Gage Roads (GRB) 9.9c

The Perth-based boutique brewer’s CFO, Marcel Brandenburg, hesitates when asked to define what a ‘craft’ beer actually is.

“It’s a contentious issue,” he told a recent annual Australian Microcap Investment Conference. “In the US, they try to define it by the size of the brewery.

“In Australia, we define it more by flavour profile, anything that has a hoppy, floral taste profile.”

A simpler definition is any brew made in a smaller batch-style facility, no matter the level of floral hoppy after tones. But the contentious aspect is that six of our top 10 selling ‘boutique’ brewers are now owned by the big guys.

This includes the top three: James Squire (Lion, owned by Kirin of Japan), Yak Ales (Foster’s owner Anheuser-Busch) and Little Creatures (Lion/Kirin). In 2015, Asahi of Japan picked up Mountain Goat and in 2017 beer wannabe Coca Cola Amatil snapped up Feral Brewing.

For Gage Roads, it’s a case of bucking the trend, winning back its independence after buying out its 25% owner Woolworths. Two years into its five-year proprietary brand strategy, Gage Roads has made inroads into transforming its business from a contract brewer for the grocer to pushing its own higher-margin brands.

Founded in 2004, Gage struggled for critical mass before the 2009 deal with Woolworths delivered enough volume to justify building what’s now WA’s biggest brewing facility.

The trouble is, there wasn’t a lot of profit in contract brewing, while Gage’s higher margin own brands – sold exclusively through Woolworths – had become the country’s fifth biggest craft brand.

But the only way for Gage to take care of its own destiny was to win back its independence — and the ability to sell through other channels including Coles, pubs and restaurants.

Two years ago, management bit the stubbie lid and bought out Woolworths’ 25% stake.

Over three years, Gage hopes to get its own brands – including its eponymous Gage Roads, Single Fin Summer Ale, Alby and Breakwater Pale Ale – to 70% of sales compared with about one-third of sales in the 2016-17 year.

Having invested $27m on German brewing and packaging equipment, Gage Road’s jewel is a state-of-the art brewery with capacity of 17 million litres a year, of which 12 million litres is currently deployed.

The $4.9bn, 1.2 billion litre a year Australian beer market in essence has been flat for years, growing at a 2% clip. But craft now accounts for 11% by value and 5% by volume and has grown at a 16% compound annually in the last three to five years.

Based on the US craft beer experience, Brandenburg says there’s plenty of room to grow. But given the top eight brands here account for 89% of the growth, the key is to have recognisable brands with a strong shelf presence.

Hipsters also won’t pay through their pierced noses for the boutique experience: on Gage’s reckoning, a case of grog won’t sell if it costs more than $62 per case, or $22 per six pack.

Rather than spending millions on billboards and other advertising, Gage Roads has tied up key venues and events in exclusive beer supplier arrangements.

These include Perth’s new Optus Stadium and NIB Stadium, Fringe World (WA’s biggest outdoor event), Cricket Victoria and the Rugby Sevens competition.

In June this year, Gage Roads acquired the Broome-based brewer Matso’s from the Peirson-Jones family for $13.25m cash, plus 35m Gage Roads shares over three years based on performance hurdles.

Matso’s is famed for its mango and ginger beers, which aren’t exactly everyone’s taste but are high selling, high margin products nonetheless. The added benefit for Gage is these lines don’t compete with its own beers.

Brandenburg dubs the acquisition, which is expected to boost earnings per share by 35% this year, as a no brainer.

 “We had made their product under contract so carried the operational risk, so all we are doing here is on boarding the brand and capturing the brand owner’s margin.”

The Matso’s buy has boosted Gage’s earnings per share by 35% to date and no doubt is a key contributor to Gage’s recent share price strength.

Joyously, Gage Road’s dash for freedom has helped the bottom line, with the company reporting a 2017-18 net profit of $2.06m, up 3% on revenue of $33.2m (up 22%).

“We are now at a point where we feel we can match it with any supplier,” Brandenburg says.

Having traded at 7.5c a year ago, Gage shares hit 14c in early September but have since drifted to around the 10c level for a market capitalisation of just over $100m.

The dilemma for management and employees, who account for 23% of Gage stock, is what to do when one of the beer multinationals comes a knockin’.

Broo (BEE) 10c

Unpatriotically, Gage and Chinese aspirant Broo are the only ASX-listed beer exposures after Lion Nathan and Foster’s Group fell into foreign hands some years back.

Broo got investors frothy in November last year when it announced a partnership with a mob called the Beijing Jihua Information Consultant, to market and distribute Broo’s beers in China for seven years.

Under the take or pay arrangement, Jihua will take 1.5 billion litres at a fixed rate per litre, generating aggregate revenue for Broo of $120 million. The first three years’ revenue is accrued and then paid to Broo at the end of this period.

Broo shares spiked about 30% on the news (to 39c) but the gains were short lived, probably as investors remembered that the difficult Chinese market proved an expensive failure for even the deep-pocketed Foster’s and Lion.

Broo listed in mid October 2016 at 20c a share.

On Friday, Broo reported September quarter distribution volumes of 19.2 million litres, which implies there’s still work to do to get to that 1.5bn litre run rate.

Broo makes Broo Premium Lager and Australia Draught, both emblazoned with a garish kangaroo emblem. To suit Chinese tastes, the alcohol content was lowered and the bitterness toned down.

Broo’s brews will be marketed as premium (rather than boutique) drops, priced similarly to the offerings of other foreign devils, such as Heineken and Budweiser. The company plans to market Australia Draught aggressively in the on-premises tap market, which Grogan describes as one of the most lucrative in the world.

Locally, Broo also has ambitious plans to build a $95m green-friendly brewery on land acquired on the outskirts of Ballarat for $2m in early 2017. Green principles, such as minimal water and chemical usage, work nicely with the hipster-oriented craft beer theme.

With a 480 million litres capacity, the brewery would be one of the biggest in Australia and would also involve contract brewing. The site would also incorporate an Australian beer museum and a “cultural engagement hub”, which come to think of it sounds awfully like a pub.

Broo owns the hip Sorrento Brewhouse and Mildura Brewery Pub and both look like decent cash cows, delivering most of Broo’s 2017-18 revenue of $2.58 million.

Broo’s September quarter report showed revenue of $646,000 and a $1m loss. Broo lost $4.43m last year and $3.4m in 2016-17 and has chewed up $12.5m over the last five years.

 With a September cash balance of $832,000, Broo clearly needs a deep-pocketed backer to realise its green dream.

Meanwhile, Broo expects first revenues from the Middle Kingdom to trickle in in November 2020.

Tim Boreham edits The New Criterion. tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.