Different Hedge Fund Managers Bought and Added Molson Coors Brewing

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Nov 24, 2014

In this article, let's take a look at Molson Coors Brewing Company (TAP, Financial), a $14.01 billion market cap company, which is the fifth largest brewer in the world, was formed in early 2005 via the combination of Adolph Coors Co. and Molson, Inc.

Light Beer

The company plans to gain market share by cross marketing its products. In Canada, it has a 13% market share with Coors Light, which makes me think it has a promising outlook in that country. Further, it will have important synergies by merger of the business of Molson and Coors.

Returning Value to Shareholders

Since 1970, the firm has a dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. The current dividend yield is 1.89%, which can improve in the future allowing higher shareholder´s returns.

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)

where:

V0 = fundamental value

D0 = last year dividends per share of Exxon's common stock

r = required rate of return on the common stock

g = dividend growth rate

Let´s estimate the inputs for modeling:

Required Rate of Return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium

Assumptions:

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So I think it is more appropriate to use this rate.

Beta: β =1.46

GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]

rTAP = RF + βTAP [GGM ERP]

= 4.9% + 1.46 [11.43%]

= 21.59%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.

g = b x ROE

b = retention rate

ROE=(Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

The “PRAT” Model:

g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Let´s collect the information we need to get the dividend growth rate:

Financial Data (USD $ in millions) 12/31/2013 12/31/2012 12/31/2011
Cash dividends declared 238,700 237,200 230,400
Net income applicable to common shares 567,300 443,000 676,300
Net sales 4,206,100 3,916,500 3,515,700
Total assets 15,580,100 16,212,200 12,423,800
Total Shareholders' equity 8,638,900 7,966,900 7,647,900
Ratios
Retention rate 1 0.46 0.66
Profit margin 0.13 0.11 0.19
Asset turnover 0.27 0.24 0.28
Financial leverage 1.88 2.08 1.61
Retention rate = (Net Income – Cash dividends declared) ÷ Net Income = 0.58
Profit margin = Net Income Ă· Net sales = 0.13
Asset turnover = Net sales Ă· Total assets = 0.27
Financial leverage = Total assets Ă· Total Shareholders' equity = 1.80
Averages
Retention rate 0.57
Profit margin 0.15
Asset turnover 0.26
Financial leverage 1.85
g = Retention rate Ă— Profit margin Ă— Asset turnover Ă— Financial leverage
Dividend growth rate 4.09%

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($75.06 ×21.59% – $1.48) ÷ ($75.06 + $1.48) = 19.24%.

The growth rates are:

Year Value g(t)
1 g(1) 4.09%
2 g(2) 7.88%
3 g(3) 11.66%
4 g(4) 15.45%
5 g(5) 19.24%

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Calculation of Intrinsic Value

Year Value Cash Flow Present value
0 Div 0 1.48
1 Div 1 1.54 1.27
2 Div 2 1.66 1.12
3 Div 3 1.86 1.03
4 Div 4 2.14 0.98
5 Div 5 2.55 0.96
5 Terminal Value 129.56 48.76
Intrinsic value 54.12
Current share price 75.06

Final Comment

The company has a 28% market share in the U.S., reaching a second position as the largest brewer behind Anheuser-Busch Inbev (BUD, Financial), which has about half the market share.

We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment. Although the model indicates a sell recommendation, in this opportunity I think it will be a good bet due to its impressive gains in the Canadian market.

Hedge fund managers Jim Simons (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Daniel Loeb (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), Steven Cohen (Trades, Portfolio) and Jean-Marie Eveillard (Trades, Portfolio) have added the stock in the third quarter of 2014, as well as Diamond Hill Capital (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned.


[1] This values where obtained from Blommberg´s CRP function.