Boston Beer (SAM) reported Q2 results on Friday that included nice improvements in sales. By all accounts, the craft brewer has reinvigorated its growth story. The company is successfully driving revenues and shipments, but the expenses being incurred to drive that growth are eating into operating income. Despite stock buybacks, earnings per share fell big time year over year. I worry that current high end guidance of $7.30 is not enough to drive the share price higher. People don't want to pay a 40x premium for a stock with shrinking earnings. Unfortunately, it's come at a high price regarding increased costs. Advertising in particular has had much more spending. The question that needs answered is whether the new marketing initiatives will have start producing higher rates of growth.
The company's shares were down 1.4% to $273.75 on Monday after sliding on Friday.
Year over year, second quarter revenues increased 10.2% to $273.1 million. Overall depletions of inventory increased 12% year over year. That means the overall amount of inventory being moved after distribution is increasing. In other words, people drank more. For the year, depletions are expected to increase by 7-12%. That's a new improvement over the previously expected 0-6% growth. The overall improving picture for sales is a welcome sight in what has been an increasingly competitive marketplace; but it's that same competition that is making Boston Beer work much harder for its sales.
Operating income is taking big hits as SAM launches new initiatives to procure customers. Total operating income for the second quarter decreased 31% year over year to $31.06 million. The main culprit here is a 27.5% increase in advertising and promotional expenses to $86.5 million. Thus far total 2018 marketing expenses are up 26.7% to $154 million. It is by far the biggest expense in Boston Beer's finances outside the actual costs of making their product. I would point out on that front that overall revenue growth is outpacing cost of goods sold allowing for improving gross profits. The issue that is affecting earnings is entirely on the operating expense side.
Even with substantially lower taxes, net income declined 19% in the second quarter to $23.5 million. That breaks down to $1.98 per diluted share. Those earnings represent a $0.37 fallout year over year. The fact that Boston Beer has had to drastically increase its marketing initiatives to breathe life back into sales is rather reflective of the beer industry as a whole right now. In a trend that seems almost un-American, beer is stagnating. Total beer volumes have been slowing for years. In 2017 total U.S. beer sales volumes were down 1.2%. With the constant growth of new craft makers, craft beer has been the remaining growth spot. Craft volumes increased 5% in 2017. That's down quite a bit from 2016. The slowdown should not be super surprising. The industry had double digit growth numbers for years. That kind of expansion can't be sustained over the long term. Things finally started showing signs of slowing down a few years ago. Boston Beer has suffered ever since.
Can the new story yield earnings results?
The question with SAM is whether or not they'll have to constantly increase that advertising budget. If they can keep that $86 million in advertising costs, but keep growing revenue quarterly as a result, there is earnings potential here. On the other hand, if the brewer has to keep expanding these marketing initiatives in order to derive higher sales, it's clear that it's not cost effective. Jim Koch admitted himself that most of their success is being derived from the non beer side of things. Things like Twisted Tea, and Angry Orchard are what's driving sales. In their second quarter release, Koch reiterated his desire to derive renewed growth from Sam Adams. To that end, there's clearly still work to be done. The new product additions that include Sam'76 and New England IPA don't appear to have done the trick.
I love a good Boston Lager. It's by far my favorite beer. Unfortunately, the oversaturation of craft beer companies is almost certainly going to limit what Boston Beer can actually do in terms of returning the Sam Adams brand to a big growth story. The Brewers Association noted that most of the craft growth is stemming from microbreweries. The small guys that have started their own thing, much in the same way that Koch did so many years ago, are the ones making a growth story. In fact, the number of microbrewers increased by 19% between 2016 and 2017. With over 6,300 brewers in the United States at this point, the total market is getting split between so many different players that it seems impossible for any particular entity to gain too much market share. The emphasis on local brews, and renewed interest in other forms of alcohol including wine and liquor, are all detrimental to the Boston Beer growth story.
At this time, I still can't say that Boston Beer is back yet. We've seen a huge rally in the stock, but it's clear from the recent pullback that earnings did not match up with expectations. I also think a big piece of that stock rally was based on the hope that Boston Beer might get sold. While there's still always a possibility for that, I think the pricing is too high right now. In a market that's struggling for momentum, I don't see anyone paying over 40 time's earnings to acquire Boston Beer. I maintain my previous stance on price targets being a little expensive. The company's own top end guidance suggests earnings of $7.30 for the year. At that marker, the stock is still trading at roughly 37 times the potential full year earnings. That's just a little too pricey for a company that's damaging earnings per share in order to drive revenue. As much as it breaks my heart, I think Boston Beer Co. remains a "hold" at best.