If You Can't Drink 'Em, Buy 'Em - Profit From Products You Can No Longer Enjoy

My alcoholic friend Mike recently stopped drinking. He no longer goes to bars and sticks to soft drinks and juice at social functions. At a recent event I half-jokingly suggested he buy shares in companies that make beer, wine and spirits so that while he no longer drank, he could take solace in the fact that those who still did might actually make him a tiny bit richer. To my surprise, Mike agreed to do just that..

“If I can’t enjoy their products, at least I can enjoy their profits,” he said. Makers of wine, beer and spirits are also fairly resistant to economic downturns, he added.

We agreed that along the same lines, someone who quit smoking could buy shares in tobacco companies, and a former gambling addict might buy casino stocks.

Mike compiled a list of publicly traded brewers, vintners and distillers from all over the world. Once he had a list of candidates, Mike applied discounted cash-flow analysis (DCF) using the weighted average cost of capital (WACC) as the discount rate, then arrived at a terminal value using the Gordon Growth Model. Mike then calculated the discounted cash flow by estimating future annual cash flows, adding them up (including the terminal value), then adjusting them for present value using the WACC. The result was an enterprise value for each of his candidate companies. Mike then subtracted net debt to arrive at a fair equity value, then divided that by the number of shares outstanding to determine a fair equity value per share, and found three companies whose shares were trading below his estimated fair value per share.

Or so he said. Each of Mike’s final three selections looked suspiciously like someone had simply looked at stock charts to pick the best performer in its sector over the past five years. When I pointed this out to Mike, his face turned bright red.

Mike confessed that he initially planned to buy shares in companies that made what had been his favourite drinks, then realized that investing in companies that produce something you like only works if thousands of other consumers eventually develop the same tastes that you have.

Instead, Mike actually did some research, but found no bargains among the shares of the drink makers. Virtually every stock in the industry traded at high multiples to earnings, sales, cash flow or book value per share. Diageo PLC, for example, the giant maker of a variety of spirits whose share price has been essentially flat over the past five years, appears overvalued by standard measures, trading at 24 times earnings per share, 6.8 times price to book value per share and 5.5 times sales per share. (Then again, after an eight-year bull market, any company whose shares still trade at bargain multiples likely has serious problems. If your stock does not look overvalued in 2017, it never will be.)

In the end, Mike settled on the best performers.

Andrew Peller Ltd. (ADW.A/TSX)

Peller, based in Grimsby, Ont., has wineries in British Columbia, Ontario, and Nova Scotia. The Company's premium wine brands include Peller Estates, Trius, Wayne Gretzky, Hillebrand, Thirty Bench, Sandhill, Copper Moon, Calona Vineyards Artist Series VQA wines and Red Rooster, while its cheaper products include Hochtaler, Domaine D'Or, Schloss Laderheim, Royal and Sommet. Peller also makes and sells wine-based liqueurs and cocktails and recently launched a Wayne Gretzky whisky. Along with vineyards, Peller has two import divisions, makes and sells wine making kits and has more than 100 retail locations in Ontario.

Peller is still controlled by the Peller family, which owns most of the class B voting shares.

Peller’s non-voting A shares climbed slowly and steadily until 2015, when the share price started accelerating along with trading volume, and the stock became more volatile. After a particularly strong run-up last summer, shareholders gave the go-ahead for the company to split its shares three for one in October. At a current price of about $11, the shares trade at 22 times earnings of 55 cents per share and three times book value per share. The price to sales per share ratio of 1.42 is relatively low for companies in the beverage alcohol business.

Despite its relatively small size (Peller has a market capitalization of just $478-million) Peller has paid a dividend since 2007, and the company offers a dividend reinvestment plan. The dividend of 16 cents per share yields about 1.4%, giving the stock some appeal for income seekers.

The company’s debt/equity ratio, now at 0.55, has been falling steadily since hitting a high of 1.34 in 2009.

Molson Coors Brewing Co. (TAP/NYSE)

Molson Coors is the result of the merger of Molson and Coors, but the company now owns all of MillerCoors as well.

In October, Molson Coors paid US$12-billion for the remaining 58% of MillerCoors (SABMiller’s stake in the MillerCoors joint venture), making Molson Coors the world’s third-largest brewer and the largest in the United States. The acquisition means Molson Coors now owns all of MillerCoors, which should translate into major cost savings as it achieves larger economies of scale and eliminates duplication. The move also increased Molson Coors debt to an awkward 105.7 times equity, but the efficiencies should help bring the debt down.

The acquisition also means Molson Coors’ Q4 and full year 2016 financials were presented “pro forma” -- as if the deal had taken place at the beginning of 2016. Even so, the company’s worldwide beer sales, net sales and net sales per hectolitre were all down.

For the full year, net income fell 48.9% to US$277.5-million or $1.28 per share, dragged down by a fourth-quarter impairment charge recorded for the Molson brands in Canada, higher U.S. GAAP tax expense, and an indirect tax provision recorded in Europe.

Molson Coors shares have more than doubled over the past five years, and when dividends are included, the total annualized return is a market-beating 18.8%, say figures from longrundata.com. Most of the big gains came before last year, however, as the stock has lagged the major indexes since last fall. The flat share price and equally flat financial results mean Molson Coors trades at just 10.5 times earnings and 1.8 times book value, although its weak global sales is likely behind its relatively high price/sales ratio of 4.2 times. The annual dividend of US$1.64 yields about 1.7%.

Constellation Brands Inc. (STZ/NYSE)

Constellation Brands, based in Victor, N.Y., makes and sell beer, wine and spirits with operations in the United States, Canada, Mexico, New Zealand and Italy. The company’s wine division includes more than 20 U.S. wineries, together with four in New Zealand and five in Italy. Its beer unit imports a variety of Mexican beers, while its Ballast Point craft beers are available in more than 40 different styles. Constellation ages its whisky at its distillery in Lethbridge, Alberta.

Constellation started as Canandaigua Industries in 1945, when founder Marvin Sands and eight employees started selling bulk wine to bottlers. In its first year, Canandaigua sold about 200,000 gallons of wine with gross sales of $150,000.

Over the past five years, Constellation’s sales, cash flow and earnings have grown steadily. The company earned US$1.055 billion ($5.18 per share) on sales of $7.224-billion in fiscal 2016.

Constellation’s shares have rewarded investors handsomely, climbing nearly sixfold since 2012. Although the company paid no dividend until 2015, figures from longrundata.com show that if the dividend was reinvested, an investor who bought in 2012 would have enjoyed an annualized return of 47.55%, and an initial $1,000 investment made then would now be worth more than US$7,000. At about US$160, the shares now trade at a lofty 26.3 times earnings, and nearly five times sales per share and book value per share. The annual dividend of US$1.60 yields less than 1%.

Along with shares of beverage alcohol makers, investors can buy the actual product itself in hopes it increases in value. Over the years there have been a few dozen dusty old bottles of vintage wines that have been auctioned off for six-figure prices. There are major risks, however. You might drop the bottle, or someone might find an identical one in a wine cellar beneath a castle somewhere. As well, only a handful of collectors in the world have the interest and the money to buy such wines, making the market for vintage wines somewhat, er, illiquid.

A better bet would be to walk into the Liquor Control Board of Ontario (LCBO) outlet in mid-town Toronto and ask to see their 700ml bottle of Bowmore 50-year-old single malt. The single bottle the LCBO says it has was distilled in 1961 at Morrison Bowmore in Glasgow, then aged for 50 years in a pair of relatively small wooden casks. A total of only 50 bottles are released every year. The price: $35,000, plus tax.

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca