The Molson Coors Brewing Company's (NYSE:TAP) second-quarter 2014 earnings added some effervescence to its stock last week, as the Denver-based brewer surged over 5% on better-than-expected earnings. While revenue increased just 0.9% from the comparable quarter last year, and volume decreased by the same amount, net income jumped nearly 8%. The company attributed the increase to better results in Europe, lower interest expense, and improved results from MillerCoors, the company's joint venture with SABMiller, of which Molson Coors owns a 42% interest. MillerCoors brews and distributes Miller and Miller Lite beers in the United States and owns a number of other smaller brands, including Leinenkugel, Redd's, and Smith & Forge Hard Cider.
These relatively diminutive labels form a vital part of Molson Coors' business strategy. For several years running, the beer industry has lost share in the alcoholic beverage market to wine and spirits. According to The Demeter Group, an industry advisory firm, from 2007 to 2012, the beer industry's volume decreased at a compounded annual growth rate, or CAGR, of 0.3%. Wine and spirits have been moving in the opposite direction and now comprise more than 51% of the alcoholic beverage market.
But this doesn't mean that Molson Coors has to accept the direction of the beer industry as its own fate. The company is employing three tactical maneuvers to find growth. The first is to plumb a fast-growing industry segment: craft beer. The second is to counter the popularity of wine and spirits by positioning beers that appeal to the drinkers in this category. The third is to introduce its mainstay beers into new international markets, as in its push to sell Coors in Latin America and Asia, while simultaneously investing in local beers.
Small brands, meaningful impact
In business, to react to the future, it can sometimes be helpful to reach deep into the past.Jacob Leinenkugel founded the Leinenkugel brewery, based in Chippewa Falls, Wisconsin, in 1867. The Miller Brewing Company acquired the five-generation family-owned business in 1988. A small brewery like Leinenkugel gives Molson Coors an entry into one subset of the beer industry that's growing much faster than the overall industry: craft beer. Last year, the craft-beer industry grew at a rate of almost 20%. Leinenkugel offers a wide variety of ales, porters, and seasonal beers, and its portfolio saw high-single-digit growth in the second quarter of 2014.
Heavily marketed Redd's Apple Ale is another tactical foray to halt the damage from the incursion of wine and spirits into the beer industry's market share. The changing dynamics of the beer industry are propelled by a generational shift: Millennials tend to prefer wine and cocktails to beer. Redd's Apple Ale and other flavored brews allow MillerCoors to offer an alternative to wine and spirits. And millennials seem to be responding: Redd's brands more than doubled their volume versus the prior year in the second quarter of 2014. While Redd's attempts to tap a market for fruity alcoholic beverages, MillerCoors is also trying to peel away liquor drinkers, primarily younger whiskey drinkers, with its black-bottled, high-alcohol-content Miller Fortune beer. This willingness to innovate should serve TAP well in its attempt to seize back some initiative from the wine and spirits category.
The rationale behind smaller, often premium labels isn't only about revenue growth. These beers also contribute a higher margin to the company's bottom line. In Molson Coors' most recent earnings conference call, CEO Peter Swinburn explained the advantage of premium and "above premium" labels versus Coors and other workhorses of the company's revenue:
"We're very comfortable with the way the portfolio is moving to above-premium, which gives us a buffer against having to take pricing and also gives us a real buffer against discounting in markets where things get difficult."
As the beer industry in North America remains flat, Molson Coors is willing to take risks to broaden its profile in international markets. In the second quarter of 2014, Molson Coors lost $3.7 million in its international division, versus $3.1 million in the comparable prior-year quarter. The company attributed its higher loss to increased marketing expenses. Yet in terms of revenue growth, international operations are a bright spot, growing by double digits. TAP posted a 21.6% increase by volume in international sales in quarter two of 2014, propelled by Coors Light growth in Mexico and Latin America. Thus, the company is content to pour dollars into gaining market share globally for the present. And this makes sense when one considers that brands like Coors Light, which are deemed tired and lower-tier here in the U.S., have much potential entering new markets with the power of Molson Coors' marketing to seed their growth.
Indeed, at a pace that it deems prudent, Molson Coors is paying increased attention to emerging consumer economies such as China and India. As Kandy Anand, president of Molson Coors International, noted last year, by 2015, one out of every four beers consumed in the world will be consumed in China. Molson Coors International has recently invested in joint ventures with Chinese brewery Si-hai Beer Company, and popular Indian label "Cobra" beer.
The beginning of an investment cycle
For several quarters, Molson Coors' management has focused on cost-cutting to improve margins and has set about lowering interest expense by reducing outstanding debt. At June 30, 2014, the company's total debt stood at $3.7 billion, or about 20% lower than the prior year. With higher pre-tax earnings, and continued contribution from the MillerCoors joint-venture, the company is choosing to invest decent cash flow in its smaller craft and premium brands. Combined with marketing dollars in Asia and Latin America used to introduce traditional brands like Coors and Miller Beer, Molson Coors may be at the beginning of a long investment cycle. But this investment is prudent given the decline of the traditional beer industry, and as long as current profits continue to accrue, investors have reason to be patient.
Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Apple and Molson Coors Brewing Company and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.