This article discusses the current agave shortage and its impact on Becle’s (OTCPK:BCCLF) profitability and valuation. My initial report on Becle provides a more detailed view of the company, its operations, and my investment thesis.
In 2019, Becle shipped 10.9 million cases of tequila making it the largest tequila producer in the world. Tequila sales equaled 61% of the company’s 2019 sales. The key raw material for Tequila is agave. For tequila to be called tequila, it must be made with the blue agave plant produced in a certain region in Mexico. On average, the agave plant takes 7 years to mature. The long maturation period means when prices are high, many producers plant agave in an attempt to capitalize on the higher prices. As supply comes on stream, prices fall and farmers often switch to other plants, as the return on investment is no longer acceptable creating future shortages. These boom-bust cycles have repeated themselves throughout history. The chart below from tastetequila.com illustrates the boom-bust nature of agave prices along with their forecast for its prices through 2027.
As of January 2020, agave prices are near all-time highs at roughly MXN28 per kilo. The agave price started to rise around 2014 or 2015 but really took off in 2017 and 2018. Given the long maturation of the agave plant, crops that were planted in 2014 and 2015 will not mature until 2021 or 2022. Those farmers that waited for price hikes in 2017 and 2018 will not see their plants mature until 2024 and 2025. The Consejo Regulador del Tequila (CRT) and the Camara Nacional de la Industria Tequilera (CNIT) believes the agave supply will increase dramatically over the next few years. By 2023, there could be an oversupply of agave and the price per kilo of agave could fall back to the MXN1 range seen from 2006 to 2010.
Other factors are driving agave prices higher. Other products made from agave like agave syrup and inulin consumed 20% of agave production in 2018 up from 0% during the previous price spike. Tequila has also seen a surge in craft tequilas. In 2019, 181 new tequila brands entered the market meaning there is competition for agave.
The Impact On Becle’s Profitability
Becle is the largest producer of agave in Mexico but is not 100% self-sufficient for its supply and must buy it from third party suppliers. The company does not disclose its level of self-sufficiency. In a June 2019 interview, the company’s brand educator in the UK stated the company’s 5,500 acres of agave plants made the company 95% self-sufficient. In 2017, Becle’s CFO stated the company would reach 90% integration by 2019 from 60% at the time of the IPO. Based on the movement in the cost of goods sold over the past few years, it would be difficult for the company to be fully self-sufficient. If it was self-sufficient, the cost of goods sold would not be increasing as rapidly as it has.
There are two types of tequila, 51% tequila and 100% tequila. Using a traditional process, a liter of 100% tequila requires 7 kilos of agave, while a liter of 51% tequila requires 3.5 kilos of agave. 51% tequilas must be made with 51% of its sugars from agave and the remaining 49% can be made from other sugars like glucose or fructose sugars. Using a diffuser, only 3.3 kilos of agave are needed to make a liter of 100% tequila. Due to the production efficiency, many larger companies have switched to a diffuser, particularly for 51% tequila. Cheaper tequilas are much more concerned with cost and therefore are more likely to use the diffuser.
100% tequilas and other premium tequilas are more likely to use the traditional process due to the focus on quality. Diffusers also can use 3 to 4-year-old agave rather than fully matured 7-year-old agave. Diffusers are extremely expensive and can only be used by the larger companies to efficiently produce lower-quality tequila. The ability to use 3 to 4-year-old agave rather than 7-year-old agave that all other producers use creates an opportunity for farmers to sell at a high but probably not as high prices without having to wait the full 7 years.
Tequila Matchmaker is a website that shows the production process of many tequila brands. 9 of the 13 Jose Cuervo products use a diffuser. Only high-end Jose Cuervo products used the traditional process. In 2019, Jose Cuervo tequila generates 67% of total tequila volume. All of the company’s 1800 branded products use a traditional production process.
In a recent conference call, the company stated 70% of tequila sold in the US was 51% tequilas, while 75% of tequila sold in Mexico was 100% tequilas. The company does not break down tequila volume by geography but I assume it matches the overall geographical breakdown (56% US, 33% Mexico, and 11% ROW). To get an estimated breakdown between 51% tequilas and 100% tequilas, 70% of volume in the US and ROW is assumed to be 51% tequila and 25% of Mexican volume is 51% tequila. All 51% tequila are assumed to use diffusers and need 1.7 kilos of agave per liter (3.3 X 51%). 100% tequila uses the traditional process and requires 7 kilos of agave per liter. The company’s agave self-sufficiency is estimated at 75%.
In 2019, the company produced 10.9 million cases of tequila meaning its estimated total agave needs were 325 million kilos with 81 million kilos coming from third-party farmers. In 2014, its total agave needs were estimated at 240 million kilos. At an estimated self-sufficiency of 60%, 96 million kilos of agave were from third-party farmers.
Using an MXN5 per kilo agave price rather than the 2019 estimated price of MXN30 per kilo on outside agave, Becle’s outside agave purchases would have been MXN406 million rather than MXN2,437 million. The company’s overall gross margin would have been 59.6% rather than 52.7%. The 59.6% is similar to the gross margin the company had from 2014 to 2017 before agave prices spike. Given the company’s financials from 2014 to 2017 were before agave prices soared, they are a road map for when prices normalize. From 2014 to 2017, gross margin averaged 60.4%. Over the last 5 years, operating expenses average 36.2% of sales with a high of 37.6% in 2018 and a low of 35.1% in 2019. Using the average gross margin from 2014 to 2017 and average operating expenses over the last 5 years, the operating margin when agave prices revert to the norm should be roughly 24.2%.
In 2018, if agave prices were MXN5 per kilo rather than the estimated MXN26 per kilo gross margin would have reached 64.2% rather than the 57.5% reported by the company. Using the 5-year average operating expense to sales ratio, the company’s operating margin would have reached 28.1% rather than the 19.9% reported operating margin.
Becle is valued using a residual income model under three scenarios. The residual income model has a 5-year forecast period with a 4-year fade to terminal assumptions in 10 years. Under all scenarios, the only thing that changes in the operating margin based on different agave prices. The discount rate is 10%, the tax rate is 25%, and capital efficiency is equal to 2019’s invested capital turnover of 0.69 times. Sales growth is 10% over the next 5 years before fading to 5% in the terminal value. The tequila industry is growing at mid-single digits and Becle is losing market share.
There is a big shift towards premium products and the company’s average selling price is below the industry average. Jose Cuervo is the entry level mass-market brand. Given the trend toward premium products and Jose Cuervo’s positioning, sales growth at double the industry before fading to a terminal growth rate of 5% is aggressive. Other spirit categories are growing at low-single digits rather than mid-single digits, so as the tequila industry matures, the industry’s growth will slow. All fair values per share are discounted by 5% to account for the current pandemic. 5% is roughly equivalent to eliminating 1 year of free cash flow.
Under the base case, the operating margin continues at the average of the last 5 years (22.5%). The last 2 years saw the gross margin and operating margin hurt by soaring agave prices, but this is the nature of the industry. Price will not remain permanently depressed or permanently elevated so using a few years of depressed prices and 2 years of very high prices seems appropriate when valuing a long-lived asset with a series of booms and busts. The bear case assumes agave prices remained elevated forever (17.5%), while the bull case assumes agave prices remain depressed forever (27.5%).
The base case’s 2025 fair value per share is MXN31.64, 24% below the current share price. The bull case 2025 fair value per share is MXN45.68, 9% above the current share price. The bear case’s 2025 fair value per share is MXN17.61, 58% below the current share price. Agave prices may fall, but the current share price already prices in that story. To generate an acceptable return in an investment in Becle requires an acquisition at an elevated multiple of peak earnings, which is speculative in nature.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.