Can Investors Tap Craft Brewers?


All you need to do to realize how quickly the craft-beer movement has grown is check out the beer aisle at your local Whole Foods Market (NAS: WFM) . Just two decades ago, maybe four or five breweries were represented at even high-end retailers. Today there are likely to be dozens. Despite this reliable secular trend in favor of craft brewers, though, it can be difficult for retail investors to play it. After all, there are only two publicly traded craft brewers, and even though they're both tiny compared with Molson Coors (NYS: TAP) or Anheuser-Busch InBev (NYS: BUD) , they're both approaching a surprising limit to their growth.

Taken as a whole, craft beers have surged. According to the Brewers Association, in 2011 craft beer accounted for 5.7% of all American beer sales by volume and 9.1% by price. These numbers should only get bigger, since the craft-brew segment has been growing by double digits annually for several year.

The movement has attracted literally thousands of new entrants into the field: There are now more than 2,100 American breweries, up from less than 100 only a few decades ago. Boston Beer (NYS: SAM) , maker of the popular Sam Adams brands, is one of the largest and oldest craft brewers. Craft Brew Alliance (NAS: BREW) is significantly smaller and operates as a consortium of the Widmer Brothers, Red Hook, and Kona breweries. Though the Brewers Association doesn't consider CBA to be "craft" because of the minority ownership stake Anheuser-Busch holds, the company's products do compete for mindshare in the craft-beer segment.

A weak beer
Both companies have put up impressive growth, but in recent quarters they've run into a surprising ceiling: enduring weakness in their core brands. Boston Beer doesn't break out sales growth by brand, but CEO Martin Roper said in August that growth was due to "strength in our Samuel Adams Seasonal, Twisted Tea, and Angry Orchard brands, offset by some slight decline in some of our other Samuel Adams brand styles." This wouldn't be alarming, except that Roper has been noting that strong Seasonal performances offset "slight declines" in core offerings for at least two years. Seven or eight quarters of even "slight" declines in a company's core product is worrying.

CBA has suffered similar deterioration: Widmer Brothers' Hefeweizen, that segment's flagship beer, has lost ground in recent years, according to an interview with CEO Terry Michaelson. CBA President Andy Thomas blamed core weakness on heightened competition in the space with new brewers.

Worse, brewing giants such as Molson Coors and Anheuser-Busch have started to compete nationally and on price by producing a line of near-craft offerings such as Blue Moon and Shock Top that offer some product differentiation from adjunct lagers such as Bud Lite at lower prices than true craft beers.

Designer drafts
The problem here is inherent to the craft brew movements' customers: People started drinking craft beer -- and paying twice as much for it -- because they liked trying new styles and weren't content to stick with a single brand. With so many options available, many drinkers won't buy the same product twice in a row even if they loved it.

That leaves Boston Beer and CBA in a position pretty similar to high-end fashion designers: Seasonal offerings drive market share and earnings because anything else will be quickly sampled and discarded once it's no longer in vogue.

Meanwhile, craft brewers are exposed to a volatility risk not normally associated with beer makers, typically considered a staple. With earnings driven by seasonal offerings, a bad season could turn consumers off the brand and into the arms of the several dozen competitors available. An off-step could hurt earnings for several quarters, since a weak fall seasonal could lead consumers to be skeptical over the winter seasonal as well.

Boston Beer understands this well, and over the summer it released not only its annual Summer Ale, but also an additional summer seasonal called Porchrocker, small batch brews Verloren and Norse Legend, and a whopping six brand-new IPAs packaged and sold together under the Hopology label. All were well regarded, but this constant investment in new brands means that today's operating margin of around 20% might be as profitable as Boston Beer can ever get, even if it grows revenue.

For investors looking to cash in on craft brewing as a secular trend, therefore, it's important to keep in mind that this rising tide won't necessarily lift all boats. In 2010, for example, 155 new breweries opened -- but 62 closed. Investors in Boston Beer or CBA should instead look at management's ability to execute well, gain market share through product differentiation, and keep the attention of their fickle customers. Unlike their distribution system-based big brewing brothers, the craft brewers are not set-and-forget investments.

To profit from the secular trend of increased interest in local, craft, and artisan food and beverages, you might just want to revisit that beer aisle in Whole Foods. Beer is just the latest category in which the grocery retailer has focused on delivering local craft goods from small producers to a mass audience, and investors have benefited tremendously. Unlike the fragmented beer market, however, Whole Foods dominates its category, so its growth story isn't over. To understand the key opportunities and risks Whole Foods faces, download The Motley Fool's premium report. This report is available for only a limited time, so click to get your copy now.

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Fool contributorDaniel Ferryhas no position in any of the companies mentioned above. The Motley Fool owns shares of Whole Foods Market and Boston Beer.Motley Fool newsletter serviceshave recommended buying shares of Molson Coors Brewing, Whole Foods Market, and Boston Beer. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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