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September 26, 2012

Stock of the Day

Recommendation: C-Rated Hold

Welcome to the Stock of the Day for September 26, 2012. Miller Lite? That's so five years ago. Craft breweries have been creeping into the U.S. commercial beer market in recent years and stealing market share from the industry's biggest players. Craft Brew Alliance (BREW) is one such company, but have its operations been successful enough to win the hearts and stomachs of America's new crowd of local beer enthusiasts? Let's find out.

Company Profile: Based in Portland, Oregon, Craft Brew Alliance was formed in a merger of two leading Pacific Northwest craft brewers—Widmer Brothers Brewing and Redhook Ale Brewery—in 2008. Then in 2010, BREW joined Kona Brewing Company and is today a unique alliance between three craft beer brands. While each of the names within Craft Brew Alliance are micro breweries, the Brewers Association does not recognize the alliance to be "craft" beer due to a minority ownership position held by Anheuser-Busch. However, the company's products do compete for mindshare in the craft-beer segment.

Craft Brew Revolution: The popularity of craft beer in the U.S. has surged in recent years, with craft breweries taking over 6% of the market. Craft breweries are defined as shops that serve less than 6 million barrels annually, and roughly 250 breweries entered the U.S. commercial beer market last year, bringing the nationwide total to 2,000. The increase in breweries does not come without consumer demand: Almost 1 in 10 U.S. dollars spent on beer now goes to a craft brewer, which industry analysts liken to a more sophisticated shift in American palates. There will always be Bud and Miller loyalists, but the preference for craft brews over commercial staples is not going unnoticed by industry heavyweights, and it also comes during a time when the U.S. beer segment is seeing an overall consumer pullback. Annual sales from big brands like Bud Light and Coors Light have dropped in the past five years, by 11.4 million bottles, or 8.1%, while the top 10 craft brewers saw a 26% increase in the same period. Last year, craft brewers sold 13% more beer and raked in 15% more in revenue.

Earnings Buzz and Outlook: With such a prosperous sector, you'd expect BREW's numbers to reflect this growth. Instead, the company reported a disappointing second quarter, with BREW's CEO calling the company's performance unsatisfactory, and stating that 2012 is an important transition year for its national strategy. The company's results were mixed, with Kona Brewing reporting the biggest gains. Kona grew 20% from the prior year period, partly due to the segment's successful implementation of its Longbard Lager in cans. Next was Widmer Brothers, which dropped 8% due to losses in West Coast markets where products face tough competition and pricing. The Redhook brand declined in its home market in Washington but gained at the national level, while the company's newest product, Omission, saw success in Oregon due to what the company chalked up to more lenient labeling regulations that allowed it to be classified as a gluten-free beer. If Omission can get this labeling at the national level, the company expects further success, but sales could also be curbed should the alternative occur as well. For the quarter, net sales increased 12% versus the same period last year; total beer shipments increased 6%; and gross profits exceeded the prior full year guidance at 30.3%. But BREW's forward guidance isn't as promising, with management expecting slower growth and lower revenues of 8% to 10%, and 13% to 15%, respectively.

Current Ratings: Before you buy any stock, you should always run it through my free Portfolio Grader ratings system. While the craft brewery segment looks bright, the picture doesn't hold for BREW, which gets a hold rating from me. I give the company's fundamentals a D, which should tell you what I expect out of sales growth (C), and operating margin growth, earnings growth and earnings momentum (Fs). Return on equity and cash flow don't stack up that great either (a D and C, respectively) and I only see average buying pressure for the shares going forward (C). BREW could see better days ahead, but in the meantime, I don't advise you put any new money into this C-level stock.

Bottom Line: As of this posting, September 26, 2012, I consider BREW a C-rated hold.

Would you like to check the fundamentals backing up one of your stocks? For more stock grades, please visit my Portfolio Grader website!

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