The Boston Beer Company Is Losing to Smaller Breweries

The Boston Beer Companyis getting knocked down as easily as a pale ale on a hot summer day. In the past year, the company's shares are down about 40% following steep decreases in total sales and profits. One of the main culprits? Smaller craft breweries.

This is an ironic development, as the maker of Samuel Adams Boston Lager is largely viewed as the entity that started the modern microbrew and craft-brew revolution in 1985. But as Boston Beer has gotten bigger and consumer preferences have changed, the largest U.S. craft brewer has consistently been losing market share to smaller rivals that have been riding the trend.

Image source: Samuel Adams.

In the 1970s, the number of total U.S. brewers numbered as few as 100. At the end of 2015, that number had skyrocketed to more than 4,200. That's impressive growth and the totals are still increasing, although 2015 saw a slowdown for the first time in a decade. On the year, 184 brewpubs and 433 microbreweries opened, compared with 249 and 635 brewpubs and microbreweries, respectively, in 2014, according to the Brewers Association.

According to the Brewers Association, breweries were last at such a high number in the late 1800s, when the number was around 4,100. I agree with the association's opinion that a return to that number of brewers-to-population ratio is unlikely, as there would currently need to be 30,000 brewers in operation to accomplish that. The numbers, however, underline the resurging American interest in the hometown, or even home neighborhood, brewpub or taproom. .

How the trend is affecting the Boston Beer Company

I believe this trend has beenone reasonfor the degeneration of Boston Beer Company's sales and profits. During the last earnings call, CEO and founder Jim Koch commented on lost market share from "increased competition and continued growth of drinker interest in variety and innovation." Increased competition has come in the form of a multitude of small upstarts that have cropped up in recent years, but smaller regional brewers have also ramped up distribution to beer retailers as well. Boston Beer believes that the number of new brewers will continue to rise over the next two to three years, but that competition fromnew distribution is starting to slow and is nearing a peak.

"I think I've actually been on record that there could be as many as 10,000 craft breweries in the United States, up from roughly 4,500, 4,800 open today," Koch said during the company's April 21 conference call with analysts. "I think what we will begin to see, maybe a bit sooner than that 2- or 3-year horizon, is the distribution channels beginning to close up as distributors and retailers kind of run out of space for craft beers. ... the number of craft breweries may well continue to grow at a fairly strong rate, but the number of craft breweries that will enter into the distribution in a meaningful way will probably not grow as fast, as the new entrants tend to rely on volume out of their taprooms rather than getting space on the shelves."

For quite some time, Boston Beer Company experienced the same benefits from changing trends in beer consumption as newer and smaller establishments have been experiencing. As American's interest in craft beverages increased, the number of U.S. breweries rose and Boston Beer's total sales also rose. Things started to change, though, as new brewery openings spiked from 2012 through 2015. While Boston Beer's sales also initially spiked, that trend started to decline in 2014 and SAM notched a YOY sales increase of just 5.9% in 2015 after recently peaking at 26.3% in 2013.

Chart data source: Boston Beer Company annual reports and Brewers Association.

The numbers illustrate the difficulties Koch was alluding to during the last conference call. Beer drinkers have increasingly shown interest in small, local, and innovative companies, which has led an increasing number of new players to join the scene. This development has shifted sales away from the Sam Adams lineup. Big beer companies have also jumped in to buy and boost smaller brands.

The areas of specific weakness have been in the company's Samuel Adams beers and Angry Orchard ciders. The declines in those key areas were only slightly offset by growth in the company's Twisted Tea division in the recent quarter.

To keep up with smaller brewing operations' willingness to innovate their production and introduce new ideas, Boston Beer recently released its Nitro project, which involves a nitrogen-filled widget in the can to help create nitro beers that are, as the company says, "known for their captivating cascade and smooth creaminess," as well as new styles under the Rebel IPA name. While the new rollouts are recapturing consumer interest, it hasn't been enough to keep up with the steep rise in competition.

Image source: Samuel Adams.

What it all means for investors

Those looking for a quick turnaround for the big craft brewer may have to wait. The company is forecasting anywhere from a 2% increase to a 4% drop in sales for the remainder ofthis year.

Brewery openings are also expected to increase, as discussed earlier. The Brewers Association cites the deepening trend toward local brewing. While more than 2,000 U.S. cities now have their own local brewery, the association has identified another 1,000 cities with populations greater than 10,000 without their own local brewer. Put simply, the Brewers Association doesn't think the growth in competition is over yet.

Important to note again, though, is that while the number of new openings is expected to rise, Boston Beer thinks distribution channels are reaching maximum capacity. If this plays out as management expects, sales drops could start to slow, as much of the company's sales comes through retail distribution.

One could argue that despite the increase in localized competition, The Boston Beer Company has fared quite well. Total sales are only off year-over-year all-time-highs by about 5%. The problem, though, isn't just the struggles with sales, but with how those sales decreases affect the bottom-line profit.

The company reported profit drops of 49% and 16% year over year in the first quarter of this year and the fourth quarter of 2015, respectively. New product development and releases could continue to tighten profit as the company rides out the expected sales declines it sees through this year.

For investors looking for a bargain, the drop in Boston Beer Company's stock may look tempting. I believe this could be a dangerous proposition, though, and investors should instead keep an eye on the number of new brewery openings in the U.S. as an indicator of a turnaround. The beer industry is undergoing change and seeing increased competition as it learns how to satisfy the new tastes of consumers. For now, these changes are enough to keep me from buying Boston Beer Company as the company navigates a difficult business environment.

The article The Boston Beer Company Is Losing to Smaller Breweries originally appeared on Fool.com.

Nicholas Rossolillo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Boston Beer. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.