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Molson Coors: Cheap But Not Cheap Enough

- By Rupert Hargreaves

Global brewing giant Molson Coors Brewing Company (TAP) has recently attracted my attention as a cheap stock. This business has many of the traits I look for in an attractive investment.

For a start, it has fallen on hard times and is trading at a relatively cheap valuation compared to its history. For example, the stock is trading at a forward price-earnings ratio of 11.7 and a price-book ratio of just under 1. These compare to is five-year averages of 23.9 for forward price-earnings ratio and 1.7 for price-book ratio.


These figures are attractive, but what I am really interested in is Coors' free cash flow. Tracey Joubert, the group's chief financial officer, told investors on the company's fourth quarter 2018 earnings conference call:


"We expect our International business to deliver a strong double-digit percentage increase to underlying EBITDA in constant currency for the full year 2019. We estimate our underlying free cash flow of $1.4 billion, plus or minus 10% this year."



With a market capitalization of $13 billion at the time of writing, this estimate implies the stock is trading at a free cash flow yield of 11.8% at the high end and 9.7% at the low end with a midpoint of 10.8% at the time of writing. Generally speaking, a company that offers a free cash flow yield in excess of 10% is excellent value.

Why so cheap?

The question is, why is Molson Coors so cheap? This company owns some of the most dominant beer brands in the world and recently (2016) completed an acquisition that almost doubled its sales and has led to substantial margin growth (the operating margin has increased to 12.8% for 2017 from 5.8% in 2016).

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But the deal to acquire the remaining 58% of MillerCoors in 2016 landed the business with a lot of debt. Around $10 billion to be exact. The company's impressive cash generation is helping management chip away at this pile.

According to the fourth-quarter conference call:


"We remain committed to our plan to reinstitute a dividend payout ratio in the range of 20% to 25% of annual trailing underlying EBITDA upon achieving around 3.75 leverage, which we expect to occur around the middle of 2019."



So, the debt is a red flag, but the group seems to have a handle on it at the moment.

Growth concerns

Debt isn't the only reason I think the market has been selling Coors. Compared to its larger peer Anheuser Busch InBev, which incidentally has much more debt (over $100 billion), it is nowhere near as efficient.

Last year, Inbev's operating profit margin was 31.8% more than double that of Coors. Inbev is also growing faster. Last year Coors' sales fell between 2% and 3%, a decline management and Wall Street analysts have attributed to the booming craft beer market.

Inbev isn't suffering from the same craft beer headwind. Last year this company reported overall revenue growth of 4.8% "driven by global premiumization and revenue management initiatives." Inbev is growing faster because it has more diversification around the world. Around four-fifths of Coors' sales come from the U.S. and Canada. In the U.S. alone, there was a 20% increase in the total number of breweries operating last year, all of which are chipping away at Coors' market dominance.

Then there is the company's recent admission that it will have to restate its 2016 and 2017 accounts due to the misstatement of its deferred tax liability. That's not a good look and does not inspire confidence in the company.

Not cheap enough

All of these headwinds are buffeting the business, but as Benjamin Graham once said, there are no bad assets, just bad prices. So what does the company's price tell us?

Well, using a discount cash flow calculation and assuming the company generates a base case $1.4 billion of free cash flow in 2019, with no growth for the next five years (I think this is probably quite an optimistic forecast considering the fact that sales are declining) and a discount rate of 10% (once again this is high but not unrealistic considering the uncertainty surrounding Coors' outlook), I calculate its intrinsic value somewhere between $60 and $65 per share, compared to the current share price of $60. Overall, the company could be undervalued, but not enough to be attractive to me.

Disclosure: The author owns shares in Anheuser-Busch InBev.

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This article first appeared on GuruFocus.