Gage Roads sets a new course
After repurchasing Woolworths' (ASX:WOW) stake and repaying debt, Gage Roads Brewing's (ASX:GRB) new 'returning to craft' strategy has begun well.
Gage Roads Brewing's (ASX:GRB) new 5-year ‘returning to craft' strategy, revealed in August 2016, aims to grow sales of its higher margin proprietary craft beer range, both packaged products and draught, and gradually replace volumes of its lower-margin contract brewing business.
To do so, the company raised capital to repay debt and repurchased major shareholder Woolworths' (ASX:WOW) stake.
Buying out Woolworths gave Gage Roads the opportunity to expand distribution of its beers such as Single Fin Summer Ale and Little Dove New World Pale Ale to the 75% of the market not controlled by Woolworths.
And new agreements with independent distributors, including Australian Liquor Marketers (owned by Metcash (ASX:MTS)), and 100Proof soon followed.
Based on its 2017 result, it seems the new strategy has begun successfully.
Gage Roads' revenue rose 7%, to $27m but, importantly, sales of its proprietary products rose 23% to 3.4m litres while contract brewing volumes fell 13% to 7.2m litres.
As a result, Gage Roads' gross margin rose from 52% in 2016 to 58% this year. Notably, this figure is up from 55% at the half, helped by the recovery in proprietary sales to national retailers such as Woolworths after they fell 22% in the first half.
Despite increased sales, marketing and distribution costs, underlying earnings before interest, tax, depreciation and amortisation rose by 33% to $3.6m.
Early signs positive
So while it's still very early, initial signs are positive.
With big brewers Lion Nathan and Carlton & United controlling around 85% of the Australian beer market between them – including the majority of taps in many pubs – it can be difficult for independent craft brewers to expand their distribution.
And doing so won't come cheaply for Gage Roads. It plans to increase sales, marketing and distribution spend more than fourfold, to around $6m in 2021. Successfully increasing consumer awareness of its beers, particularly on the east coast, will help it negotiate access to more taps in pubs and hotels and persuade more retailers to stock its range.
Gage Roads and other craft brewers are also being helped by the fact that Australians are moving away from consuming mainstream, tasteless brews like Victoria Bitter or Tooheys New towards more expensive craft beers.
So while the overall beer market fell 1.1% per year in the six years to 2016, the craft beer market grew at 16% per year over this period and is projected to continue growing at similar rates.
Spare capacity
After spending $25m in recent years, Gage Roads has a modern brewery with 35% spare capacity, so it's well placed to increase production should demand require it. This should also support margins given the high proportion of fixed costs, and the resulting operating leverage, in the brewing business.
It's too early to declare victory, though. Woolworths' commitment to purchase minimum volumes from Gage Roads expires in 2019, when it will purchase a minimum of 6.7m litres. Woolworths does, however, have an option to renew the agreement for another two years and, in any case, Gage Roads earns lower margins on these sales.
While $5m in net cash at June 2017 provides a decent buffer for the company to continue investing in its new strategy, its large operating leverage and the projected sales and marketing expense increase means its business could quickly sink should something go wrong. For example, east coast Australians may not like its beers as much as their Western Australian counterparts or perhaps Woolworths will dramatically reduce its minimum purchases or even opt not to renew their agreement in 2019.
Should its ‘returning to craft' strategy prove successful, however, we wouldn't be surprised to see Gage Roads follow Little World Beverages and Byron Bay Brewing and be bought by one of the big brewers.
Disclosure: the author owns shares in Gage Roads.