the beverage industry: this one’s on the house!
TRANSCRIPT
The Beverage Industry: This One’s on the House!
By
Ken FreelandBob GabrukKim LaidlawJonathan LevineMatt MichaelsGreg Schramm
May 4, 1998
I. Corporate Governance Analysis
Balance of Power
Of the six beverage companies we have chosen for our valuation, only Molson (which is
managed by CEO E. James Arnett) is not family operated. For example, Brown-Forman is run by
Owsley Brown II and Anheuser-Busch is overseen by August A. Busch III, the CEO for the past
21 years. Excluding Anheuser-Busch, the managing families also own a significant portion of
their companies’ publicly traded stock.
Moreover, incumbent management maintains its power primarily through their boards of
directors. Generally, the composition of the boards of directors include a Fortune 500 CEO and
at least one member of the originating family. Many directors are insiders (current executives,
former executives, or family members) or have close ties to the controlling families.
Robert Mondavi and Brown-Forman provide representative examples of the board
compositions of our companies. Of the eight members of the directors of Robert Mondavi, four
are employees and members of the Mondavi family, and they own a combined 48% of the
outstanding shares. The remaining four directors hold very little stock in comparison, only 3.8%
of the outstanding shares, and have no discernable connection to the company. One is the CEO
of Netscape and on the board since 1996, while another is the CEO of Medical Data Company
(on the board since 1989). The board of Brown-Forman is comprised of four insiders and five
outsiders. Of the four insiders, three are related to the CEO and have been on the board for more
than 26 years. The fourth is the Vice-Chairman of Brown-Forman and has been on the board for
27 years. The remaining five board members are or have been senior executives at other firms.
They include the former CEO of British-American Tobacco Company Ltd. and the former CEO
of Kraft General Foods.
Manifestations
The CEO’s of the companies we analyzed all receive generous compensation packages,
although Coors offers a considerably less lucrative package of approximately $300,000. Owsley
Brown II (CEO of Brown-Forman) earned more than $1,900,000 ($657,000 salary, $523,000
bonus, $605,000 in stock options and $114,000 in stock gains) last year, while August A. Busch
III received more than $8.6 million in compensation, including stock options. Robert Mondavi
earned more than $400,000 in salary, $75,000 in other benefits and options to buy 50,000 shares
of stock at an exercise price of $28.50. E. James Arnett’s compensation included a pro-rated
salary of $263,500 (he was named CEO on May 9, 1997), a bonus of $190,000, $3,500 in other
compensation and 50,000 stock options. The financial situation surrounding Nick Caporella, the
CEO of National Beverage Corporation (NBC), is interesting. He was compensated via his
management company, which received $3,854,000 in fees from NBC last year. These fees also
included payments to another employee supplied Caporella’s management company.
Managerial Performance
As shown below, the stocks of the companies we studied performed well over the past
few years, with the exception of Molson. The best performers were Mondavi and National
Beverage Corporation, the only two companies that do not derive the most of their revenues from
the very competitive brewing business. Mondavi, which has only been public since 1994, and
National Beverage Corporation posted average rates of returns of 50% and 30%, respectively.
STOCK PERFORMANCE (1993 – 1997) – Rate of Return (ROR)
Anheuser Brown- Adolph Molson Robert Nat'l BeverageYear Busch Forman Coors Co. Ltd. Mondavi Corporation1993 -16% 6% -2% 0% N/A 11%1994 4% 5% 3% -30% 19% 8%1995 31% 20% 32% 15% 140% -10%1996 22% 25% -14% -7% 32% 235%1997 10% 21% 75% 20% 34% 13%
5-year Cumulative 53% 101% 102% -10% 406%** 273%5-year Annual Average 9% 15% 15% -2% 50%** 30%**4-year numbers
Stockholder Reaction
The voting shares of the companies we analyzed are mostly family owned; therefore, the
marginal investors have very little power with respect to corporate management. For example,
only common shareholders of National Beverage Corporation have voting rights and CEO owns
almost all the common stock (77.17%). Also, only Class “B” common shareholders of Molson
stock have voting rights, and the Molson family owns nearly 50% of these shares. Voting rights
for Mondavi shares is a little more complex in that both Class “A” and Class “B” shareholders
having voting privileges. However, Class “A” shareholders are entitled to one vote for each share
of Class A common stock they own, while Class B shareholders are entitled to ten votes for each
share of Class B common stock that they own. Class B common stock is held almost exclusively
by the Mondavi family.
Firm and Financial Markets
Half of the six companies are followed extensively by research analysts (e.g. nineteen
and nine analysts follow Anheuser-Busch and Coors, respectively). This extensive coverage
should ensure accurate information exchange between these companies and their investors. Two
of our companies, Molson and National Beverage Corporation, are not followed to any
significant extent, perhaps due to the lack of trading volume (see Section II).
Company Number of AnalystsAnheuser-Busch 19Brown-Forman 5Adolph Coors 9Molson Co. Ltd. 1Robert Mondavi 7National Beverage Corp. 0
Firms and Society
With the exception of NBC, all of the companies manufacture and distribute alcoholic
beverages. For this reason, they are often targets of public criticism. However, most of the
companies have reputations for being good corporate citizens. For example, Molson has earned a
good reputation due to its involvement in AIDS-related benefits and charities in Canada. In
addition, Molson created the Molson Companies Donation Fund. In Fiscal 1997, the Fund
donated $1,285,928 to a variety of charities, including the United Way, public education
programs, community centers, Youth groups and environmental concerns. In addition, Molson
owns the Montreal Canadian NHL hockey team, which has one of the most storied histories in
all of professional sports. This certainly adds to the popularity of the Molson name in Canada.
Anheuser-Busch has also worked hard to build a positive reputation within society. For
example, the company initiated “Family Talk about Drinking”, a consumer awareness program
aimed at preventing underage drinking through education between parents and their children. So
far, more than 2 million parents and educators have received “Parent Talk” materials. The
company also sent 5 million cans of drinking water to flood victims in 1997 and protects
endangered species at its Busch Gardens’ theme parks throughout the country. The remainder of
our companies also provide community services but to a far lesser degree.
II. Stockholder Analysis
Composition
Anheuser-Busch: Although there are more than 64,000 shareholders (including some foreign
investors), 61.2% of the stock is held by institutional investors. Insiders own approximately 20%
of the stock, with Nationsbanc – who has a representative on the Board of Directors – having a
claim on 3.85%. Barclays Bank PLC, Putnam Management, and Barrow Handley each own
approximately 2% of the outstanding stock.
Brown-Forman: There are 3,156 voting shareholders and 5,054 non-voting shareholders. Seven
insiders (all family members) claim 70.9% of the stock in the company. National Asset
Management owns 23% of the Class B common stock, much more than that of the next largest
institutional investor, T. Rowe Price, which owns 5.24%. Barclays, David Babson & Company
each hold slightly more than 4%.
Coors: The family holds all voting stock in a trust for the family and 54% of the non-voting
shares in different trusts. They are the only insiders of the company and exert virtually complete
control. Institutional investors hold 41% of the remaining outstanding non-voting shares.
Molson: Members of the Molson family own nearly 50% of the voting shares (Class B common
stock). Of the remaining shares outstanding, institutional investors hold 32.41%, of which 9% is
held by the Ontario Municipal Employees Retirement Fund.
Mondavi: The Mondavi family owns most of the Class B Common Stock, which contain the
majority control of voting rights. Of the Class A Common Stock outstanding, there are 78
institutional holders of the stock, representing more than 86% of the outstanding shares. Capital
Guardian owns nearly 9.13% of the stock, while Fidelity Management and Wellington
Management each own more than 8% of the stock. The marginal Mondavi stockholders are
likely to be domestic institutional investors.
National Beverage Corporation: Institutional investors own 4.7% of the stock, while insiders
hold 78.4%. The insiders include Nick A. Caporella, Joseph G. Caporella (Executive VP,
Corporate Secretary and Director), Samuel C. Hathorn (Director), S. Lee King (Director) and
George R. Bracken (VP and Treasurer).
* See the following table for a detailed breakout of major stockholders.
Company (Ticker) Number of Shares % of OutstandingAnheuser-Busch (BUD)Nationsbanc 18,730,000 3.85%BZW Barclays Bank 13,086,000 2.69%Putnam Mgmt. 10,846,000 2.23%Barrow Handley 10,430,000 2.14%Fayez Sarofim 8,829,000 1.82%Brown-Forman (BF/B)National Asset Mgmt. 9,165,000 23.00%T Rowe Price 2,089,000 5.24%BZW Barclays Bank 1,778,000 4.46%David L. Babson & Co. 1,668,000 4.18%State Street Corp. 900,309 2.26%Coors (ACCOB)Coors Family 18,978,000 54.19%BZW Barclays Bank 1,361,000 3.89%State Street Bank 785,604 2.24%Bankers Trust 716,888 2.05%NY State Teachers 649,700 1.86%Molson (MOL/B)Molson Family 4,953,000 38.55%Ontario Mun. Empl. 1,156,000 9.00%La Caisse 435,344 3.39%Cundill & Associates 24,000 0.19%Toronto Dominion 6,200 0.05%Mondavi (MOND)Capital Guardian 729,300 9.13%Fidelity Mgmt. 687,500 8.61%Wellington Mgmt. 659,920 8.27%Capital Research & Mgmt. 566,700 7.10%Mass Financial 341,900 4.28%National Beverage Corporation (FIZ)Nick Caporella 14,267,000 77.17%Dimensional Fund 307,960 1.67%BZW Barclays Bank 302,330 1.64%O'Shaughnessy Capital 133,503 0.72%Vanguard Group 71,840 0.39%
Stock Listings
With the exception of Molson and Brown-Forman, the companies are only listed on U.S.
stock exchanges. Molson is listed in Canada on the Montreal, Toronto and Vancouver Stock
Exchanges, while Brown-Forman’s non-voting stock is traded on the London Stock Exchange
and the New York Stock Exchange (NYSE). Coors and Mondavi are traded on the NASDAQ,
Anheuser-Busch is traded on the NYSE and National Beverage Corp. is traded on the American
Stock Exchange (AMEX). The table below presents the average daily trading volume for the
companies. Anheuser-Busch is by far the heaviest traded company, while Molson and National
Beverage Corporation are the least traded. The data come at no surprise since Anheuser-Busch
has the most shares outstanding and, on percentage basis, the least number of shares that are
family owned. Moreover, the Molson and National Beverage Corporation are smaller companies
with most of the outstanding shares owned by the managing families.
AVERAGE DAILY TRADING VOLUME (1996 – 1997)
Anheuser Brown- Adolph Molson Robert Nat'l BeverageBusch Forman Coors Co. Ltd. Mondavi Corporation
Trading Volume 927,799 52,410 225,417 8393 54,421 8947
III. Risk & Return
A Top-Down Beta Estimate
In analyzing the risk and return factors for the beverage industry (both alcohol and non-
alcohol) we first looked at past performance. While the industry itself has entered a mature
growth phase, international opportunities are still prevalent. In the U.S., growth in alcohol
consumption is projected to grow at only 1%, whereas in countries such as England and Japan,
there are still tremendous growth potential. The stock prices and earnings for most of the
companies have grown steadily over the past five years.
Four of the companies’ betas are under 1, hovering around 0.7, signaling a stable, less
volatile stock price relative to the market (refer to graph below). The company that caught our
attention was Mondavi, a wine-retailer that continues to experience high growth. Mondavi has a
levered beta of 1.52 and an unlevered beta of 1.3, which are considerably higher than the
industry averages of 0.67 and 0.59, respectively. Mondavi resides in the premium wine category,
which has a significantly different risk profile than the rest of the alcoholic beverage industry.
Unlevered Betas
0
0.2
0.4
0.6
0.8
1
1.2
1.4
Alcoho
l
Non- A
lcoho
l
Enter
tainm
ent
Retail
Adolph
Coo
rs
Anheu
ser B
usch
Brown-
Form
an
Mols
on
Mon
davi
Nation
al
Since the Mondavi is relatively young and actively reinvesting to grow in this market, the
company carries unique risk characteristics. Therefore, we used the regression beta for Mondavi
throughout our calculations.
To calculate the Jensen’s Alpha, we used a monthly risk-free rate of 0.45%, which we
annualized to determine excess annual returns for all five firms relative to the market.
AdolphCoors
AnheuserBusch
Brown-Forman
Molson Mondavi NationalBeverage
CorpSlope 0.67 0.63 0.51 0.83 1.56 -0.17Intercept 0.44 0.24 0.49 -0.89 0.52 3.61Jensen's α, monthly(%) 0.28 0.07 0.25 -0.98 0.78 3.07Jensen's α, annually(%) 3.51 0.84 2.98 -11.09 9.36 36.84R-Squared(%) 7.00 21.00 10.00 27.00 16.00 0.00
The analysis suggests that most companies have performed better than expected. For
example, Mondavi and National Beverage Corporation have both had significantly better than
expected returns; National Beverage exceeded expectations by more than 36% over the past five
years. The only company to return worse than expected is Molson, which under-performed the
market average by 11%.
Although it may be an anomaly specific to these six companies, we note that there seems
to be a correlation between how well, or poorly, a firm performed to the amount of market
specific risk it holds. Molson had the highest R-Squared (0.27), but also the lowest Jensen’s
Alpha, suggesting poor past performance. Based on this analysis, it is not surprising that
Anheuser-Busch had the second highest R-Squared (0.20), and the second lowest Jensen’s
Alpha. However, when looking at National Beverage, we find that it has no risk due to market
factors (R Squared = 0) and the highest excess return. These findings suggest that the higher the
firm is subjected to market risk, the lower the excess annualized return. Thus, there is a negative
correlation between the two.
A Bottom-Up Beta Estimate
For most of the companies, we found that the top down beta carried too much noise (a
high standard error). Therefore, we calculated and applied a bottom up beta for all firms except
Mondavi. To estimate a bottom-up beta, some firms were separated into their respective business
divisions. The tables below present the various business sectors that some of our companies are
evolved in. For example, Anheuser-Busch is involved in entertainment activities that include
amusement parks. Brown-Forman actually is involved in household good sales, and Molson’s
businesses include alcoholic beverages and retail. Subsequently, the overall unlevered betas for
these companies were calculated from a weighted average of the business betas.
Companies with Different Businesses (All $ values in millions)Anheuser-Busch
Business EstimatedValue
UnleveredBeta
Division Weight Weight Beta
Alcohol Beverages $21,933.6 0.59 80% 0.47Entertainment $5,483.4 0.57 20% 0.11Firm $27,417.0 100% 0.59
Brown-FormanBusiness Estimated
ValueUnlevered
BetaDivision Weight Weight Beta
Alcohol Beverages $3,060.7 0.59 73% 0.43Household Goods $1,132.0 0.67 27% 0.19Firm $4,192.7 100% 0.62
MolsonBusiness Estimated
ValueUnleveredBeta
Division Weight Weight Beta
Alcohol Beverages $807.9 0.59 58% 0.34Entertainment $118.4 0.57 9% 0.05Retailing $459.7 0.74 33% 0.24Firm $1,393.0 100% 0.63
Coors, National Beverage, and Mondavi are involved solely in the beverage industry, so
their betas are calculated directly from their respective beverage betas. To lever up the betas of
our companies, we determined their market values of debt and equity with the following
formulas:
Market Value of Equity = Pstock * Shares where Pstock = Stock Price
Shares = Number of Shares Outstandingand Market Value of Debt = Expint* PVA(i,n) + BV of Debt * PV(i,n)
where Expint = Interest ExpensePVA = Present Value of Annuity FactorPV = Present Value Factori = Cost of Borrowingn = Average Maturity of Debt
The results are shown below.
AdolphCoors
AnheuserBusch
Brown-Forman
Molson Mondavi NationalBeverage
Market Value of Equity $1,186.0 $22,966.0 $3,879.0 $1502.3 $622.9 $191.8Market Value of Debt $273.9 $4,450.0 $313.7 $341.3 $164.9 $60.9Total Market Value $1,459.9 $27,416.0 $4,192.7 $1,843.6 $787.8 $252.7
From the market values of equity and debt, we computed the debt and equity ratios, which are
plotted in the following chart.
To determine the cost of equity, we used a riskfree rate of 6% and a risk premium of
5.5% with the following equation:
Expected Return = Rf + Beta*Rp
where Rf = Riskfree RateRp = Risk Premium
Debt and Equity Ratios
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
Alcohol
Non- Alco
hol
Entertainment
Retail
Adolph Coors
Anheuser B
usch
Brown-Form
an
Molson
Mondavi
National
Debt Ratio
Equity Ratio
Consistent with the top-down beta calculations, Mondavi is again the only company that
lies above the industry average for cost of equity. Their cost of equity is 14.36%, while the
industry average remains below double digits at 9.36%.
Business Unlev. Beta D/E Ratio Levered Beta Riskfree Rate RiskPremium
Cost ofEquity
Alcohol 0.59 22.00% 0.67 6.00% 5.50% 10.35%Non- Alcohol 0.73 37.00% 0.9 6.00% 5.50% 11.67%Entertainment 0.57 61.00% 0.8 6.00% 5.50% 11.01%Retail 0.66 71.00% 0.74 6.00% 5.50% 9.26%Adolph Coors 0.58 23.09% 0.67 6.00% 5.50% 9.73%Anheuser-Busch 0.59 19.38% 0.66 6.00% 5.50% 9.63%Brown-Forman 0.61 8.09% 0.64 6.00% 5.50% 9.52%Molson 0.63 22.72% 0.83 6.00% 5.50% 9.28%Mondavi 1.3 26.47% 1.52 6.00% 5.50% 14.36%National 0.73 31.75% 0.88 6.00% 5.50% 10.84%
Cost of Debt and Cost of Capital
To estimate the cost of debt for the different companies, we first ascertained the current
ratings of the companies. If the company was not rated, we used its interest coverage ratio to
determine a synthetic bond rating and a corresponding spread. We based cost of debt calculations
on a long-term Treasury bond rate of 6%, and added the respective spreads for each company to
this rate. To calculate the after-tax cost of debt, we used the following formula:
After-Tax Cost of Debt = (LT bond rate + Spread)(1-tax rate)
The marginal tax rates for each company depended on where they conducted business,
and added percentage points to the statutory tax rate of 35%. For example, Anheuser-Busch
conducts business primarily in the U.S., yet must also look at any tax issues in other countries.
Therefore, we used a 40% tax rate in determining the after-tax cost of debt for Anheuser-Busch.
On the other hand, Adolph Coors has less international penetration than Anheuser-Busch, and
thus a marginal tax rate of 35% is more appropriate for determining their after-tax cost of debt.
To calculate the cost of capital, we used a weighted-average of the cost of equity and
after-tax cost of debt, as shown in the following formula:
Cost of Capital = Cost of Equity(Equity Ratio) + A-T Cost of Debt(Debt Ratio)
The cost of equity, after-tax cost of debt, and cost of capital are given below both in tabular and
graphical form.
Business EquityRatio
Cost ofEquity
Debt Ratio A-T Cost ofDebt
Cost of Capital
Alcohol 83.72% 10.35% 16.28% 4.28% 9.36%Non- Alcohol 88.91% 11.67% 11.09% 5.30% 10.96%Entertainment 69.17% 11.01% 30.83% 3.93% 8.82%Retail 85.61% 16.35% 14.39% 4.43% 9.26%Adolph Coors 84.50% 9.73% 15.50% 4.88% 9.39%Anheuser-Busch 85.00% 9.63% 15.00% 4.20% 8.86%Brown-Forman 92.52% 9.52% 7.48% 4.42% 9.32%Molson 81.38% 9.28% 18.62% 4.07% 9.35%Mondavi* 81.00% 14.36% 19.00% 4.80% 12.36%National 76.00% 10.84% 24.00% 4.71% 9.37%
*We computed a bottom-up beta for Mondavi although a top-down beta was used here after.
Cost of Equity / Cost of Capital
0.00%
2.00%4.00%
6.00%8.00%
10.00%
12.00%
14.00%16.00%
18.00%
Alcoho
l
Non- A
lcoho
l
Enter
tainm
ent
Retail
Adolph
Coo
rs
Anheu
ser B
usch
Brown-
Form
an
Mols
on
Mon
davi
Nation
al
Cost of Equity
Cost of Capital
After analyzing the previous aspects of the company’s financial situation, it is also not
surprising that both Mondavi and Coors have the highest cost of capital. Mondavi is confronted
with a high cost of capital due to its very high cost of equity combined with their 81% equity
ratio. Their cost of capital is 12.36%, versus an industry average of 9.36%. Consistent with the
fact that Adolph Coors has a low rating of BBB, the company has the highest after-tax cost of
debt (4.88%), which is 0.6% higher than the alcoholic beverage industry. Coors also has the
second highest cost of capital (9.39%), due in part to the high cost of debt and low debt ratio.
However, this cost of capital is in line with the industry average, which suggests that the current
BBB rating does not increase their cost of capital by an extreme amount.
Analysis
In summary, we have analyzed the companies and calculated the betas from both a top
down and a bottom up approach. Based on this analysis, we used bottom up betas since they
provide a more accurate picture of firm risk and less noise in the information. The exception was
Mondavi, where we used the top-down beta because of its unique risk and return characteristics.
Furthermore, we see a wide range in the cost of equities for our companies, from a low of 9.28%
for Molson to a high of 14.36% for Mondavi. The wide range persisted in the cost of capital
comparisons with a low of 8.86% for Anheuser-Busch and a high of 12.36% for Mondavi. In the
next section, we perform a more comprehensive analysis of the hurdle rates that each company
needs to achieve, as well as how they have performed over the past few years.
IV. Measuring Investment Returns
The following table breaks down project characteristics by division.
Company Division Project Type CharacteristicsAdolph Coors Beer Manufacturing • Long term
• Dollar denominated• Non-cyclical
Anheuser-Busch EntertainmentTheme Parks
• Long term• Dollar denominated• Cyclical
Anheuser-Busch Beer Manufacturing • Long term• Mixed financing – U.S., Mexico, Japan, and Great Britain
Brown Forman Distilled AlcoholManufacturing
• Long term• US and Canadian dollar denominated• Non-cyclical
Brown Forman Crystal Manufacturing • Long term• US dollar denominated• Cyclical
Brown Forman Luggage Manufacturing • Long term• US dollar denominated• Cyclical
Brown Forman Wine Manufacturing • Long term• Variable due to weather/ environmental conditions• Mixed currencies, Italian, French, Chilean, and US• Cyclical
Molson Entertainment/Theme Parks
• Long term• Dollar denominated• Cyclical
Molson Beer Manufacturing • Long term• Canadian Dollar Denominated
Molson Building MaterialsRetailing
• Long term• Canadian Dollar Denominated• Cyclical
National Beverage Soft DrinkManufacturing
• Long term• Domestic• Non-Cyclical
Robert Mondavi Wine Manufacturing • Long term• Variable due to weather/ environmental conditions• Cyclical• Primarily dollar denominated w/ French and Chilean exposure
Project type characteristics of these companies are predominantly long term. Characteristics vary
by division with regards to cyclicality, currency, and unique characteristics.
Comparing return on equity (ROE) to the cost of equity and the return on capital (ROC)
to the cost of capital shows the effectiveness of project selection. These values are presented in
following table and chart.
Company ROE Cost ofEquity
EquityReturnSpread
ROC Cost ofCapital
CapitalReturnSpread
Adolph Coors 6.16% 9.73% -3.57% 5.47% 9.39% -3.92%Anheuser-Busch 28.90% 9.63% 19.27% 14.65% 9.47% 5.18%Brown Forman 23.54% 9.52% 14.02% 19.78% 9.32% 10.46%Molson 2.53% 10.57% -8.04% 1.65% 9.36% -7.71%National Beverage Co. 20.61% 10.84% 9.77% 12.71% 9.37% 3.34%Robert Mondavi 17.50% 14.41% 3.09% 8.90% 12.36% -3.46%Alcoholic Bev. Ind. Avg. 11.30% 9.70% 1.60% 9.25% 8.86% 0.39%Soft Drink Ind. Avg. 34% 11% 23.00% 20.47% 9.66% 10.81%
Equity Return Spread / Capital Return Spread
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Adolp
h C
oors
Anheuse
r Busch
Bro
wn F
orm
an
Molso
n
Natio
nal B
eve
rage
Robert M
ondavi
Alc. B
eve
rage In
d.
Non-a
lc. Beve
rage
Ind.
Equity Return Spread
Capital Return Spread
Based upon these results, it appears that Busch, Brown-Forman, and National Beverage
select good projects, but Adolph Coors and Molson choose poor ones. Depending on which
perspective we choose – that of an equity investor or that of a firm investor, Robert Mondavi
may or may not be selecting good projects.
Economic value added applies the equity spread and the capital spread to the book value
of the firm. The results of our calculations are represented in the following table.
Company Equity EVA (in $MM) Firm EVA (in $MM)Adolph Coors ($25.54) ($34)Anheuser-Busch $778 $787.07Brown Forman $93.93 $95.81Molson ($95.16) ($107.42)National Beverage Company $5.54 $6.42Robert Mondavi $20.71 ($13.95)
The EVA analysis mirrors that of ROE and ROC. Robert Mondavi has mixed results based upon
the perspective of the investor. Adolph Coors and Molson have made poor project choices. Last,
Anheuser-Busch, Brown Forman, and the National Beverage Company are earning returns on
their investments more than the capital and equity invested.
There are a variety of challenges facing the beer industry going forward, specifically for
Coors and Molson. Forecasts for the beer industry are not optimistic, the industry faces stiff price
competition and decreasing margins. The companies with the best fundamental performance in
this category appear to be Anheuser-Busch and Brown Forman, who are diversified in a variety
of different industries including theme parks, crystal and luggage. National Beverages is in a
healthy position to take advantage of an anticipated 5% increase in world wide soft drink
demand in 1998. Mondavi faces a variety of uncertainties. It is aggressively expanding its
operations and is ever more exposed to the vagaries of California weather. The 1997 grape
harvest was extremely strong, which threatens to trigger price competition in the premium
category of California wines.
V. Capital Structure Choices
Current Financing Mix
The following is a comparison of the different financing arrangements and their
maturities across the various business sectors of our companies.
Anheuser-BuschType of Financing Dollar Amount Interest Rate on Books Maturity
Commercial Paper $591.9M 5.5% VariedMedium Term Notes $62.5M 5.5%-8.0% 1-3 yearsSinking Fund Debentures $68M 8.5%-8.625% 1-20 YearsMedium Term Notes $250M 8.75% 2 yearsLong Term Notes $1,200M 6.75%-7.125% 4 – 20 yearsForeign Denominated Notes $675.2M 4.1%-5.1% 2-4 yearsLong Term Debentures $1,000M 6.75%-9% 11-29 yearsIndustrial Revenue Bonds $198.4M 5.625%-7.4%ESOP $282.1M 8.3%Other L/T Debt $37.5M Varied VariedTotal $4,365M 8 years
Brown-FormanType of Financing Dollar Amount Interest Rate on Books Maturity
Commercial Paper $155M 5.6% 1 yearMedium Term Notes $30M 6.82%-7.38% 8 yearsLong Term Notes $17M Variable 29 yearsOther Notes $22M 11.25% 2 yearsTotal $224M 5.75 years
CoorsType of Financing Dollar Amount Interest Rate on Books Maturity
Unsecured Medium Term Notes $88M 8.63% - 9.05% 1-3 yearsUnsecured Senior Notes $100M 6.76%- 6.95% 6 & 9 yearsIndustrial Dev. Bonds $5M 4.3% 17 yearsTotal $193M Approx. 5 years
MolsonType of Financing Dollar Amount Interest Rate on Books Maturity
Construction Loan $117.2M 4.88% 5 yearTerm Loan $157.7M 7.5% 5 yearsDebentures $160M 8.2%-9.1 6-21 yearsLand Lease Obligations $50M Prime rate 99 year leaseOther $17MTotal $501.9M Approx. 8 years
National Beverage CorporationType of Financing Dollar Amount Interest Rate on Books Maturity
Unsecured Notes $50M 9.95% 3 yearsUnsecured Term Loan $16.6M 1.25% above Libor CurrentCapital leases $.268 8% 1-2 yearsTotal $66.9M Approx. 1.5 years
Robert MondaviType of Financing Dollar Amount Interest Rate on
BooksMaturity
Fixed Rate Secured Loans $19.2M 6.33%-10% 1-8 yearsFixed Rate Unsecured Loans $89M 7.39% - 8.92% 2-10 yearsCapitalized Lease Obligation $5.9M 6.96% - 8% 5-13 yearsTotal $114.4M
Although the total debt balances vary by company within the sector, the composition of
the debt is quite similar, with the exception of Anheuser-Busch, which has the most sophisticated
debt arrangements of the group. The companies are primarily using a combination of unsecured
notes and term loans to provide financing as well as revolving credit agreements.
Trade-offs on Debt versus Equity
As shown below, a comparison of the advantages and disadvantages of debt relative to
other companies in the industry shows many common characteristics.
Factor All CompaniesTax Benefit See Table below labeled “Tax Rates”Added Disciplineof Debt
All of the companies are family run businesses and therefore have very significant stakes intheir respective companies and do not need the discipline that debt provides. All of thecompanies, except Molson, have family members managing the day-to-day business activities.The Molson family has three members on the board of directors including the Chairman.
Bankruptcy Cost See Table below labeled “Bankruptcy Costs”Agency Costs The companies are all family run and costs are more likely tracked very closely. Agency risk
does not appear to be significant for these companies.Future Flexibility This industry is not a high growth industry, but rather a mature industry. The growth has been
slow or negative for these companies. All of these companies already have existing beveragefacilities and there does not appear to be a significant need to expand further in the near termexcept Mondavi which is trying to expand its wineries and vinyards. Overall, financingflexibility does not appear to be an overriding factor. All continue to require debt for thecontinuation of their operations.
Tax RatesCompany Anheuser-
BuschBrown
FormanCoors Molson National
BeverageCorp.
RobertMondavi
Ind. Avg.
Marginal TaxRate
35% 35% 35% 41.9% 35% 35%
Effective TaxRate
38.1% 38% 42% 40.7% 37% 39% 38.79%
Bankruptcy CostsCompany Bankruptcy Costs
Anheuser-Busch Anheuser-Busch has had free cash flow (FCF) of less than $100M, on EBITDA of $2,053,over the last three years. However, they have taken on good projects in the past and theiroperating income has continued to rise which should help in stabilizing their cash flows. Thebankruptcy risk should be fairly low given these factors and the size of the company.
Brown Forman Brown-Forman has historically taken on good projects. They have FCF of approximately $50Mon EBITDA of $337M. The company has had very consistent earnings as well as cash flows.Additionally they have been able to handle higher levels of debt in the past. The bankruptcy riskshould be fairly low given these factors.
Coors Coors has taken on bad projects over the last few years. Their FCF has fluctuated and has notbeen that strong. Their earnings have also fluctuated from ($42M) to $78M over the last 10years or so. The company has moderate to high bankruptcy cost and should be wary of takingon any new debt.
Molson Molson’s net income has been decreasing over the past few years and this, in turn, is reducingtheir FCF. Nonetheless, they did have a relatively high income balance each of last five years.With an exception of 1996 which is an anomoly. This company has a low risk of bankruptcy.
NationalBeverage
National Beverage has had stable earnings that have ranged from about $18M-$20M over thelast five years. Overall, cash flows have been positively stable. This company has a low risk ofbankruptcy.
Robert Mondavi Although Mondavi’s earnings have been stable, their FCF’s have continued to erode to anegative position. They should not be taking on any more debt and present a moderatebankruptcy risk.
A Qualitative Judgement
Based on the above analysis, Brown-Forman and National Beverage appear to have some
excess debt capacity and are in a position to take on new debt if necessary. Anheuser-Busch
should maintain its debt position since its debt ratio appears to be about right. Robert Mondavi
and Coors should be not taking on any new debt, and Coors should begin to reduce its debt due
to its high earnings volatility and debt ratio.
VI. Optimal Capital Structure
Current Cost of Capital and Financing Mix
In Section III, we calculated the market value of equity from the top-down or bottom-up
betas and the cost of debt from the estimated bond ratings. We then used a debt ratio weight to
calculate the cost of capital. With the exception of Robert Mondavi, the costs of capital fell
within a narrow range. Mondavi’s higher hurdle rate is due mainly to company’s higher cost of
equity.
Company Cost of Capital – CurrentAnheuser-Busch 8.86%Brown-Forman 9.32%Coors 9.39%Molson 9.35%National Beverage 9.37%Robert Mondavi 12.36%
Comparison of Optimal Cost of Capital at Various Debt Ratios
The table below presents the cost of capital as a function of debt ratio for each company.
Cost of CapitalDebt Ratio Anheuser-
BuschBrown-Forman
Coors Molson NationalBeverage
RobertMondavi
0% 9.24% 9.39% 9.25% 9.74% 10.01% 13.15%10% 8.91% 9.08% 11.43% 9.40% 9.67% 12.77%20% 8.74% 8.90% 12.63% 9.16% 9.47% 12.74%30% 8.85% 8.89% 13.83% 9.04% 9.25% 13.08%40% 9.20% 9.12% 15.03% 9.38% 9.45% 15.02%50% 10.41% 9.70% 16.23% 9.59% 9.64% 15.92%60% 12.11% 10.83% 17.43% 11.17% 10.25% 16.82%70% 13.01% 12.69% 18.63% 13.10% 10.32% 17.72%80% 13.91% 13.59% 19.83% 14.05% 12.23% 18.62%90% 14.81% 14.49% 21.03% 15.00% 12.98% 22.31%
The optimal debt ratio varies significantly within the industry. For example, Coors has a
0% optimal debt ratio while at the high end, National Beverage, Molson and Brown-Forman all
realize their optimal ratio at 30%. It is unlikely that Coors will move to the 0% ratio, since it
currently has outstanding debt that is rated BBB and will need to continue to use debt to help
finance the activities of the company, and Coors is unlikely to be willing to give up any control.
(For further information on control of shares by the family, see Section I). Of the remaining
companies, only Brown-Forman and Molson currently operate far from their optimal debt ratios.
Firm Value at the Optimal Debt Ratio
The following are the formulas for the calculations in the ensuing table:
Annual Cost Before = WACC (Before)*Firm ValueAnnual Cost After = WACC (After)*Firm ValueChange in annual Cost = WACC (Before)*Firm Value - WACC (After)*Firm Value
(We assumed an implied growth rate of 5% in firm value over time)
Increase in firm value = Change in annual Cost*1.05/( WACC (After)-.05)Change in stock price = Increase in firm value/# of shares Outstanding
Company Annual CostBefore
Annual CostAfter
Change inAnnual Cost
Increase inFirm Value
Change inStock Price
Anheuser-Busch N/A N/A N/A N/A N/ABrown Forman $379.6M $365.2M $14.4M $388.7M $5.54/shareCoors $131.8M $129.8M $2.0M $49.4M $1.41/shareMolson $177.4M $173.2M $4.2M $109.4M $1.87/shareNational Beverage $23.7M $23.4M $0.3M $7.4M $0.40/shareRobert Mondavi N/A N/A N/A N/A N/A
The above table shows that by moving to the optimal, Brown-Forman, Coors, National
Beverage and Molson can all increase their firm value. National Beverage will only be able to
increase their firm value by about $13M while Brown Forman will be able to increase their firm
value by $389M. Therefore, moving to the optimal has very different effects on each company
and, while it makes sense for Brown-Forman, National Beverage, Coors and Molson to move to
their optimal, it is unclear whether these companies would since they maintain control through
family ownership and probably value flexibility. Since Mondavi and Anheuser-Busch currently
operate very close to their optimal debt ratio, we did not calculate new values for these firms.
Operating Income Variability
As shown below, normalizing operating income by averaging over the past few years has
little effect on the optimal debt ratios, except for Mondavi and Molson. However, since both
Mondavi and Molson have experienced sharp trends in operating income (although in opposite
directions) over the past four years, we decided to use the optimal debt ratios calculated in the
previous subsection with non-normalized income levels.
Company New Debt Ratio Old Debt RatioAnheuser-Busch 20% 30%Brown Forman 30% 30%Coors 0% 0%Molson 30% 50%National Beverage 30% 30%Robert Mondavi 90% 20%
Ratings Constraint
Rating constraints are given in the table below. Most of the companies would probably be
able to move to their optimal debt ratio without needing to impose a rating constraint. As all of
these companies are family operated, they do not need the control afforded by debt. However,
the companies may also be willing to finance with greater debt ratios, since they are not as
concerned with the other stockholders and may not be concerned with debt ratings.
Company Optimal DebtRatio
Optimal Rating ConstrainedRating
Constrained DebtRatio
Anheuser-Busch 20% BBB 20% BBBBrown Forman 30% BB 30% BBCoors 0% D 0% DMolson 30% BB 30% BBNational Beverage 30% BBB 30% BBBRobert Mondavi 20% B 10% Min. A rating
Industry and Market Analysis
Half of the companies have debt to equity ratios that are comparable to the industry
average of 22%, with the exceptions of Brown-Forman at 8.09%, Molson at 53.61%, and
National Beverage at 31.75%. As there is limited historical information on some of the
companies, performing regressions with multiple variables would not provide a statistically
significant information. The average debt to equity ratio for the overall marketplace is 24.28%,
which is above that of Coors, Anheuser-Busch, and Brown-Forman but below that of National
Beverage, Molson, and Mondavi.
Summary
The above analysis indicates that the companies’ optimal debt ratios are insensitive to
“outlier years” since the results do not change when normalized incomes are applied (except as
noted with Mondavi and Molson). It is unlikely that Coors will change its debt ratio since the
potential change in firm value and the need for manager control are relatively small. However,
Brown-Forman would be wise to move to the optimal since even with a ratings constraint the
company can significantly increase firm value. National Beverage and Molson are also
underlevered, however, not to the same degree as Brown-Forman. Thus, we do not anticipate a
substantially change in leverage for these firms. Finally, Mondavi and Anheuser-Busch appear to
be properly levered and will most likely not change their debt ratios.
VII. Mechanics of Moving to the Optimal
Path to the Optimal
The following table provides information on how our companies should move towards
their optimal debt ratios. Although we provide suggestions on how they should achieve their
optimal debt ratio, we anticipate that only Brown-Forman will change its leverage significantly.
Company Actual/Optimal Threat ofTakeover/Bankruptcy
How should it movetoward the optimal
Adolph Coors Coors’ current debt ratio is15.5% and the optimal is0%.
Rated BBB. It is a familyowned business and it hasbeen profitable for over 10years. The firm hasmoderate to highbankruptcy costs.
No new debt orarrangement of debtshould be taken. If Coorswants to take on projects itshould use equity tofinance them.
Anheuser-Busch Anheuser-Busch’s currentdebt level is 16% and theoptimal is 20%.
Rated A. It is below itsoptimal debt level but isnot a likely takeover targetbecause of its large size$23 billion and because ofthe large amount of stockheld by insiders.
Earning above its cost ofcapital (8.86%) based onits ROC (14.7%). They arecurrently at their optimallevel and should try to staythere.
Brown-Forman Brown-Forman’s currentdebt level is 8% and theoptimal is 30%.
Rated A+. Not at risk of atakeover because of thelarge amount of stock heldby the family 70%.
Earning well above its costof capital (9.32%) basedon ROC (19%). Theyshould use debt to expandand invest over the next 5years.
Molson Molson’s current debtlevel is 22.32% and theoptimal is 60%
Rated A+. Not at risk of atakeover because of thefamily ownership of alarge number of shares.
Eaving problems earningabove its cost of capitalrecently, but if the firmfinds good projects itshould use debt to pay forthem.
National Beverage National Beverage’scurrent debt level is 24%and the optimal is 30%.
Rated A- synthetically.Not at risk of a takeoverbecause of the largepercentage of shares heldby the family.
Above its cost of capital(9.37%) based on ROC(15%). They should usedebt to expand and investover the next 5 years.
Robert Mondavi Robert Mondavi iscurrently at their optimaldebt ratio 20%.
Synthetically rated A-. Notat risk of a takeoverbecause of the largepercent of shares that thefamily owns. The firm hasmoderate to highbankruptcy costs.
Currently at their optimaldebt ratio 20%.
None of the firms are in serious danger of a takeover due to the large number of shares
held by family members or the large size of the firm. Adolph Coors and Robert Mondavi are the
firms with the lowest ratings but are in little risk of bankruptcy. Anheuser-Busch, Brown Forman
and National Beverage should continue to expand using debt since they are choosing good
projects. They should use debt to take on additional projects because they are all below their
optimal debt ratios and they can maximize firm value by approaching the optimal debt ratios.
The Right Financing for Our Firms
The following table provides the project cash flow characteristics and types of financing
that our firms should use.
Business Sector Project Cash Flow CharacteristicsProjects are likely to be:
Type of FinancingDebt Should be:
Beverages(Alc.)
• long term• primarily in dollars; some firms w/ foreign incomes• non-cyclical
• long term• dollar denominated but portions
in foreign currency• try to link to success of new
products introduced Beverages (Non-Alc.)
• long term• primarily in dollars• non-cyclical
• long term• dollar denominated• try to link to success of new
products introduced Entertainment • long term
• primarily in dollars• cyclical
• long term• dollar and Canadian dollar
denominated HomeFurnishings
• medium term• primarily in dollars• cyclical
• medium term• in dollars
Retail-BuildingSupply
• medium term (tied to store life)• primarily in dollars• cyclical
• in the form of operating leases
Most of the projects in these sectors are long term and denominated in dollars. More specifically,
the Beverage Sectors have long-term projects that include the introduction of new products and
the building of new production facilities. Home Furnishings and Retail-Building Supply have
medium term projects and have some operating leases. The duration of the debt in these sectors
should match the length of the project.
Influences of Macro-Economic Variables on Firm Value and Operating Income
Macro Variable Company/Results of Regression Implications for FinancingLong Term Interest RatesRegression Coefficients for:(1) Firm Value(2) Operating Income
(1) (2)Adolph Coors -10.20 17.80Anheuser-Busch -1.99 17.30Brown-Forman 0.68 -3.96Molson 2.34 1.20National Beverage 3.80 -7.10Robert Mondavi 69.00 -11.40Average 0.6 (-1.07) 2.31
Although some of the individualregressions show some signs of long-term duration, on average thecombined averages do not show signsof long term duration. It appears asthe firms become stable, they shoulduse short-term duration debt.
Real GDP Growth(1) Firm Value(2) Operating Income
Adolph Coors -8.00 30.50Anheuser-Busch -9.02 9.30Brown-Forman 2.23 -6.77Molson -7.68 10.90National Beverage 12.50 -11.90Robert Mondavi 175.00 -31.80Average 27.5 (-2.00) 0.04
On average, it appears that thesefirms are non-cyclical. The firmvalues seem to be influenced bycyclicalities on average, but whenRobert Mondavi’s outlier is removedfrom the average the relationship isfar less significant.
Weighted Dollar(1) Firm Value(2) Operating Income
Adolph Coors -1.24 3.94Anheuser-Busch 0.60 -3.89Brown-Forman 1.08 0.28Molson 4.82 -5.22National Beverage 0.77 4.80Robert Mondavi 2.90 -0.41Average 1.49 -0.08
The effect of the dollar does not seemto have a large effect on these firms.Therefore the majority of the debtshould be issued in US dollars, butthere is evidence to suggest that someof the debt should be issued inforeign currencies. This should beevaluated on a firm by firm basis.
Inflation Rate(1) Firm Value(2) Operating Income
Adolph Coors -12.80 14.60Anheuser-Busch 0.20 71.70Brown-Forman -3.87 -1.32Molson 10.40 -9.20National Beverage -5.43 -26.20Robert Mondavi 8.60 5.80Average -0.48 9.23 (-3.26)
Again, conflicting results reveal thatthe companies are not consistent buton average the firm’s income seemsto be effected by the inflation rate.This indicates that some of thesector’s debt should be issued atfloating rates.
Looking at the regressions, a general sense of the types of debt that these firms should
use is evident. It appears that the firms should use medium to long duration debt, but as the firm
becomes more stable, the duration should decrease. Robert Mondavi is the best example of a
firm that should use long-term debt, while Anheuser-Busch should use short-term debt.
On average the firms do not appear to be cyclical, with the exception of Robert Mondavi.
They also do not appear to be influenced by fluctuations in the dollar. The majority of the debt
should be issued in dollars and does not need to be shielded from cyclicalities. The exceptions
are Brown-Forman and Robert Mondavi, which have substantial investments internationally and
should issue a portion of their debts in foreign currencies. The firms’ incomes seem to be
effected by the inflation rate; thus, some of the debt should be issued with floating interest rates.
Influences of Macro-Economic Variables on Sector Value & Operating Income
Macro Variable Results of Regression Implications for FinancingLong Term Interest RatesRegression Coefficients for:1) Market Value2) Operating Income
Beverages (Alc.) -14.6 6.84Beverages (Non-Alc.) 0.65 2.56Entertainment 20.7 2.75Home Furnishings 1.67 10.7Retail-Building Supply 0.27 6.73
Based on industry averages itappears that the duration of debt inthe Beverages (Alcoholic) sector is15 years. All of the other sectorsthat these firms are in seem to favorshort-term durations of debt.
Real GDP Growth1) Market Value2) Operating Income
Beverages (Alc.) -6.80 -20.9Beverages (Non-Alc.) 0.90 6.39Entertainment 25.8 9.70Home Furnishings 3.98 23.9Retail-Building Supply -2.74 1.61
The Alcoholic-Beverage sectorseems to be influenced bycyclicalities. As the GDP rises thefirm value and the income arereduced. The other sectors seem tobe sensitive to cyclicalities as wellbut they tend to move with the GDPgrowth. This indicates a need fordebt that protects from GDPfluctuations or reduced debt levels.
Weighted Dollar1) Market Value2) Operating Income
Beverages (Alc.) -1.14 1.69Beverages (Non-Alc.) -0.58 0.38Entertainment -0.17 0.57Home Furnishings -0.11 1.43Retail-Building Supply 1.18 -0.56
Once again the Alcoholic-Beveragessector does not seem to be sensitiveto fluctuations in the dollar. Theother sectors are also not sensitive tofluctuations in the dollar.
Inflation Rate1) Market Value2) Operating Income
Beverages (Alc.) -67.7 -14.7Beverages (Non-Alc.) -0.01 -2.12Entertainment 30.7 -9.05Home Furnishings -1.24 3.20Retail-Building Supply 1.69 -1.50
In the Alcoholic-Beverages sectorthe firm value and operating incomeare strongly influenced by theinflation rate. The relationshiphowever is one such that wheninflation increases the income andvalue decrease. Only theEntertainment sector’s value moveswith inflation. This indicates thatsome of the debt in this industryshould be a floating rate.
Some of the other sectors that the firms are in conflict with the type of debt that should be
used in the Beverage Sector. Each firm should evaluate itself and adjust its debt accordingly.
These regressions were computed using five data points for each economic variable and
produced T-scores that were quite low, indicating that the data did not provide statistically
significant results. Each firm should regress of its value and income and compare to the
macroeconomic data. In general, the data presented here is a good estimate for the sector, but
each firm should be aware of its differences from the sector and make adjustments accordingly.
VIII. Dividend Policy
With the exception of Mondavi and the National Beverage Corporation, the companies
have historically used a mix of dividends and stock repurchase programs to return cash to their
investors. The National Beverage Company initiated its first stock repurchase program in 1997
and has never paid dividends. The tables below summarize the cash returned to shareholders for
each of these companies and the corresponding dividend ratios.
Company 1997 1996 1995 1994 1993Adolph Coors Dividends ($millions) 18.98 19.07 19.15 19.00 18.80 Stock Repurchase ($millions) 2.95 9.94 9.94 - - Cash to Stock Holders ($millions) 21.93 29.01 29.09 19.00 18.80Anheuser-Busch Dividends 492.60 485.90 429.50 389.80 370.00 Stock Repurchase 587.10 770.12 393.40 - - Cash to Stock Holders 1,079.70 1,256.02 822.90 389.80 370.00Brown-Forman Dividends Dividends 73.00 71.00 67.36 73.84 71.56 Stock Repurchase - - - - - Cash to Stock Holders 73.00 71.00 67.36 73.84 71.56Molson Dividends 39.18 35.56 40.05 36.82 38.22 Stock Repurchase - - - 0.02 120.28 Cash to Stock Holders 39.18 35.56 40.05 36.84 158.50Nat'l Beverage Co. Dividends - - - - - Stock Repurchase 1.20 - - - - Cash to Stock Holders 1.20 - - - -Robert Mondavi Dividends - - - - - Stock Repurchase - - - - - Cash to Stock Holders - - - - -
Company DividendYield
DividendPayout
Adolph Coors 1.62% 68.50%Anheuser-Busch 2.18% 46.26%Brown Forman 1.89% 27.00%Molson 2.81% 180.00%National Beverage Company 0.00% 0.00%
Robert Mondavi 0.00% 0.00%Industry Average 2.50% 39.09%
The dividend yield for the industry is relatively small, which is also reflected in the
companies represented here. Anheuser-Busch and Molson pay the most of their earnings in the
form of dividends. However, it is clear that Molson is paying out more than it can afford.
Trade-Offs on Dividend Policy
The following tables provide detailed discussions of the ramifications of the dividend
policies of each company.
Stockholder Tax PreferencesCompany Implications
Adolph Coors Given Coors’s long history of consistent dividends their shareholders clearlyhave a preference for dividends.
Anheuser-Busch Busch’s shareholders are predominantly institutional investors who wouldnot normally desire dividends however their dividend policy has been inplace for over ten years and recent shareholders might prefer dividends.
Brown-Forman The majority of Brown-Forman’s investors are family members, given theconsistent history of dividends family members seem to prefer dividends asa source of income.
Molson Molson has a long consistent dividend policy the average investor is likelyto have a preference for dividend income.
National Beverage Company The company has not used a consistent dividend policy or stock buybackprogram implying that its shareholders prefer capital gains.
Robert Mondavi The company has never paid dividends or used dividends it investors areinterested in capital gains.
Information Effects and Signaling IncentivesCompany Implications
Adolph Coors Coors should not have to use dividends as a signal to markets in the fashionthat it does.
Anheuser-Busch Anheuser-Busch is one of the most well followed beer companies in theUnited States and does not need to rely on dividends for communicationswith markets.
Brown-Forman The company uses dividends as a signal unnecessarily; the vast majority ofits investors is family members and should not need these signals.
Molson Molson is a large well followed firm in Canada and should not need to usedividends as a signal of its health.
National Beverage Company The insiders who are the majority of National’s investors do not need stockrepurchase as a signal from the company.
Robert Mondavi The company has eight analysts following the stock and does not need stockrepurchase or dividends to signal markets.
Effects on FlexibilityCompany Implications
Adolph Coors Coors is in a low growth industry, consistent markets share, and has controlover its financial needs flexibility is not a high priority.
Anheuser-Busch Busch takes on long term projects and has produced consistent earnings overits long history future flexibility is not an important factor.
Brown-Forman Brown-Forman has highly consistent earnings and exercises a great deal ofcontrol over its projects; future flexibility is not meaningful concern.
Molson Molson has recently gone through a difficult period where earnings havedeclined, future flexibility might be a concern however dividend payout isrelatively low.
National Beverage Company Although, National is in a mature slow growth industry, it is a relativelynew company and probably values flexibility.
Robert Mondavi Mondavi is attempting to grow quickly taking on a variety of new projects.They have had relatively consistent earnings but variable cashflows. Futureflexibility is very important.
Bond Covenants and Rating Agency ConcernsCompany Implications
Adolph Coors Coors bond covenants do not pertain to dividends,Anheuser-Busch No restrictive bond covenants, rating is not likely to be concern.Brown-Forman No restrictive covenants, rating is not likely to be a concernMolson Neither bond covenants nor rating would be a concern for Molson.National Beverage Company No restrictive bond covenants, rating is not likely to be concern.Robert Mondavi No restrictive bond covenants however, a change in rating is likely to be a
concern if a dividend policy is initiated.
The mature nature of the beverage industry, predictable earnings, and long-term projects
of these firms suggest that returning cash to investors is a reasonable policy. However, several of
these companies have been paying out more in dividends and stock repurchases than their free
cash flow to equity. For instance, Anheuser-Busch may be repurchasing stock in order to move
to their optimal debt ratio. This suggests that adopting stock repurchase programs might be a
more effective means of returning cash to stockholders, particularly to a company such as
Molson, which has had decreases in earnings but has been obliged to pay dividends to its
shareholders. Many of these firms have been paying dividends consistently for many years, and
investors would be upset if the dividend policy were changed, with the exceptions of Mondavi
and National Beverage Company. Mondavi has been reinvesting in the firm heavily and has not
returned cash to investors, nor has it been able to do so. National Beverage Company has just
instituted a repurchase program to return cash to its investors, but still returns only a minimal
amount of cash to shareholders.
IX. Dividend Policy: A Framework
Free Cash Flow To Equity (FCFE) between 1993 and 1997
The following tables shows the free cash flow to equity and the actual cash to
shareholders for each firm over the past five years.
Firm Net Income (Cap Ex-Depr)*(1-DR) Chg in WC*(1-DR) FCFEAdolph Coors $23.34 -$29.09 -$4.13 -$9.88Anheuser-Busch $925.60 $341.52 $3.94 $580.14Brown-Forman $264.91 $7.69 -$18.30 $275.52Molson $21.04 $87.82 $13.21 -$79.98National Beverage $7.17 -$1.67 -$1.03 $9.86Robert Mondavi $21.65 $16.42 $24.84 -$19.60Average $210.62 $70.45 $3.09 $126.01
On average, the firms could have returned $126 million in cash to its stockholders in
dividends or stock repurchases.
Average payments to equity between 1993 and 1997
Firm FCFE Dividends + Stock BuybacksAdolph Coors -$9.88 $18.73Anheuser-Busch $580.14 $778.30Brown-Forman $275.52 $71.35Molson -$79.98 $62.03National Beverage $9.86 $0.24Robert Mondavi -$19.60 $0.00Average $126.01 $155.11
Some of the firms actually returned more to the stockholders in the form of dividends and
stock buybacks than they had in free cash flow to equity, and are thus paying more than they can
afford. This of course will not continue indefinitely. Over the past few years, Adolph Coors,
Molson and Robert Mondavi averaged negative free cash flows to equity. Robert Mondavi did
not return any cash to the stockholders, but Molson and Adolph Coors did. Anheuser-Busch
paid more to the stockholders than it had in free cash flows. This indicates a strong desire by
stockholders in this sector to have cash returned to them.
Trust in management
It appears that the management at these firms take strong interest in the stockholders’
needs because the average payback to stockholders is larger than the free cash flow to equity.
The investors in these firms have come to expect cash paybacks to the stockholders and currently
some of these firms do not have enough free cash flows to pay them. In the short-term, it appears
that the managers of these firms are very committed to the stockholders, which may be due to the
family ownership and control of the companies.
Stock price performance is another indicator of how much these firms should be trusted.
The companies are consistent in their performance in this area, with the exception of Molson –
which has incurred annualized returns of –11%. The rest of the firms have above average gains,
topped by Mondavi and National Beverage Corporation, which have returned over 30% more to
investors than similar firms and the market.
The last criterion is the firms’ investment policies. Below is a five year average of each
companies’ investment returns (i.e., return on equity, return on stock, and required returns).
Return on Equity and Stock and Required Returns (5-year Average)
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
Adolph
Coo
rs
Anheu
ser B
usch
Brown-
Forman
Molson
Nation
al Bev
erag
e
Rober
t Mon
davi
ROE
ROS
Required Returns
As you can see from the chart, Brown-Forman, National Beverage and Robert Mondavi
all had returns on stock that exceeded their required returns, while only Brown-Forman’s return
on equity exceeded its required returns. On average, Adolph Coors and Anheuser-Busch have
not achieved their required returns.
Conclusions
Adolph Coors, Anheuser-Busch, Molson and Robert Mondavi cannot continue to pay
more to equity than they have in free cash flow. Of these companies, Anheuser-Busch is in the
least troublesome position due to its size and the relative difference between the cash flow and
payments to equity. Anheuser-Busch has earned some flexibility in their dividend policy and
should try to reduce their high dividend payout of 46%. Adolph Coors, Molson and Robert
Mondavi, on the other hand, are in precarious positions since they have negative free cash flows
to equity. Mondavi has not made payments to equity and should not until their growth stabilizes.
Coors and Molson are stable firms and need to increase their cash flows to equity if they wish to
continue with their current dividend policy.
National Beverage and Brown-Forman have demonstrated better performance with
respect to free cash flow, and may therefore be more trusted by their stockholders. As a growth
firm, National Beverage should continue with its 0% payout policy until growth subsides, and
should subsequently set their payout ratio close to the industry average of 39%. Brown-Forman
has a consistent dividend policy with a payout ratio of 27%, which is lower than the alcoholic
beverage industry average of 39%. Brown-Forman is now a stable firm and should move the
payout ratio closer to the industry average. Both National Beverage and Brown-Forman have
earned some leeway on their dividend policy due to their high performance with respect to their
capital returns on stock.
X. Valuation
Model Selection
Mondavi, National Beverage Corporation, and Anheuser-Busch
We valued Mondavi, National Beverage Corporation, and Anheuser-Busch using a 2-
stage FCFE discount model since we expect these companies to grow at double-digit rates, but
with no substantial change in debt ratio. Although Anheuser-Busch has realized only moderate
EBIT growth over the past 5 years, the company has gone through some restructuring and is
poised for exceptional growth. Moreover, Mondavi and National Beverage are both relatively
small and do not present high barriers to entry, so we expect their exceptional growth period to
be limited to approximately 5 years. Anheuser-Busch has brand equity as a barrier to entry, but
we feel that the barrier is declining with the heightened popularity of other small and moderately
sized alcoholic beverage companies. Thus, we also used a 5-year exceptional growth period for
Anheuser-Busch.
Brown-Forman
We valued Brown-Forman using a stable growth FCFF model since Brown-Forman has
low expected growth, and we anticipate a change in debt ratio towards its optimal.
Coors and Molson
We valued Coors and Molson using a stable growth FCFE model because these
companies have low expected growth, and we do not anticipate any significant change in debt
ratio.
Estimation of Inputs
The inputs are summarized for each firm on the pages following this section.
Valuation
A schematic representation of each firm’s valuation is given on the pages following this
section. We valued our companies as follows:
Anheuser-Busch, Mondavi and National Beverage Corporation:
The present value of the free cash flow to equity (per share) is added to the present value
of the terminal value (per share) to determine the value of equity per share, which are shown
below for Anheuser-Busch, National Beverage Corporation and Mondavi.
Value of Equity Per Share for Anheuser-Busch = $52.76Value of Equity Per Share for National Beverage Corporation = $12.75Value of Equity Per Share for Mondavi = $44.03
Brown-Forman:
The present value of the free cash flow to the firm is used to determine the value of the
firm, which is shown below.
Value of Brown-Forman = $3056 Million
We next subtracted the market value of existing debt of $313 million from this value to
arrive at the value of equity.
Value of Equity for Brown-Forman = $2743 Million
Finally, we arrived at the value of equity per share by dividing by the number of shares:
Value of Equity Per Share for Brown-Forman = $39.07
Adolph Coors and Molson:The present value of the free cash flow to equity (per share) is used to determine the
value of equity per share, which are shown below for Adolph Coors and Molson.
Value of Equity Per Share for Adolph Coors = $29.03Value of Equity Per Share for Molson = $12.44
Analysis
The current and forecasted stock prices are shown graphically below. Our analysis
indicates that Anheuser-Busch, Mondavi, and National Beverage Corporation are currently
undervalued, while Adolph Coors, Brown-Forman, and Molson are overvalued. On a percentage
basis, National Beverage Corporation is most undervalued (by 23% of the current price), and
Molson is the most overvalued (by 52% of its current stock price).
0
10
20
30
40
50
60
NationalBeverage
Coors Mondavi Brown-Forman
Molson AnheuserBusch
Current & Forecasted Stock Prices
Current
Valuation
Sensitivity to Assumptions
All of these valuations incorporate subjective parameterization, and the appraisal can be
sensitive to these specifications such as the assumed debt ratio changes. For example, the value
of Adolph Coors goes from $29.03 per share to $28.43 per share when the debt ratio changes
from the current value of 15.5% to the optimal of 0%. However, most of our firms (except
Brown-Forman) are near their optimal debt ratio, so the magnitude of debt change effects is
small. The assumed growth rate of the stable growth period has perhaps the most significant
effect on the valuations. The results of a growth rate sensitivity analysis are provided below.
Stock Valuation as a Function of Stable Phase Growth Rate
$-
$20.00
$40.00
$60.00
$80.00
$100.00
$120.00
$140.00
$160.00
1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
Growth Rate
Sto
ck V
alu
atio
n
Adolph Coors
Anheuser Busch
Mondavi
Brown-Forman
Molson
National Beverage
From the chart, we see that the stock valuations are quite sensitive to the assumed stable
phase growth rate. For example, the valuation of Brown-Forman increases from $39.07 at a
growth rate of 5% (as in our previous analysis) to $62.50 at a growth rate of 7%, as compared
with the current stock price of $55.25. Moreover, the valuation of Molson jumps from $12.44 at
a growth rate of 5% (as in our previous analysis) to $23.76 at a growth rate of 8%, as compared
with the current stock price of $25.75. Likewise, the valuations of the other firms can be made
consistent with the current stock prices by altering the growth rate assumptions.
Summary of Valuation
The previous sensitivity study indicates that valuations are quite sensitive to model input
assumptions. By iterating on input parameters, valuations can altered to provide values that
match the current stock price. Obviously, this procedure invalidates the valuation. In our initial
valuation, we attempted to use a combination of historical financial data and objective
assumptions to forecast future free cash flows, then discounted the case flows by either the cost
of equity or cost of capital to determine equity value. Although our valuations are much different
than the current stock prices in two cases, we are fully confident in all of our results. For
example, our valuation of Molson indicates that its stock price should be approximately 50% of
the current value. This is a surprising result, however, we believe that the company has been
taking poor projects and, against better judgement, paying dividends far exceeding earnings.
Thus, we feel that the current price is well above what is deserved. The other company that we
significantly undervalue is Brown-Foreman; a valuation that we found to be quite sensitive to the
growth rate assumption. In our best estimate, however, we believe that Brown-Foreman is
overpriced at the current stock price. All other valuations are close enough to the current stock
prices to conclude that they are reasonably valued in the stock market.