Tuesday, May 09, 2006
Is Redhook Ale skunky beer?
Would you buy a dollar for 50 cents? How about a brewery on sale for liquidation prices?
Redhook Ale Brewery (HOOK) makes beer, and good beer at that. Their most popular brews include their own Redhook ESB and India Pale Ale as well as Widmer Hefeweizen (a contract brew for Widmer Brothers).
Yet, great products don't always make great companies. For the last five years, HOOK has been stuck in the proverbial 1st (more accurately, reverse) gear while earning net profit margins of negative 3-5% and experiencing a 4% annual sales dollar decline. HOOK's lackluster financial performance has coincided with an almost 90% cumulative decline in share price since it peaked in the late 90s. Has this been warranted?
Maybe, maybe not. While there are a number of explanations for sales decline and profit performance (sales team restructurings, new distributor agreements, brewing capacity utilization), I'd like to fast-forward to the valuation. I'll let you do your own reading of the company's 10K -- I've already done mine.
At a first glance, Yahoo says that HOOK is currently trading at ~50% of book value. In other words, you or I could buy $60M worth of assets for $30M. I often like to take a closer look at the balance sheet to see what's really under the hood. Below, I've detailed how I would estimate the reproduction cost of the assets.
I see no reason to adjust the current accounts and the only adjustment for fixed assets is to take into account the land appreciation of the Washington facility. Assuming 4% annual appreciation (covers inflation and minimal asset value increases), I estimate BV at $73,5M or $9 per share.
I think stocks trading at a discount to reproduction cost are great finds; however, I need more to go on before buying. I like to identify two supporting data points:
- What would an industrial buyer pay for similar assets?
- What could be a catalyst for the stock to converge on BV?
Given BUD's economic interest in HOOK, I feel pretty comfortable with my an $8-9 intrinsic value estimate for HOOK shares. Now, what could catch Mr. Market's attention to realize that price?
If HOOK could just muster up some profitability, I think investors would reward the stock. And, I think Management is working towards this goal. Since 2001, EBITDA margins have improved 300 basis points to 6,8% and HOOK turned free cash flow breakeven-to-positive in 2005.
Management has offloaded most sales & marketing responsibilities (while conceding gross margin) through the use of distributors (e.g. BUD, Craft Brands) and seems to be improving plant utilization through contract brewing agreements (e.g. Widmer Brothers). Those actions have reduced COGS / unit and improved EBITDA margins. In addition, they re-launched the brand in 2005 and preliminary results are positive.
To summarize:
- HOOK is cheap, really cheap.
- Budweiser, the King of Beers, thinks HOOK is worth $8 a share.
- Profits are improving, albeit slowly.
RMA
# posted by RMA @ 13:14 
Comments:
<< Home
Really like your content here, and find it to be pretty interesting analysis. Because you've valued Redhook (rightfully) based on assets, however, you need to look beyond book value and into liquidation value (though you did this somewhat). Essentially, a more rational marking of book value to market is warranted here. In example, your assumption of 50% fixed assets being land is overly generous - their 10K pegs the actual portion of land as total fixed assets as ~5%. Moreover, it shows that 90-95% of the fixed assets are tied up as buildings and production equipment, both of which 'trade' in incredibly illiquid markets (e.g. even a 50% liquidity discount may be too generous). Finally, as an FYI the Budweiser "valuation" was not actually a value estimate put together by Bud, but rather an estimate based on book value that Redhook assigned itself for the purposes of recording the transaction on its books. Still, I do like your writing style and enjoy coming across this kind of material.
# posted by 
: 7:32 PM
: 7:32 PM 
Anonymous,
Thank you for commenting... your feedback is exactly the reason I decided to author a blog. It provides a sounding board from which I can continually improve my approach.
1 - My reproduction cost adjsutment for Land & Buildings is 50% of Land & Buildings accounts (excludes machinery and all other PP&E) multiplied by (1 + 4%)^13. I believe the other facilities are leased. I've chosen a simpler, more naive approach to the valuation and would agree that a more detailed estimate would be more accurate.
2 - I became comfortable with the 50% liquidation value after speaking with the HOOK IR department to understand the rationale behind the recent contract brewing agreements. Apparently, the Widmer brewery in the Northwest is at capacity, suggesting that there could be a buyer for HOOK brewing capacity should the need arise.
3 - As for the BUD equity exchange, I took a bit of a leap of faith.
HOOK IR informed me that it was more than just an accounting adjustment; however, they couldn't confirm that it was the result of a value estimation as I've described it. I intrepreted it as such for the following reasons:
a) HOOK made a $2M cash payment to BUD (by request of BUD) outside of any contractual obligation.
b) BUD had the option to request that HOOK buy the stock back (though unlikely given historical cash flow).
c) The stock was exchanged as part of the expiration of the previous distribution agreement between HOOK and BUD. The liquidity of common stock must have some value to BUD.
d) Since the exchange, BUD has not decreased it's position.
Thank you for spending the time to comment. I have not followed HOOK very long (1 - 2 weeks) and there are surely specific issues that I have not fully understood.
À vous...
RMA
Post a Comment
Thank you for commenting... your feedback is exactly the reason I decided to author a blog. It provides a sounding board from which I can continually improve my approach.
1 - My reproduction cost adjsutment for Land & Buildings is 50% of Land & Buildings accounts (excludes machinery and all other PP&E) multiplied by (1 + 4%)^13. I believe the other facilities are leased. I've chosen a simpler, more naive approach to the valuation and would agree that a more detailed estimate would be more accurate.
2 - I became comfortable with the 50% liquidation value after speaking with the HOOK IR department to understand the rationale behind the recent contract brewing agreements. Apparently, the Widmer brewery in the Northwest is at capacity, suggesting that there could be a buyer for HOOK brewing capacity should the need arise.
3 - As for the BUD equity exchange, I took a bit of a leap of faith.
HOOK IR informed me that it was more than just an accounting adjustment; however, they couldn't confirm that it was the result of a value estimation as I've described it. I intrepreted it as such for the following reasons:
a) HOOK made a $2M cash payment to BUD (by request of BUD) outside of any contractual obligation.
b) BUD had the option to request that HOOK buy the stock back (though unlikely given historical cash flow).
c) The stock was exchanged as part of the expiration of the previous distribution agreement between HOOK and BUD. The liquidity of common stock must have some value to BUD.
d) Since the exchange, BUD has not decreased it's position.
Thank you for spending the time to comment. I have not followed HOOK very long (1 - 2 weeks) and there are surely specific issues that I have not fully understood.
À vous...
RMA
<< Home
