Crafting Profits with This Brewer

This great American success story has plenty of room to grow and is now a likely takeover candidate. Using options can have you saying Cheers!

One of legendary investor Peter Lynch’s maxim was to invest in what you know.   With this in mind I feel uniquely qualified to recommend establishing a bullish a position in Boston Beer Company (SAM), the original and premier craft beer brewer.

Since its humble inception in 1984 with its single Sam Adam’s lager it has grown to into a $3 billion company that offers over 80 beers, alcoholic teas and ciders with $920 million in annual sales.   Since it went public in a 1995 its shares have risen over 1,000%; a true Peter Lynch “ten bagger” and great American success story.

Small but Growing

Despite all that growth with just 4.1 million barrels sold 2014 it still represents just 1% of the domestic beer market. Craft brewers, which are defines as an independent U.S. based company that produces less than 6 million barrels a year, comprise about 12% of U.S. beer and malt beverage sales.

Many of the “craft” labels such as Blue Moon have been gobbled by the large international companies such as MolsonCoors (TAP) and Anheuser-Busch InBev (BUD) which themselves were created through iconic American brands being bought out or merged.

Despite their small size craft brews have shown large growth with sales increasing by 20% annually over the past five years. This compares to the mostly flat, to even negative, volumes by for the overall beer industry. So it’s easy to understand why the big brewers have been scooping up the little guys making them a somewhat endangered species.

Indeed, SAM’s second quarter results reported on July 30th showed revenues increased by 7% to $252.2 million from $231.6 million and earnings grew 16% to $2.18 per share. Both were above analysts’ estimates but shares slipped by 2% as the company lowered forecast of sales by distributors to retailers, to increase 6% to 9%, down from its earlier estimate of 8% to 12%.

Friday’s slide added to the nearly 30% decline in the stock over the past six months. At $220 a share in now sits near a 52-week low. It is now near important long-term support.

SAM 073115

Endangered Species Ready to be Poached

All of this helps explain why there was a collective shudder when Jim Koch, SAM’s founder and President, testifying before Congress last week said “Because of our broken corporate tax system, I can honestly predict that I will likely be the last American owner of Boston Beer Company.”

Mr. Koch has no immediate plans to sell or step down. But what his comments should do though is put a bid under the shares as takeover of his company seems inevitable. Koch has acknowledged that investment banks have been aggressively courting him with potential deals.

With shares now trading at their lowest valuation since 2009 a takeover bid with a large premium will be hard to ignore.

The Trade:

Using longer dated options is a great way to establish a bullish position that would benefit from shares of Boston Beer regaining their old momentum. And provide the additional kicker of a potential “10 bagger” should a takeover bid come along.

I’m targeting the March 2016 LEAPs $230 calls for $17.50 a contract.

Here is what the risk graph looks like for these calls.

SAM r.r 230 call graph

These calls expire March 2016, a little over seven months, giving a good amount of time for shares to rebound back towards at least the $260 level. That would make the calls worth at least $30 per contract for a 76%.

For a takeover bid to be taken seriously I think it would have to come in above the old high $320 shares, making calls worth over $100 for 480%. Not quite the elusive 10 bagger, but something would us saying Cheers!

— Steve Smith

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About the Author: Steve Smith