer brands not only steals market share from the Anheuser-Busch’s and Miller’s of the industry, but also the entrenched regional players.

The data point that supports this contention is the fact that, of breweries that sell less than 100,000 barrels of alcohol per year and have been in existence for at least 25 years, only 32% of them have higher volumes today than in 2007. The rest are either selling less beer or have gone out of business.

Most attention from alcohol analysts have focused on the volume losses from Bud Light or Miller Lite. People are consuming about 5% of it less than they did last year, and about 13% less than they did in 2006. That is of course relevant.

But regional brewers are not in as strong of a position to absorb these hits, and their brands aren’t competing well against the onslaught of new craft beer entrants in the marketplace and lower prices from the industry giants that are trying to win back customers.

Every business hopes that money spent on advertising will have both a short-term and long-term impact. If you advertise in 2017, you will catch a potential customer’s attention, he will give it a try, and then he will continue purchasing your product in 2018, 2019, and 2020 even if you stop advertising. This “long tail” model is what regional brewers relied on—you would try a beer that got produced locally, and become a loyal customer.

But now, there are other craft brands that are also produced locally and providing more aggressive near-term advertising.

I suspect it will be difficult for many regional beer brands to grow their revenues absent a very strong and sustained commitment to advertising. This does not mean that you should not invest in regional breweries. Some of them are valued in the 10-14x earnings range and carry surprisingly low debt loads. That could very well prove to be a price point that could support strong investment returns.

But I do think that modest revenue gains can no longer be treated as an assumption from this niche of the marketplace. Even 2-3% sales gains will need to be fought for. The profit margins for many alcohol companies remain enticingly high in the 10-28% range.

Selling 25,000 barrels of alcohol, and earning a nice profit on it, is a different question from getting that 25,000 barrels in sales up to 50,000 barrels in sales.

I suspect that you will see a lot of beer advertising from regional brands (e.g. not Miller or Anheuser-Busch) in the coming years, as that will be a necessary condition to drive sales growth. I also suspect that, of the companies that don’t choose to advertise heavily, you will actually see volume declines and perhaps even buyouts from the likes of Anheuser-Busch for a lower premium than you’d historically expect.

The baseline for regional brewers of 2-3% annual growth without advertising or reinvestment no longer exists. If you consider regional brew stocks, I would insist upon a lower than historical multiple and I would only prioritize those businesses with robust advertising budgets and perhaps even minimal debt burdens as well. This may always be good investment practice, but the consequences of not heeding it will be worse than it used to be.