Craft Brewers Alliance's Comeback

FILED NOVEMBER 26, 2009

Dear Client:

Craft Brewers Alliance posted its second quarter in a row of profitability, and they seem to have turned a corner with respect to growing the topline while also cutting costs. The merger of Widmer and Redhook last year (with investments also in fast-growing Kona and Goose Island), allowed the company to increase capacity utilization, cut duplicate costs, and operate with one national sales force.

CBA's shipments were up 1% in the third quarter following heavy distributor inventories at the end of the second quarter. STRs were up a healthy 3% for a mature brewer, which was "close to meeting our expectations," said CBA chief Terry Michaelson on a conference call. Terry said their growth is "confirmation of our strategy of growing brands....in the face of an extremely challenging economic environment." CBA increased gross margins and reduced expenses while improving shipments.

CBA's strategy is one that speaks to what BBD has been exploring in the past several days: Leveraging the stable and mature flagship brands to cover the costs of a salesforce and a chain division while also introducing high-end reserve lines to improve margins and capture growth. Driving distribution in chains is also crucial. "We are going to continue to focus on that off-premise channel," says Terry. He adds that "we're actually in a good position to call on key chains, and due to our diverse portfolio, continue to gain new distribution." Terry says that they have "strengthened our position with retailers" and CBA is "getting more activity with ads and displays which is important to increasing velocity.....We're continuing to introduce new products into the marketplace...that are important to margins.....IRI shows that Drifter is the second fastest new product in the craft category this year....We see things as continuing to be challenging from an overall perspective in the beer industry, but we're pleased about the growth craft has had."

Craft brewers' increasing face time with retail chains is one of the things that is continuing to drive craft growth, particularly as consumers turn to the off-premise in this recession. Craft brewers have always been good on-premise marketers, that's their legacy. But to get to Kim Jordan's dream of 10 share or even Martin Kelly's dream of 20 share, you gotta have serious scale in the chains. You also gotta have serious capacity....

CRAFT BREWERS' CAPACITY ISSUE

Which brings us to the capacity issue. The problem with brewing and packaging capacity is that it ain't cheap, and you have to do it in rather big chunks. This means brewers have to borrow heavily against the hope that demand will grow into the investment in fermenters and bottling lines. It's a risky bet.

But even if craft brewers can drive demand to 20% of the market, how to pay for it? Dan Kopman at Schlafly points out that it takes about $100 a barrel to build additional capacity (on the low end). If craft brewers can drive consumer demand to sell 30 million extra barrels to gain 15 points in market share, that's $3 billion in investment. That's a lot of dough. It highlights the importance of the small brewer tax break. It also points out the advantage big brewers have, because they already have plenty of capacity, and even if they need to build more, they can squeeze quite a bit out of their current facilities.

But the main thing is not to build too much capacity. Beer econ 101 tells us that too much brewing capacity drives prices and marginal profits down. We still have plenty of capacity in this country, it just needs to be shared. As Jim Koch as proved, there's no shame in contract brewing; (as Jim says, if Julia Child makes a meal in your kitchen, it's still a Julia Child meal). There's a lot of this going on. Matt bottles beer for Brooklyn, for example. Our point is that if indie craft brewers want to get to 10 or 20 share, there will have to be a lot more creative contract brewing deals to make it financially viable while protecting everybody's flank on pricing by not building too much brewing and packaging capacity.

BEER BRIEFS:

BOSTON BEER says it will release Samuel Adams Boston Lager with new packaging to commemorate its 25th year in business. The new labels will appear on 12 oz. bottles included in 6-packs as well as on 22 oz. bombers.

WE REGRET TO REPORT that Katherine Rebecca "Kitsie" Buck, 97, of Maryland, passed away. She was the co-founder of Buck Distributing, a Miller distributor, which began in 1946. She is the mother of former NBWA chair Betty Buck. Our condolences go out to Betty and the entire Buck family.

NEXT ISSUE on Monday. To our U.S. readers, have a great Thanksgiving holiday. To our overseas and Latin American readers, I apologize in advance for taking this local holiday, but as it involves gorging on food and beer, naturally it is among my favorite.

Until tomorrow, Harry

"People talk about the dead hand of globalized brand uniformity, but I don't think that's true in beer. Stonking great global brands haven't worked. Heineken is the most global brand and that's under 25% of its owner's volumes."
-SABMiller chief Graham Mackay to the Times

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