Slower growth in craft likely to spur consolidation

As craft beer enters a period of slower growth, a growing cadre of analysts and industry observers expect the industry’s ongoing consolidation to accelerate.

It’s business 101: Fragmented industries consolidate. And there aren’t many industries more fragmented right now than craft beer. There are nearly 6,000 U.S. craft breweries today, up from 1,460 a decade ago.

On average, U.S. craft brewer revenue grew 16.1 percent annually between 2008 and 2016. But craft sales decelerated significantly in 2016 to 5.4 percent, according to IBIS figures cited by Stifel’s Mark Swartzberg in a report issued last week. “And as the market for craft beer becomes saturated, industry revenue is projected to slow to an annualized growth rate of 4.4 percent between 2017 and 2021,” Swartzberg writes, again sourcing IBIS data.

That’s going to put pressure on craft brewers of all sizes, particularly those that have made large, recent investments in property, plant and equipment. “We believe consolidation is in the early innings,” Swartzberg writes. “We expect slowing segment growth to fuel further segment consolidation, through further M&A and scaling of craft brands regionally and, in many fewer cases, nationally.”

That stands to benefit the four largest brewers in the U.S. — Anheuser-Busch, MillerCoors, Heineken and Constellation Brands, Swartzberg writes. Because as craft sales slow and retailers revisit the size and composition of their shelf sets, more Americans paralyzed by the “paradox of choice” may “forsake another novel, hoppy IPA, creating an opportunity for scale brewers with competence and insight not only in brewing but also distribution, brand management and retailing.”

A separate report issued last week by Bank of America Merrill Lynch also questions whether the craft segment has grown too crowded, saying “brewers, retailers and consumers need a breather.”

By no means, however, does this mean craft is dead. Quite the opposite. Nevertheless, even the Brewers Association, a Denver-based craft beer trade group, acknowledges that craft’s best days — at least in terms of percentage growth — may be in the rear-view.

“The total market growth for craft brewing production is slowing down,” Bart Watson, the Brewers Association’s chief economist, told the St. Louis Post-Dispatch. “It’s still growing but not at the double-digit rates we saw over the past decade.”

Concerned craft brewers, cautious suitors

That has some craft brewers worried, according to the Post-Dispatch. Civil Life Brewing Co.’s co-founder and owner, Jake Hafner is among them: “That’s the elephant in the room. The percentage of craft beer drinkers is slowing down, and at the same time you have all these breweries opening,” he told the newspaper. In the same story, O’Fallon Brewery’s president and CEO Jim Gorczyca, a former Anheuser-Busch marketing executive who bought O’Fallon in 2011, said his brewery’s capacity allows for him to brew four more times the amount of beer he’s currently making. “We’d like to be further along,” he said, according to the Post-Dispatch.

With the crush of competition and expansion-funding debts not going away, some likely will be forced into combinations or outright sales. Who are the likely suitors? Among so-called strategic investors (read: brewers and other CPG companies), Swartzberg says the “best-positioned” is Anheuser-Busch InBev “not only because of its scale, but also because of its track record and strategy.”

The company, which owns 11 U.S. craft breweries and several others across the globe, “appears to be backing away from focusing on acquisitions” and instead growing internally as craft slows, Bank of America Merrill Lynch’s Bryan Spillane says in a report released last week.

Indeed, ABI CEO Carlos Brito said last week the company doesn’t have any immediate plans for further purchases. "We're very happy with the business we have today. We don't need to do any acquisitions to grow the business," he told CNBC.

MillerCoors, meanwhile, continues to vet potential craft acquisition targets. Pete Marino, president of the MillerCoors craft division Tenth and Blake, this fall told a group of MillerCoors distributors that the company will continue to explore partnerships with craft breweries, provided their location or beer style complement the company’s existing portfolio and their valuation is realistic. The breweries most likely to survive, he said, are those that focus on brand-building.

Private equity interest?

Swartzberg also expects more private-equity activity in the craft industry, from players such as Ulysses Management, TSG Consumer Partners and Fireman Capital. As craft growth slows, “favoring a thinning of the herd,” more private-equity investments could be on the way, especially if craft brewers “face increasing retailer pressure, translating into lower return thresholds,” he writes.

But, because of the relative short-term nature of private-equity investments (firms typically seek to exit within seven years), interest could be constrained. Obstacles include difficulty exiting via an IPO because most craft brewers lack national scale as well as limited interest by strategic investors, given larger breweries’ willingness to invest in or purchase craft brewers on their own.

Still, some of the biggest and most well-established craft brewers already are owned in part by private equity, including Dogfish Head, Stone Brewing, Oskar Blues and Cigar City Brewing.

Swartzberg expects more purchases are coming. “Interest continues, in our view, because a metropolitan or regional approach can produce attractive cash flows.”