Household budgets may be under strain, but nobody seems to be pinching pennies in the craft beer aisle of the supermarket.
The high-end specialty brews saw year over year (yoy) volume gains of 13% through November 2007, while beer shipments overall varied between 1-2% according to late-December estimates. Frothy times in the craft sector may merit a round of toasts for Boston Beer Company (NYSE:SAM), brewers of the Sam Adams line of beers and ales. The challenges in the year ahead are many, however, as the company brings new capacity on board from a Pennsylvania brewery it is acquiring from Diageo PLC (NYSE:DEO). In addition, rising agricultural costs will continue putting pressure on margins. (To read more about the grain market, check out Grow Your Finances In The Grain Markets.)
Recipe for Success
The high-end beer market, long the province of established imported brands like Heineken and Beck's, got a local makeover in 1985 when Boston Beer founder Jim Koch debuted his great-great grandfather's recipe for hand-crafted beer at a Patriots' Day event in Boston.
The craft sector is small by comparison with the total U.S. beer market though, and sector leader Boston Beer still accounts for only about 1% of the total U.S. market, according to the company's website. But, continued craft sector growth could eat into the success of high-end foreign beers. International brands are a critical strategic platform for the large U.S. domestic brewers. For example market leader Anheuser-Busch (NYSE:BUD) has a 50% equity interest in Mexico's Grupo Modelo, a 27% stake in China's Tsingtao and a strategic alliance with many well-known foreign brands like Grolsch, Stella Artois and Kirin. If one six-pack more of Sam Adams Pale Ale means one six-pack less of Grolsch Blonde, it could spell trouble for the erstwhile King of Beers.
The stock market may be in a tailspin but commodities are a different story. The Lehman Brothers Agricultural Commodities Index is up about 6% year to date, meaning that the prices of hops, barley and other basic brewing inputs continue putting pressure on the beermakers' cost structures. High input costs may particularly impact smaller producers lacking sufficient size for economies of scale. Boston Beer may have an edge on other craft brewers but still could find itself under pressure relative to the larger domestic producers. For the third quarter in 2007, the company's gross margin fell to 51.2% from 57.3%, a meaningful deterioration in large part due to higher ingredients and packaging costs.
Pennsylvania Plant Key to 2008 Strategy
Boston Beer currently plans to open the Lehigh Valley, PA plant it is acquiring from Diageo in June this year and estimates it will add 1.4 million barrels of brewing capacity to the firm's existing plants in Boston and Cincinnati, OH. The company estimates plant-related capital expenditures in the area of $50-110 million over the next several years in addition to the $55 million purchase price. This will put additional pressure on the bottom line for 2008, while potential gains from operational efficiencies will depend on the company's ability to complete the acquisition, and necessary restructurings, and to bring new production on-line in accordance with the current summer 2008 target.
Boston Beer faces near-term challenges from a difficult cost environment and the need to get its new plant operational in a timely manner. As the volume leader in the most attractive sector of the U.S. beer market, though, I think the makers of Sam Adams stand a better than average chance of providing investors with some good cheer in the months to come.