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Article / 21 September 2011 at 8:13 GMT

Cheap alcohol stocks in the market!

Strategist & Equity Analyst / Private
Denmark

Alcohol producers Royal Unibrew, Constellation Brands and C&C Group appear to be potential takeover candidates and investing in these relatively cheap defensive stocks now amid such volatile and difficult investment times might be a sensible step to take.

In our ‘Devil’s Stock’ theme we highlighted the apparent investment advantages of sin stocks, of which alcohol is included. In this theme we take a closer look at the alcohol sector which is much less volatile than some of the other sin stock sectors as incomes are predictable (exactly what we need at the moment) and investors are generally willing to pay a high premium for this. In this analysis though we have found companies which are priced at market level P/E, which is a good start.

Screening
When a private equity company wants to take over a company some basic criteria needs to be invariably met before proceeding. Stable sectors are always preferred as this makes higher leverage possible and therefore results in a higher return on the overall investment. Stable consumption is therefore ideal.

Low current debt is therefore also preferred and the more Free Cash Flow (FCF) the better, as the company has a reliable “engine” to pay off its debt. In chart 1 we show Net Debt / EBITDA versus Free Cash Flow to Market Cap. Both are relative measures so as not to discriminate between large and small companies. Notice though that the overall market cap size has been limited to USD 5 bln in order to allow for a reasonable chance of takeover. The best selection is illustrated in the triangle, as more debt should be followed by more FCF.



But you don’t want to pay too much for a company measured by Price Earnings. In comparing the level of Return on Equity it is easier to select the best combination. The best selection based on these metrics is shown in chart 2.



Combining the selections
In the two selections we have identified five companies of interest as these have the right characteristics concerning sector, size, price, possible leverage and FCF. The companies have been scrutinised for large investors who could potentially block a takeover attempt, and in two of the candidates a stake of 35 percent is placed. In these cases a takeover is less likely to happen, but you never know. That leaves three candidates: Royal Unibrew, Constellation Brands and C&C Group which all have low P/E and look cheap compared to the overall market i.e stable companies trading at no premium. On top of this Royal Unibrew has a very large expected dividend yield of 6.2 percent. See table 1 for more details about the companies.



Make sure however that you do your own analysis before you consider these companies as investment opportunities.

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