During lengthy bull markets like the present one, it seems to get progressively harder to enter into new equity positions. Yet reasonably valued companies, which are investing for revenue and margin expansion now, can provide investors with the comfort to be agnostic as to future market direction. In this article we'll delve into three companies which are funneling resources into growth with a vengeance.
Acquisition and CapEx south of the border
"Our beer business is on fire."
Constellation Brands CEO Rob Sands, at the outset of prepared remarks during the company's fiscal Quarter 1 2015 earnings conference call.
In quarterly earnings conference calls, CEOs are typically prudent in describing their businesses, preferring understatement over hyperbole. But Rob Sands of Constellation Brands (STZ -0.18%) had reason to be pumped up during the company's July earnings conference call. In 2013, the company acquired Grupo Modelo's U.S. beer business from Anheuser-Busch InBev (BUD 0.39%) for $5.2 billion, and management was beginning to see the payoff.
The transaction gave gave Constellation Brands ownership of the other 50% of beer distributor Crown Imports it didn't already own, and the exclusive right to import, market and sell a premium portfolio of Mexican beers, including market-leading brands Corona, Modelo, Pacifico, and Victoria in the U.S. STZ also picked up a 10 million hectoliter factory in Mexico, ten miles from the Texas border, as part of the deal. The acquisition showed immediate results: 1st quarter 2015 beer sales, which Sands referred to in the quote above, grew 14% from Q1 of 2014.
Constellation Brands new West Coast headquarters. Source: HKS Architects.
Constellation Brands undertook significant risk to complete the acquisition: debt more than doubled, from $3.3 billion at the end of fiscal 2013, to $7.5 billion after closing. But STZ boosted its revenue handily: for the first six months of fiscal 2015, net revenue was $3.1 billion, nearly 50% greater than the comparable period's $2.1 billion. And the import-driven beer portfolio is indeed heating up, if not on fire, growing at a 10% rate year-to-date. This compares more than favorably to the beer industry's overall annual growth rate of negative 2%, and the import segment's annual growth rate of negative 0.6%, according to the Brewers Association.
STZ's beer acquisition gives it a much broader field to increase organic growth in the coming years. Revenue from beer now accounts for 56% of sales, versus 44% in the slower growing wine and spirits division. These ratios stood at 48% beer to 52% wine and spirits before the Grupo Modelo transaction.
Yet pitfalls await, perhaps in the form of growing pains: the company plans to expand its new Mexican brewing plant from 10 million to 25 million hectoliters by 2017. This will require substantial capital investment, as well as refinement of current distribution systems. STZ has already had to deal with a recall of its best-selling "Corona Extra" beer this year, the result of glass sourcing problems. Shareholders will hope for steady earnings increases to offset Constellation's learning curve as it continues to scale up its beer portfolio.
What's the Greek word for "Life?"
Zoe's Kitchen Inc (ZOES), which takes its name from co-founder Zoe Cassimus, wants to make an impact in the fast-casual segment of the dining industry. The company, which went public in April of this year, operates 116 Mediterranean themed restaurants, and licenses 6 six franchise restaurants, located primarily in the Southeast.
Zoe's may be tiny, but it has outsized ambitions. The chain, whose name also means "life" in Greek, plans to double its restaurant base within four years. Zoe's locations are characterized by bright and colorful interiors. The company describes its food as "made generally from scratch using produce, proteins and other ingredients that are predominantly preservative- and additive-free, including our appetizers, soups, salads, and kabobs."
Zoe's may remind some investors of other successful fast casual chains that have taken a niche concept and expanded enormously over the years, namely, Panera Bread (PNRA) and Chipotle Mexican Grill (CMG -1.34%). As yet, Zoe's is in its infancy, both in terms of number of locations, and unit volumes. Zoe's has grown its average unit volume, or AUV, from roughly $1.1 million in 2009 to $1.5 million. For context on both the potential inherent in this number and the long hill to climb, Chipotle, which has the advantage of many more years of growth and restaurant optimization, currently boasts an AUV of $2.4 million.
The contemporary design of Zoe's restaurants is proving popular with diners. Source: Zoe's Kitchen.
The risk for this promising upstart is that there's no long-term forecasting of consumer tastes. At present, fast-casual restaurants hold the attention of diners, as they're deemed to offer a better value proposition than aging quick service behemoths like McDonald's.
But this shouldn't be taken to mean that consumer tastes can't change again. In addition, competition could come from unlikely places. For example, Chipotle has already expanded its business model into pizza and Asian food, making a future foray into Mediterranean dining possible, if Zoe's succeeded wildly and CMG's management perceived a market opportunity.
An online travel trailblazer quietly ramps up its acquisitions tenfold
TripAdvisor Inc's (TRIP 0.75%) branded online travel sites average 315 million unique visitors quarterly, and it's grown to this size by building a global travel community whose members have posted over 200 million reviews on hotels, restaurants, and activities in over 28 languages.
TripAdvisor derives the majority of its revenue from click-based advertising, in which other online travel agencies and travel aggregators pay for eyeball space on TRIP's various Internet properties, and for prominent placement in front of TripAdvisor's vast online community.
In 2014, the company has expanded its business model, which previously focused primarily on hotel and airline booking revenue, to include restaurant reservations and tour activities in its offerings to visitors. It's achieving this by stepping up acquisitions significantly. Year-to-date, the company has acquired companies with a total value of $352 million, and to complete these transactions, TRIP has used $284 million of its cash (net of cash acquired). As shown below, the purchases significantly outstrip previous years' dealmaking:
Source: SEC filings. Dollar figures in chart in millions.
Most notably in 2014, TripAdvisor has purchased European restaurant reservation system LaFourchette, and tours and attractions company Viator. Both companies enable an end-to-end research and booking experience for travelers.
TRIP's strategy is to extend its user base by gaining traction in segments of the online travel agency that are relatively untapped. Steadily rising numbers of travelers on a broader range of TripAdvisor sites provides some diversification from the company's largely hotel-centric, click based revenue model.
While the snapping up of promising companies in lesser explored avenues of online travel supports future revenue growth, TripAdvisor's risk lies in a general truth regarding acquisitions across industries: the larger the purchase, the higher the need for the acquired assets to create value in the long run. But in exchange for having a proactive management team, this is likely a risk that shareholders can live with.
