Description

Cuervo has been written up a few times on VIC, but not since ’20.  I will keep this short and sweet. 

Cuervo primarily sells Tequila and Irish Whiskey, the two fastest growing global spirits.  It’s currently under-earning due high agave prices (their largest input), which have started to plummet, and a strong Peso, which has started to reverse its rise.  Over the next few years, growth should be relatively non-cyclical owing to Cuervo’s high mix of mid-priced brands and secular growth in their categories, and margins should expand 900 bps+, resulting in EBITDA nearly doubling by ’26.  Yet, Cuervo trades at a discount to global spirits peers and ~13x ’24 consensus EBITDA (mid-high teens EBITDA multiple is normal in spirits).  Shares should rise 75%+ in MXN terms and 60%+ in USD terms over the next 2yrs.

Agave

Agave costs currently represent ~20% of Cuervo’s revenue vs. 10-12% historically.  Agave is a ‘mom and pop’ commodity in Mexico with thousands of small farmers that drive a significant portion of supply.  It also has a long growing cycle of 5-7 yrs.  This dynamic has resulted in consistent ‘boom / bust’ cycles in agave prices.  Prices have historically skyrocketed when there’s not enough near-term agave supply, and when there’s too much supply, prices have no problem falling far below marginal cost to produce.  In fact, in the early twenty-teens when prices were in the LSD’s, there were widespread reports of agave farmers giving away agave for free simply to free up their land for other crops. 

The chart above from Grover at Tequila Matchmaker highlights this dynamic.  From ’17 to ’20, prices increased 3-4x, as tequila’s growth stripped through agave supply.  This drove 800 bps+ of margin pressure at Cuervo.  The mom and pop farmers saw this happening and decided to get into the agave game… at exactly the wrong time.  New agave plantings, according to the CRT (tequila regulatory council), went through the roof, as did plants in the ground. 

Recall, you can’t use the agave until it’s been in the ground for at least 5yrs – the first year of super-normal agave plantings was 2017, hence, many expected agave prices to plummet in ’21 ahead of huge agave harvests in ’22.  However, prices stayed high at around 30 MXN.  This is primarily bc, again according to the CRT, significant demand for high-end 100% agave that is aged led distillers to produce tequila in excess of current period demand for purposes of aging.  That has now come to an end.  Prices have started to plummet and are currently somewhere between 10 and 16 MXN vs mid 20’s at this point last year (there’s no market here so exact prices are tough to figure out).  Prices should fall into the single digits over the next 12-18 mos as agave harvests get larger and larger.  2017’s plantings were 72% larger than the prior 3yr avg, but ’18 and ’19 were 20-30% larger than ’17 and ’22 was massive – more than 2x the size of ‘17’s plantings.  In short, outside of a massive famine that kills 25% of the agave crop, there’s basically no scenario where agave demand is even close to supply for the next 5-7 yrs.  There’s a 6-9 month lag between spot agave prices and Cuervo’s margins, so we should start to see significant margin tailwinds by late ’23 / early ’24, culminating to at least 500 bps of margin within the next 24 months. 

So what happens to Cuervo’s agave margins in 5-7 yrs?  The answer is nothing.  They’ve spent the last 3yrs building internal agave capacity – enough to supply 90%+ of their needs in 3-4 yrs.  So the next agave boom cycle should have minimal impact on their margins.

FX

The frustrating thing is that at exactly the same time agave started falling, FX became a significant headwind to margins.  Cuervo’s biz is 60% US but the bulk of their costs are in Mexico, so a strong peso is a significant headwind to margins.  For every 100 bps of MXN deprecation vs the USD, margins fall by 15-20 bps.  From ’22 to ’23, the peso appreciated by 20%, resulting in 300-400 bps margin pressure for Cuervo.  Historically, the peso has depreciated vs the USD (50-150 bps p.a.) due to higher inflation in Mexico vs the US.  But, recently inflation in the US has been quite similar to inflation in Mexico, and higher rates in Mexico combined w record remittances drove significant MXN appreciation.  I’m not an FX forecaster but most experts believe the MXN is at peak-ish levels and it should go back to depreciation from here.  The chart (below) suggests the peso may have run out of steam.  I model the peso returning to ’22 levels by ’24 or ’25, driving 300 bps of margin tailwinds.

Catalyst

Earnings beats beginning in '24.  Peso depreciation.  Continued newsflow on agave price declines.