Initiation of Coverage
Gage Roads Brewing Co. Ltd. (GRB) is the only craft brewer listed on the ASX with operations based in WA. GRB recently won a tender allowing them exclusive pouring rights to supply beer to the new Optus (Perth) Stadium. This deal will provide a marketing platform which should assist GRB with its five-year strategy of increasing volumes of its higher margin craft-brewed products while stepping down production of its lower margin contract brewed beer. The shift in production profile should see a lift in margins and translate into strong earnings growth over the next few years. We believe that GRB is well placed to take advantage of the growing craft beer market. We place a Speculative Buy recommendation on GRB with a price target of $0.12 per share.
Optus (Perth) Stadium tender win provides leverage to grow craft brand: We believe that the tender win, which allows exclusive pouring rights, will be key in driving brand recognition and will essentially provide free marketing for their products to millions of people each year. The win will provide leverage for GRB to tap into new retail distribution channels and will assist with securing more tap points at bars and clubs across the country. It will also allow them to potentially win further partnership deals at events further assisting brand enhancement, important to the successful execution of their “Returning to craft strategy”.
Returning to Craft Strategy to drive a shift in earnings: In 2016 GRB announced a change in strategy which will effectively see a shift in sales mix away from the lower margin contract brewing operations and will focus on converting the 11m litres of volume into their higher margin, proprietary craft brands. GRB’s gross margins were 52% in FY16 and they are targeting 70% by FY21. If achieved, this could see EBITDA per litre moving from $0.23 to $1.00.
Craft beer continues to grow in popularity: Consumers are becoming more health conscious which has seen changing taste preferences and a move away from the high volume mainstream beer market towards more premium beers and craft, preferring quality over quantity. Over the past five years revenue in the sector has grown at an annual average rate of 9.7% and is expected to continue to grow over the next five years at an annual pace of 6%, compared to only 2.1% for the wider beer manufacturing industry, according to IBISWorld.
$25m in capex spent with plenty of spare capacity available: Since 2010 GRB has spent a significant amount on state-of-the-art brewing equipment and is currently producing around 11m litres p.a. out of the maximum plant capacity of 17.4m litres p.a. available.
Strong balance sheet with no debt and $5.6m in cash: In 2016 GRB raised $10.1m which allowed GRB to strengthen its balance sheet by retiring $4.7m in debt. GRB has $5.6m in cash and a $6m undrawn debt facility.
Potential takeover target in time: In 2016 GRB bought back a 23.5% stake held by Woolworths (WOW) which removed a potential blocking stake and allowed them to regain their independent brewer status. M&A activity in the craft beer segment in Australia has been increasing as large brewers looked to acquire smaller companies to ensure they can participate in the growing craft segment. However, GRB will need to increase the proportion of its craft brewed products before a major would likely look to acquire a stake in GRB with WOW still being a major customer.
Recommendation: We initiate coverage on GRB with a Speculative Buy recommendation and a valuation of $0.12 per share.
This Research Report, expresses the personal view of the Author. DJ Carmichael Pty Limited, including authors of this report, its directors and employees advise that at the time of publication they hold or may become entitled to securities of the issued capital of the company and/or earn brokerage and other benefits or advantages, either directly or indirectly from client transactions in stocks mentioned in this report.
The analyst does not hold securities in Gage Roads Brewing Co. Limited.
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SPECULATIVE BUY – Potential 10% or more outperformance, high risk
BUY – Potential 10% or more outperformance
HOLD – Potential 10% underperformance to 10% over performance
SELL – Potential 10% or more underperformance
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