Changing Tastes Benefit Spirits Companies
Capital Group Equity Analyst
Sit down at almost any bar or restaurant these days and you’ll quickly be handed a menu. But it won’t spell out appetizers, entrées or even happy-hour noshes. Instead, it will list a half dozen or more specialty cocktails featuring tantalizing names and exotic ingredients. This is one of the more visible examples of a “cocktail culture” that is burgeoning across the U.S. and other parts of the world. Demographic and economic shifts are spurring an increased taste for mixed drinks, which I believe will propel sustained growth in the alcoholic beverages industry in coming years.
After expanding steadily from roughly 1960 to 1980, the spirits industry experienced a lull of sorts over the next two decades. Health concerns and the demise of three-martini lunches contributed to a decline in alcohol consumption. That has changed in recent years, with the liquor business being paced by many of the trends driving upscale food and deluxe coffee — namely, rising disposable income and an affinity for high-end offerings.
The liquor industry is benefiting from expanded living standards in emerging markets. Products made by leading global companies are supplanting locally made alcohols. In some cases, the local liquors are little more than the modern equivalent of Prohibition-era moonshine. The local hooch is cheap and plentiful, but there are wide variations in flavor and quality. Foreign-made liquors, by contrast, are prized for their consistent taste and the cachet they bestow.
The developing world is also providing a significant boost to the beer industry. Even more than liquor companies, major brewers are grabbing market share from local players. That stems partly from the lower cost of beer. As consumers in the developing world move up the income ladder, beer becomes increasingly affordable. In some countries, there were no local beers before the introduction of foreign brands, so brewers in these markets have essentially created a new product category.
Outside of the emerging markets, the prospects for the beer industry are more subdued. Craft brews with distinctive flavors and appealing brands are gaining in popularity, but the outlook for mainstream beer makers in the U.S. and Europe is modest. Growth has been held back by ongoing concerns about drinking and driving. Beer makers have also been unsuccessful in attracting female drinkers. Despite countless marketing efforts, the industry has made little headway with women and has returned its focus in recent years to men. Among beer makers, I favor companies that have loyal and growing customer bases in the developed world and strong prospects overseas.
Shifting demographics spur interest in mixed drinks.
The flip side of the challenges for beer companies is the brightening outlook for liquor makers. Beer and alcohol consumption in the U.S. used to follow a fairly predictable pattern based on the age of consumers and their stage of life. Typically, people favored beer in their 20s, before their tastes branched toward alcohol, and mixed drinks in their mid-30s and beyond. Increasingly, that dynamic is evolving as people become interested in spirits earlier in their adult lives. As a group, millennials are known for their pursuit of new experiences and their desire for products that are unique. Designer libations fit the bill on both counts. The introduction of trendy drinks in nightclubs has broadened the overall allure of mixed drinks, with both men and women finding concoctions that appeal to them. (Wine is also gaining market share, but it makes up a relatively small share of revenue at publicly traded spirits companies.)
Perhaps surprisingly, the liquor business is getting a boost from the aging of the population, particularly baby boomers. As they grow older, many tend to drink less than they did when they were younger. That’s due to a variety of factors, including an awareness of alcohol’s high calorie counts. But while people may consume fewer drinks each time they go out, they’re willing to pay more for superior taste and an overall perception of quality. That is spurring sales of higher-margin liquors. In fact, such “premiumization” is catching on among all age groups in the U.S. and even in the developing world. Also, as drinkers discover new tastes in bars, they buy the liquors themselves to mix their own exotic creations at home.
Distribution networks are vital when launching new products.
Aside from consumer trends, large beer and liquor companies are able to use size to their advantage to fend off ongoing competition from upstart brands. Leading companies have the scale and financial muscle to fund research, marketing and distribution, all of which are critical when launching new products in an increasingly crowded marketplace. Given the consumer penchant for craft beers and liquors, large companies have put an emphasis on research and development. Their goal is to introduce a handful of promising products each year, and they rely on extensive marketing and global distribution networks to get products into restaurants and nightclubs. Large companies also have the financial wherewithal to fund costly distribution efforts in emerging markets.
To be successful over the long term, companies need strong management with the vision to anticipate consumer trends — sometimes years in advance given the long lead times inherent in the distillation process. Managements must choose the right products to promote while effectively motivating their sales forces. I meet regularly with company managements to understand their strategies and assess their ability to anticipate consumer trends.
A few other factors appear to be pointing in the right direction. The industry was hurt in the past few years by an anti-corruption effort in China as the country’s leadership cracked down on governmental fraud. The previously routine practice of giving a bottle of alcohol to an official as a courtesy fell sharply because of fears that the gesture could be interpreted as bribery. For major distillers, that meant dented sales and inventory back-ups. I believe most companies operating in China have now adjusted their sales projections and inventory levels, and will see improved revenue moving forward.
Also, the industry has finished a consolidation period in which some companies took on heavy debt to fund acquisitions. Debt levels have become more manageable, freeing up cash that can be earmarked for increased dividends and share buybacks. I believe dependable growth in coming years will allow companies to increase the amount of money they return to shareholders.
Archana is an equity analyst covering the alcoholic beverages industry. Based in London, she has 17 years of investment experience and has been with Capital Group since 2014.