Molson Coors Canada Inc, $51 – Toronto symbol TPX.A

MOLSON COORS CANADA INC. (Toronto symbols TPX.A $78 and TPX.B $81; Conservative Growth Portfolio, Consumer sector; SI Rating: Average) is a wholly owned subsidiary of Molson Coors Brewing Company (New York symbol TAP), which was formed in February 2005 through the merger of Molson Inc. and Adolph Coors Co. Its exchangeable shares are equivalent to common shares of the parent company. The families of the two founding companies control roughly 79% of the votes.

Molson Coors is the world’s fifth-largest brewer by volume. Major brands include Molson Canadian, Coors Light and Carling. It sells its products in four of the world’s top eight beer markets: North America, Europe, Latin America and Asia.

The main reason for the merger was economies of scale in an increasingly competitive industry. The new company set a goal to cut its annual costs by $175 million in the first three years (all amounts except share price in U.S. dollars). In 2005, it realized $59 million in savings, which exceeded its $50 million target.

Most of these savings came from the sale of 68% of Kaiser, its money-losing Brazilian brewery. The company still owns 15% of Kaiser, which will make it easier for it to launch Coors Light or other brands in Brazil. Molson Coors no longer has to consolidate these operations, so Kaiser’s losses will have little impact on its overall earnings.

More savings on the way

The company also closed an older brewery in Memphis, and plans to open a more modern facility in Virginia early next year. Thanks to these initiatives, Molson Coors now feels it can cut $75 million more from yearly costs by the end of 2008. That would give it $250 million in annual savings.

These savings are starting to show up in Molson Coors’ earnings. In the third fiscal quarter ended September 24, 2006, profits from continuing operations fell 7.2% to $1.41 a share (total $122.4 million) from $1.52 a share ($131.0 million) a year earlier. These figures include pre-tax special charges of $28.5 million in the most recent quarter, and $33.5 million in the year-earlier quarter. Sales grew 3.3%, to $1.58 billion from $1.53 billion.

Now that the company is making good progress cutting its costs, it can turn its attention to building sales and market share. The main way brewers like Molson Coors compete is marketing. An effective advertising campaign can attract new customers, or spur fresh interest in older brands.

Canada accounts for 35% of Molson Coors sales, and 40% of its profit. In the past two years, the growing popularity of low-cost brands from small brewers has cut the company’s market share.

Smaller brewers face higher taxes

These smaller brewers are exempt from certain excise taxes that larger brewers must pay, which lets them sell their products at close to the legal minimum price. They also receive some favourable treatment from government liquor distributors. However, that could soon change. Some of these small brewers set themselves up as income trusts, and will become taxable in 2011. That could spur them to raise prices and erode their price advantage.

The United States supplies about 45% of the company’s sales, and 40% of its profit. The main competition in the U.S. is large brewers such as Anheuser-Busch and SABMiller. Big competitors like these are usually reluctant to trigger a price war, so Molson Coors’ U.S. operations should have little trouble passing along higher fuel, packaging and labour costs to beer drinkers.

Europe (including the UK) accounts for 20% of Molson Coors’ sales and profits. The company mostly sells its beer in the UK through pubs.

In the past few years, many of these pubs have merged. Consequently, pubs now have more clout with brewers, which has put pressure on beer prices. New anti-smoking laws have also prompted more people to drink beer at home instead of in pubs, and led to greater price competition at retail stores.

However, cost cutting is starting to improve the profitability of the UK business. Exports to Germany and other European countries should also expand this division’s sales in the next few years.

Balance sheet getting stronger

Molson Coors’ long-term debt is a reasonable 37% of shareholders’ equity. Cash flow is also growing, which should help it pay down more of its debt. It also has $179.1 million ($2.08 a share) in cash.

The stock jumped to $98 after the merger, but has moved down and stayed in a narrow range for most of the past two years.

The class ‘A’ shares now trade at 17.6 times its likely 2006 profit of $3.94 U.S. a share (18.3 times for the Class ‘B’ shares). They are also attractive in relation to Molson Coors’ sales of $66 U.S. a share.

The $1.28 U.S. dividend (which yields 1.8% for the ‘A’ and ‘B’ shares) seems safe. However, the company will probably use most of its spare cash to pay down debt before raising the dividend.

Molson Coors is a buy. The cheaper ‘A’ shares are the better choice.

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