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Research Report - Gage Roads Brewing Co. Ltd. (GRB)
Update ahead of FY19 earnings release

16 August 2019
Recommendation: Speculative Buy
Last Price: $0.09
Price Target: $0.13
Potential Upside: 44%

Key Points

• Packaging line expansion to increase efficiencies: Earlier this year, GRB raised $8m placing 84.2m shares at 9.5c to fund the installation of a new commercial scale canning line, a new high-speed bottle filler and to fund other site improvements. GRB expects to see savings from labour & variable production efficiencies, reduction in wastage and materials costs. GRB’s ability to raise capital via equity markets is a key competitive advantage that it has over smaller craft brewers who generally struggle to fund the capex and marketing costs required to achieve scale, growth and profitability. The $0.4m in offer costs will reduce profitability for FY19 which we’ve incorporated into our numbers. GRB is targeting incremental EBITDA benefits of $1.5m to $2.5m p.a. by FY22, however we expect that GRB will need increase marketing spend to fully activate sales on the east coast which we see as partly offsetting these gains. This may turn out to be a conservative view.

• Sydney Redfern micro-brewery/taproom ticks a lot of boxes: A main concern of ours was for the location of the first east coast taproom. If GRB got this wrong from the outset, it could have put the project’s chance of success immediately at risk. The 578m2 inner-city site will house a small-craft brewery and 250-person hospitality venue which will be open to both public and trade. Its expected to provide up to an additional 2m litres of capacity.

Redfern and surrounding areas are undergoing a significant amount of urban renewal with new development projects. Google was planning on locating its Australian HQ to the area, but Mirvac’s initial development plans were rejected at the government level. Approval for the $1b project next to the Redfern station has now been granted and will eventually house 18,000 workers from Commonwealth Bank, Channel 7 and the CSIRO. The CBA tenancy is due to be completed by 2020 and will see 10,000 workers move to the site.

The Redfern site will improve brand awareness and is expected to increase retail sales on the east coast, potentially beyond their five-year FY21 “returning to craft” targets of 70% gross margin, 14m L pa. and $1 EBITDA per L. $3m in capex is expected to be spent by December 2019 with commencement of trade planned for 3Q FY20. The site is expected to be cash flow positive, which we haven’t factored in, potentially providing further upside.

• Institutional interest continues to grow: Over the past couple of months we’ve seen a lot of institutional movement on the register. Spheria Asset Management and Perennial Value Management increased their substantial holdings from 5.34% to 8.77% and 6.49% to 8.26% respectively, while AustralianSuper became a new substantial holder with 5.02%. The total institutional holdings in GRB now makes up 46% of the register, up from only 14% in April 2018, highlighting the growing institutional interest in the stock.

GRB has executed well on its strategy of shifting its sales mix away from lower margin contract brewing products to own brand products, boosting margins and profitability. We expect that the east-coast activation strategy will result in EPS growing by 60% CAGR over the next 2 years. In our view, GRB is following a similar model to Little Creatures and is an eventual takeover target as profitability increases. GRB is undervalued, trading at a 44% discount to our 13c per share price target. We maintain a Speculative Buy rating.
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Michael Ron
Research Analyst
Redfern – First East Coast Taproom Site

To help mitigate execution risk of the micro-brewery and taproom strategy, GRB employed Stew Wheeler as the GM of Hospitality who will oversee the construction of the venue and its management upon completion. Stew is highly experienced in this field having worked for Little Creatures building out their venues in Hong Kong, Singapore, London and San Francisco as well as working as the GM of Hospitality for Lion.

Student accommodation development has been increasing in the Redfern area with the University of Sydney and University of Technology Sydney being located in close proximity. To accommodate the increasing number of students and workers in the area, +$100m in government funding will be spent on upgrading the busy Redfern station which sees around 70,000 passengers already commuting through it on weekdays.

The inner-city location will provide logistical advantages in distributing draught beer (kegs) throughout the local Sydney market and will assist with increasing sales of their higher margin proprietary products, providing an uplift to margins and profitability.

An initial five-year lease was entered into on 13 March 2019, with options for two additional five-year terms (total 15 years). $3m in capex for the installation of the brewhouse and fit-out of the taproom is expected to be spent by December 2019. Commencement of trade is planned for 3Q FY20. GRB are in the process of looking for at least one other site as part of their east-coast activation strategy.
Model Assumption Changes

- We like the brand in hand marketing strategy that GRB is employing but believe that additional marketing spend will be required to truly unlock additional market share gains on the east coast. We increase our sales and marketing spend assumptions over the next few years. We incorporate additional leasing costs for the new Sydney head sales office and Redfern site. We see all of these costs partly offsetting the efficiency gains GRB expects to achieve from the recent spend on plant, but this may turn out to be a conservative view.

- We feel comfortable with our volume growth assumptions for GRB’s own name products (as well as new Atomic brand which has moved from own name). We slightly reduce our expectations for Matsos volumes this year but believe we were too conservative on Matsos brand growth in future years. With our expectations for additional marketing spend, we increase our Matsos volume assumptions slightly from FY21 which sees revenue 1% lower for FY19 but 2% higher from FY21.

- We expect the $7.8m capex spend on new canning line and bottle filler will see gross margin improvements. A reduction in cost of goods is expected from savings in raw materials, reduction in wastage and lower bottling costs. However, the capex spend will result in a higher level of depreciation, along with the dilution in shareholding from the capital raising, will result in lower forecast EPS.

Technical Analysis

Historically we’ve seen good buying support between the 8.7c – 9c range. Barring an overall share market collapse or large correction, we expect the strong support to continue as institutions look to accumulate the stock. 10c is likely to act as a psychological resistance level which we expect to be overcome with the market likely to price in the strong EPS growth over the next year. Our 12-month fundamental DCF price target of 13c ties in reasonably close to the historical resistance level ~14c.

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The analyst does not hold securities in Gage Roads Brewing Co.Ltd (GRB).

The recommendation made in this report is valid for four weeks from the stated date of issue.  If in the event another report has been constructed and released on the company which is the subject of this report, the new recommendation supersedes this and therefore the recommendation in this report will become null and void.
Recommendation Definitions:

SPECULATIVE BUY – Potential 10% or more outperformance, high risk
BUY – Potential 10% or more outperformance
ACCUMULATE - 10% or more out-performance, buy on share price weakness
HOLD – Potential 10% underperformance to 10% over performance
SELL – Potential 10% or more underperformance
Period: During the forthcoming 12 months, at any time during that period and not necessarily just at the end of those 12 months.

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