Final Strategic Recommendation – Grupo Damm Essay

George Simmons Friday, May 4, 2012 International Studies Program – Barcelona Professor Fischer Grupo Damm Final Strategic Recommendation Introduction and Summary of Recommendation Grupo Damm, one of the largest beer brewers in Spain, is a strong company in a weak home market. Although many opportunities exist for expansion, the strongest plan for the company to embark on is an aggressive expansion of its business in the United States. This project will give Damm access to a large consumer base with minimal risk due to previous conservative investments in the region. Situation Analysis

Grupo Damm’s current situation is the third largest beer company in Spain. It is a large player in a market dominated by two other beer producers: Grupo Mahou, and Heineken (Appendix 3). Grupo Damm is extremely concentrated in the Catalonia region and, more specifically, Barcelona. The company commands 70% of the market share in and around Barcelona, but it claims only about 30% of the beer market nation-wide (Company presentation). Grupo Damm’s main strength lies in its quality portfolio of beers, which commands an extremely loyal following in its home region of Catalonia.

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Also, valuable resources the company controls, like a high tech factory with excess production capacity, add to their overall strengths. One weakness with Grupo Damm’s current market concentration is the risk of this small market weakening and hurting the company’s overall sales dramatically. Companies without diversified revenue streams, whether it is through product line diversification or geographic diversification, are more risky than diversified companies. Grupo Damm’s main competitors are larger and more diversified than itself, and this produces a competitive disadvantage from a risk-adjusted return standpoint.

One way to mitigate this weakness is to expand Grupo Damm’s geographic distribution, potentially outside of Spain. Although the Spanish market is project to contract severely over the next several years, other global beer markets are projected to flourish (Roman). One huge opportunity Grupo Damm has is the ability to be the first internationally recognized Spanish beer; something Corona has done with Mexican beer, Fosters has done with Australian beer, and Guinness has done with Irish beer.

These are not countries renowned for their beer making, like Germany or Belgium, but these brands have captured an association with their home countries that makes them ubiquitous throughout the world. A major threat to Grupo Damm – as well as all Spanish firms – is the potential collapse of the Spanish economy. This scenario is not far-fetched – Spain’s credit rating has recently been cut to BBB+ and the country has recently entered into yet another recession (Roman). This means many Spanish workers will have to be laid-off (despite the extremely stringent labor laws) as firms look for ways to cut costs.

As the recession continues, discretionary consumer items, like beer, are the first things to be cut back on – especially at the high-margin, on-trade retail segment (Appendix 3). This is not a risk Grupo Damm can diversify away, as even if it gains a foothold in international markets it could still be wiped out by a depression in Spain. Lastly, Damm is fairly well positioned financially. The company does have some leverage, with a debt to equity ratio of about 50% (Bloomberg).

However, when one examines the company’s quick ratio, (how much cash, short term investments and accounts receivable can cover short term liabilities) it is very healthy at 1. 35x (Bloomberg). The most important metric I would look at is the EBITDA to interest ratio, which measures how many times a company’s cash flow can cover its debt payments. This ratio is over 19x, which means Grupo Damm could service it’s current levels of debt for 19 years, purely with the money it made in 2011 (not including current cash reserves).

The company has enough financial resources to take on a large international project, because its large cash balance of $276 million and free cash flow of $85 million per year is sufficient to finance sizeable investments (Bloomberg). Basis for Recommendation 1. The Spanish beer market is contracting, and trying to win a larger piece of a smaller pie will prove very costly (Appendix 2). As the Spanish recession continues, revenue will decline as less beer is consumed and margins will shrink as consumers buy beer in supermarkets, significantly constraining Damm’s profits (Appendix 3). 2.

Damm has already entered the U. S. market via a 17% acquisition of U. S. Beverage, a specialty distributor that works mainly with premium imports (Peet). U. S. Beverage has had a successful track record with imports in the past, and this partnership will allow Grupo Damm to circumvent the process of having to find a reliable importer and distributor. 3. The U. S. beer market has been growing, and more specifically, the imported premium beer segment has been growing within the overall market (Appendix 4). Although other markets have been shown to be growing at a higher rate (Group 6, Slide 5), the U. S. arket is several times larger at over 208 million barrels sold per year (Jones). Financial Impact of the Recommendation Under a conservative analysis of the project, an expansion plan in America will have a net present value of over $350 million for Grupo Damm (Appendix 5). This project requires minimal capital expenditures because U. S. Beverage has already put much of the groundwork in place. The main expenses Grupo Damm will face under this strategy will be: 1. Acquisition costs for U. S. Beverage of about $10 million per year for the first three years (to gain a controlling stake in U. S. Beverage). 2.

Capital Expenditures of about $10 million for the first three years, with declining amounts in the following years to expand U. S. Beverage’s distribution capability. 3. Sales and Marketing expenses of about 10% of revenue in the first several years to establish a foothold in the U. S. market, with the percentage declining to around 7% in later years. The discounted cash flow analysis discounts cash flows of the project – which we project to be negative for three years before breaking even and then becoming profitable – at a cost of equity of about 9% (as Grupo Damm will not need to raise debt to finance the project) (Appendix 5).

The company has enough present cash to finance the project for the first several years, and free cash flow generation by Damm covers all expenses for the project more than three times. This shows Grupo Damm has ample cash and cash flow to finance the project for the few years it will take to break even, and the net present value of the project will benefit Damm significantly. Implementation of the Recommendation The implementation will first target the New York metropolitan area and will focus on marketing, distribution and sales efforts.

New York and its surrounding geographic area makes the most sense to target initially because the Port of New York is the easiest entry point into America for container ships from Europe. Also, as U. S. Beverage is located in Connecticut, a lot of their heavy distribution efforts are focused in the North Easter U. S. (Peet). To get Estrella Damm, Inedit, and Estrella Damm Daura to the customers, Grupo Damm will focus on obtaining control of U. S. beverage and leveraging the company’s existing resources and capabilities to focus on their portfolio.

They will do this by obtaining a controlling stake in the brewer (of which Damm currently has a 17% stake) (Peet). Furthermore, Damm will hire a large sales team to go to “on-trade” retailers such as supermarkets and “off-trade” retailers such as restaurants and bars to carry the product. Damm will be able to leverage its novelty as the “first Spanish beer” in the U. S. to win shelf space initially, which will be supported later on by strong demand. To target end consumers, Damm should hire a U. S. based marketing firm experienced in promoting alcoholic products.

One of Damm’s strengths in Spain is advertising, and it should continue this tradition in the U. S. (Company presentation). However, because the legal environment and consumers differ between Spain and the U. S. , it will be most beneficial to hire a U. S. -based company. The marketing campaigns should focus on connecting Damm with Spain (and the fun, vacation-esque atmosphere it conjures) to anchor the brand in consumers’ mind. However, the marketing should also focus on the quality of the beer, as this is a strong selling point in Spain and will justify premium pricing in the U.

S. market. As these initiatives begin to take hold in New York, an effort that is expected to take around four to five years, Grupo Damm should expand its distribution and marketing to other Eastern U. S. cities. A proposed list of possible further expansion cities includes: Boston, Philadelphia, Washington D. C. , and Miami. Metropolitan areas will provide the most consumers per dollar spent in marketing and sales, as well as provide the most cosmopolitan consumer base. Other Options Considered Expanding into the United States is not the only project Grupo Damm could undertake.

Multiple proposals have been created, ranging from cutting costs in Barcelona, to winning market share nationally in Spain, to exporting alcohol-free beer to the Middle East. Although each idea has its merits, none of the alternative projects offer Damm the opportunity to access as many customers as the U. S. offers, nor at a cost comparable to the U. S. expansion plan. Expanding in Spain poses many potential problems. First, the Spanish economy has recently entered a recession, and history shows recessions are usually not the best time to undergo large capital expenditure-heavy projects (Roman).

Second, the other large beer makers in Spain, Grupo Mahou and Heineken, are also strong regionally and will take offense to Damm “encroaching on their turf. ” Damm management has specifically stated that competitors can and will outspend Damm in their home regions, and they do not view a marketing campaign in the other regions as a viable option (Company Presentation). Expanding into the Middle East provides a unique and creative proposal. There are a large amount of untapped customers with large amounts of disposable income.

However, the current “malted beverages” available in Saudi Arabia are very sweet, fruity beverages, and there is no indication that Saudi consumers will switch their preference to the bitter, hoppy taste of Free Damm. Further more, expanding into a completely foreign market, both culturally and business-wise presents many risks that are not present in Damm’s American expansion proposal. The new relationships and agreements the company will have to forge in Saudi Arabia are largely in place in America, and the U. S. lan offers a much more conservative roll-out. The risk that must be taken on to enter Saudi-Arabia does not justify the potential returns from the region, especially when compared to the opportunity in America with distribution agreements already in place. Summary Grupo Damm will benefit most by expanding its business into America. Although other options exist, such as expanding in Spain or expanding in the Middle East, the greatest risk-adjusted returns will come from the large and growing beer market in the United States.

The project will diversify Damm’s revenue between two continents, as well as give the company access to a huge consumer base which values “national brands,” giving Grupo Damm a change to tap America’s large powder keg. Appendix 1: Bibliography “Beer Industry Profile: Spain. ” Beer Industry Profile: Spain (2009): 1. Business Source Complete. Web. 4 May 2012. Jones, Lester. “Brewers Almanac. ” The Beer Institute. 1 Aug. 2011. Web. 02 May 2012. <http://www. beerinstitute. org/statistics. asp? bid=200>. Peet, Laura B. “S. A. Damm Makes Equity Investment in US Beverage. ” E-Releases. MEK Enterprises, 29 Nov. 2010. Web. 02 May 2012. lt;http://www. ereleases. com/pr/damm-equity-investment-beverage-43518>. Roman, David, and Stephen Fidler. “Spain in Recession, Braces for Protests. ” The Wall Street Journal. NewsCorp, 1 May 2012. Web. 2 May 2012. <http://online. wsj. com/article/SB10001424052702304050304577375312057039088. html>. Appendix 2: Spanish Beer Market Trends Source: Beer Industry Profile Source: Beer Industry Profile Appendix 3: Spanish Beer Market Breakdown Source: Grupo Damm company presentation Source: Beer Industry Profile Appendix 4: U. S. Beer Market Source: Brewer’s Almanac Source: Brewer’s Almanac Appendix 5: Project Valuation