Waterloo Brewing Ltd. (TSX: WBR) formerly Brick Brewing Co Ltd., is a Canada-based brewery. It is engaged in the production, distribution and sale of alcohol-based products. It produces, sells, markets and distributes packaged and draft beer under the Waterloo brand name, as well as beers under the Laker, Red Baron, Red Cap and Formosa brand names, collectively known as the Brick Beer Brands.

Investment rationale

• Branded Volume Reported ~ 28% Growth on a YoY basis: The group closed the second quarter of FY21, with a 28% volume growth in branded sales against the year-over period. The growth was driven primarily by increased sales volumes of the Laker brand due to its price in comparison to competitive products. Laker family brand sales volumes increased by 27.9% on a YoY basis, while Waterloo brand sales volumes increased by 25.0%.

Branded Volumes. Source: Company Q2FY21 Result Update

• Focus on Improving Gross Margin Per Unit: The Laker brand volume has performed well despite the presence of many beer brands at the same or similar pricing. Laker’s fit and finish are comparable with mainstream brands. The management believes that this volume performance in a highly competitive pricing environment is the result of brand support, a compelling value proposition, and significant quality improvements at Waterloo Brewing in recent years. Further, with the decrease to the MRP by Ontario’s provincial government in August 2018, the Company would strive to maintain healthy margins while facing potential competitive challenges. Also, Sales of Seagram and Waterloo products, along with LandShark® would also contribute to margin improvement due to higher revenue per unit. The Company will continue to maximize margin and minimize complexity within the organization by delisting underperforming brands.
• Insiders are increasing the stake consistently: Over the past 1-year, the insiders have significantly increased their stake in the company, especially after the correction recorded in March 2020. Insiders capitalized the opportunity to accumulate shares at a lower price. Also, a higher insider buying activities over the past 1-year implies that the insiders are quite bullish on the company’s future performance. These insiders buying activities bring a lot of confidence in the stock from existing and potential shareholders standpoint. Also, WBR shares are up approximately 42% on a YoY basis, and strongly outperforming the benchmark index at the same time. We believe that insiders buying played an important role in the stock price surge.

Insiders Transactions Over the Past 1-Year. Source: Refinitiv (Thomson Reuters)

• Shares Recorded Strong Relative Performance: Amid market turmoil, WBR shares recorded a secular price rally, as the shares are up by ~ 42% on a YoY basis, up ~29% on a YTD basis, soared ~ 49% in the last 3-months and gained ~11% in a moth over period. The stock significantly outperformed the benchmark TSX Composite index in the above time period by 48%, 38%, 51% and 13%, respectively.

• Shares are Hovering above the Crucial Support Levels: Despite the recent weakness in the stock over the past two weeks, shares of WBR still traded above the crucial short-term as well as long-term support levels of 50-day SMA and 200-day SMA. More importantly, the Price/200-day SMA ratio in the WBR stocks stood at 1.35x, which implies that WBR shares are trading approximately 35% above its 200-day SMA, a positive indicator. Also, the Moving Average Convergence Divergence (MACD) is hovering above its signal line, with the spread between 12-day and 26-day EMAs is positive.

WBR Price vs 200-day and 50-day SMAs. Source: Refinitiv (Thomson Reuters)

• A Potential Pull-back on the Cards: At the last closing price, WBR shares traded below the lower Bollinger Band©, which is 2x downside deviation from 20-day SMA. This implies a potential pullback can take place in the stock. Otherwise, CAD 4.27 will act as major support for the stocks, which 3x lower deviation from 20-day SMA.

Technical Price Chart (as on November 03^rd, 2020). Source: Refinitiv (Thomson Reuters)

• Consistent Dividend Payment: Regardless of the market conditions, the company  consistently paid a dividend over the past five years. At the last closing price, WBR shares were featuring a dividend yield of 2.3%, which is moderate, given the lower interest rate environment. Further, the company has paid CAD 1.8 million in dividends in the Q2FY21, compared to dividends of CAD 0.9 million during the same quarter the previous financial year. Consistent dividend payment reflects the cash flow generating capacity of the group across the economic cycles.

Dividend Payment Over the Past 5-years. Source: Refinitiv (Tomson Reuters)

• Risk Associated with Investment: The Company is exposed to commodity price risk with respect to agricultural and other raw materials used to produce the Company’s products, including malted barley, hops, corn syrup, water, and packaging materials (including glass, aluminum, cardboard and other paper products), where fluctuations in the market price or availability of these items could impact the Company’s cash flow and production. The supply and price can be affected by several factors beyond management’s control, including market demand, global events, frosts, droughts and other weather conditions, economic factors affecting growth decisions, plant diseases, and theft.

Financial Highlights: Q2FY21 (CAD million)

Source: Company Filing

• The company closes the second quarter of FY20, with a net revenue of CAD 24.57 million, recorded an increase of approximately 44% against CAD 17 million reported in the corresponding quarter of the previous financial year.
• Solid growth in net revenue was driven by an increase in branded sales volumes despite an increasingly competitive industry due to competitive pricing.
• In the second quarter of FY21, the Company’s overall branded sales volume increased by 27.8% to 100,700 hectoliters, compared to 78,800 hectoliters in the second quarter of FY20.
• Revenue generated from co-packing products for customers increased by 76% in the second quarter of FY21 compared to a 3.2% increase in the second quarter FY20. This was primarily driven by recently signed multi-year contracts with Carlsberg®, Hiram Walker®, and another large copack partner that cannot be named due to terms of the Company’s agreements with this partner. The Company continues to seek new partners to drive incremental growth and utilize excess capacity.

Revenue Break-up. Source: Company Filing

• During the second quarter of fiscal 2021, the Company’s production tax and distribution fees represented approximately 55.4% of owner-brand gross revenue compared to 56.2% in the same period during fiscal 2020.
• In the second quarter of fiscal 2021, selling, marketing and administration (SM&A) expenses totaled CAD 3.4 million, down CAD 0.4 million from the same period in fiscal 2020. The reduction is driven by the cancellation of sponsorships and special events, as well as a reduced sales force due to COVID-19.
• SM&A expenses as a percentage of net revenue were 13.9% during the second quarter of FY20 against 22% reported in the second quarter of FY20.
• The Company reported a net income of CAD 2.2 million in the second quarter of fiscal 2021, compared to a net income of CAD 1 million in the same period of fiscal 2020.
• The Company’s current liabilities were CAD 36.8 million on July 26, 2020, compared to CAD 19.5 million on January 31, 2020, an increase of CAD 17.3 million.
• Long-term debt (including the current portion) on July 26, 2020, increased by CAD 0.9 million from the balance on January 31, 2020. During the first quarter fiscal 2021, the Company received CAD 2.0 million of new term debt for the purchase of equipment offset by principal repayments of CAD 1.1 million during the year-to-date period ended July 26, 2020
• During the second quarter of fiscal 2021, the Company utilized CAD 1.0 million of cash to reduce its bank indebtedness, as well as paid CAD 1.8 million in dividends, compared to dividends of CAD 0.9 million during the same quarter of fiscal 2020.

Capital Structure at the end of Q2FY20

Source: Company Filing

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 57.9% of the total shareholding. Benbrick Holdings, Inc. is the entity holding maximum shares in the company at 25.50%. Kernwood Ltd is the second-largest shareholder, with a holding of 12.27%.  Institutional ownership in the company stood at 15.27%, and strategic ownership in the company stood at 43.58%, respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Earnings based Valuation Metrics

(Note: All forecasted figures and peers have been taken from Thomson Reuters)

Stock Recommendation: The company recorded a solid performance in the second quarter of FY21, driven by volume spurt in branded products. The Company will continue to focus on growing the Waterloo, Seagram, LandShark® and Margaritaville® trademarks, and long-term meaningful copack agreements, all of which contribute a higher amount of profit per unit sold. Further, the Company has the exclusive Canadian rights to both the LandShark® and Margaritaville® brands for beer, cider, and coolers.

Also, it will continue to offer in-case promotions, such as the inclusion of merchandise in specially marked cases of LandShark® bottles and provide increased marketing support to further grow the brand in Canada.

However, annual increases in the minimum retail price (“MRP”) have seen the price gap between value and mainstream brands reduced, creating increased competitive pressure. Effective August 27, 2018, the Ontario government reduced the MRP for beer to a dollar plus deposit per 341ml bottle. With the government’s change to the MRP, there can be no assurance that further changes to the pricing environment will not have a material impact on the company. Also, The Company is exposed to commodity price risk with respect to agricultural and other raw materials used to produce the Company’s products.

Therefore, based on the above rationale, considering the risks involved in investment and valuation, we have given a ‘Speculative Buy’ at the closing price of CAD 4.50 on November 03, 2020. We have considered Diamond Estates Wines & Spirit Inc, Andrew Peller Ltd and China Food and Beverage Co etc., as a peer group for the comparison purpose.

*Recommendation is valid at November 4, 2020 price as well.

Disclaimer

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