Is beer a discretionary purchase or a consumer staple? Experts reckon it should be a staple. But why? Consumer staples are products that we must buy on a regular basis. So, food and detergents, and the myriad of items that we find on our supermarket shelves are considered consumer staples. We don’t have much choice about whether we buy them. Consequently, the companies that make these products tend to do well in both good times and bad. They could do even better, when economies are slowing. Not mandatory That is because consumers might have to cut back on consumer discretionary,…
Is beer a discretionary purchase or a consumer staple? Experts reckon it should be a staple. But why?
Consumer staples are products that we must buy on a regular basis. So, food and detergents, and the myriad of items that we find on our supermarket shelves are considered consumer staples.
We don’t have much choice about whether we buy them. Consequently, the companies that make these products tend to do well in both good times and bad. They could do even better, when economies are slowing.
That is because consumers might have to cut back on consumer discretionary, when times are tough. These are goods and services that we don’t need to buy. We don’t, for instance, need go out and buy new clothes or a new TV set. So, consumer discretionary tends to take a back seat when an economy is not doing well.
What about beer? In theory we don’t need to put a six pack in our baskets, when we do our weekly shop. Some might argue otherwise. They claim that beer is no different to, say, tea or coffee that are not discretionary items. They have a point. And the numbers could bear this out.
Beer sales tend to hold up better than discretionary products when economies are going through tough times. In the US, the beer market typically grows around 1% a year, over a rolling ten-year period.
And over the last decade, which includes the Great Financial Crisis, the average return on equity for two dozen brewers was 14%. Put another way, they generated $14 of profit for every $100 of investor capital.
The return on equity did fall momentarily to 8.5% in 2008, before rebounding to 16% the following year. So, beer could be said to be recession-resistant rather than recession-proof.
The consistently high return on equity is due, in part, to an efficient use of assets by brewers. They generate around $0.80 of sales on every dollar of asset used. That is quite high.
But it needs to be that high to help offset a low net income margin. On average, brewers only make $7 on every $100 of sales, which is not very much.
That is why economies of scale are important. It might also explain why the brewing industry has been consolidating. This helps to cut costs, which could help to protect margins.
In 2004, the industry’s top 10 brewers controlled 51% of the market. By 2014, half the market was controlled by four brewers. Today, that market share is dominated by just three companies after AB InBev merged with SABMiller in 2016.
There is something else to note, namely, brewers can be quite heavily leveraged. Their total liabilities can be as much as half their total assets. The average leverage ratio over the last decade was 2.1.
That could be worrying, if they didn’t have reliable cash flows. But because they are consumer staples, they do. Interest payments are nearly 10 times covered by cash generated.
There is plenty of free cash flow too, which helps with dividend payments that are a hallmark of consumer staples. This is money left over after brewers have paid for capital expenditure.
The dividends are nearly twice covered by free cash flow, which should provide investors with some assurance that dividend payments can be easily met.
Brewers also retain a fair proportion of profits for reinvesting in the business. The average retention ratio is around 50%. In other words, they only pay out about half their profits as dividends. That, together with their high return on equity, should enable brewers to lift their pay outs over time, which is why they are popular with income investors.
A high retention ratio, coupled with an attractive return on equity, implies that these businesses could grow their pay outs quickly. They do. The median dividend growth rate is an enticing 8.7%. Put another way, a 5-cent dividend could more than double to 11.5 cents after ten years. That has been the case for several brewers.
In 2006 Molson Coors (NYSE: TAP) paid out US$0.64 per share in dividends. By 2017 the dividend had grown to US$1.64 per share. That equates to an annual growth rate of 9%.
Tsingtao Brewery (SEHK: 168) paid dividends of 0.22 yuan in 2006, which almost doubled to 0.42 yuan ten years later. The dividend growth rate at Carlsberg Malaysia (KLSE: 2836.KL) has been even more spectacular. In 2006 it paid out 0.09 ringgit per share in dividends. By 2017 that had grown to 0.76 ringgit – a growth of 21% per year.
Brewers can be an attractive proposition for income investors. But it’s important to focus on those with good dividend cover, high return on equity and a good brew that gets customers and investors coming back for more.
A version of this article first appeared in The Business Times.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned. The Motley Fool Singapore has recommended Carlsberg Malaysia.