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Sipping The Good Stuff

Posted: Mar 27, 2008 15:16 PM by Will Ashworth

Tickers in this Article: ABD, FO, DEO

The other day I was savoring my favorite Scotch whisky, and it got me thinking about the liquor industry. There is a move afoot to premium and super-premium beverages as people seek out better, more expensive brands of their favorite drink.

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While people tend to drink less today than in the past, when they do, they are drinking "better", according to David Ozgo, chief economist for the Distilled Spirits Council of the United States. No longer are we satisfied with bottom-of-the-barrel quality. We want the good stuff. (For related reading, check out Demographic Trends And The Implications For Investment and A Top-Down Approach To Investing.)

Premium Spirits On The Rise
Revenue from spirits grew by 5.6% in 2007, according to the Distilled Spirits Council's "2007 Industry Review" (pdf). And since 2001 spirits have added 4.4% market share, to 33.1% from 28.7%, mostly at the expense of the beer business. Last year, in terms of volume, the super premium category grew by 11.3%, adding close to $400 million in new revenue.

Meanwhile, down at the lower end, the value category grew 0.3%, which translated into a loss in revenue of $106 million. Clearly, people are trading up. Single malt scotch sales by volume were up 6.7% and super premium blended scotch, 24.3%. The Distilled Spirits Council projects 2008 growth by volume of 1.9%, to 185 million, the lowest in seven years. However, the combination of increased prices and a move to premium products, means revenue growth should be around 4.6%. Given the global economic situation, that's not bad at all. Now lets examine the publicly traded companies that own some of the top selling Scotch whisky brands:

• Johnnie Walker - Diageo PLC (NYSE:DEO)
Diageo is the world's largest producer of premium beverage brands. The company is a result of the 1997 merger between Grand Metropolitan and Guinness. This marriage created an alcohol powerhouse with well-known brands like Johnnie Walker, the world's largest selling scotch with 15.4 million cases annually. Others include J&B scotch, Guinness beer, Smirnoff vodka, Captain Morgan rum, and Cuervo tequila. With annual revenues in 2007 of $15 billion and pre-tax margins of 26%, this is one profitable company and scotch is leading the way with 13% growth in 2007. Diageo is in the ideal position to take advantage of the consumer's desire to trade up to better brands. With double-digit growth in both net sales and operating profit, Diageo is a welcome addition to any portfolio, in good times or bad.

• Ballantine's - Pernod Ricard (Paris Stock Exchange)
Pernod Ricard is a major player in the liquor business. In 2005, it bought Allied Domecq, a British liquor company, instantly doubling sales in America. Ballantine's, the world's No.2 scotch brand, was one of the brands that came with the acquisition. In 2007, company sales were $10 billion, up 6.2% from the previous year with pre-tax income of $1.7 billion. Last year Ballantine's sold 5.9 million cases, growing sales 22% globally, which is clearly becoming the main battleground (and profitable one) for the world's largest liquor producers. Pernod Ricard also owns the world's fourth best selling whiskey Chivas Regal. Pernod is a strong competitor to Diageo, though not nearly as large, nor profitable. From a financial perspective, the company is solid and the growth prospects real. The dividend yield is 4%, making Pernod an excellent place for your money.

• Teacher's - Fortune Brands (NYSE:FO)
Teacher's Blended Scotch Whisky is No.10 on the list of best-selling scotch labels. Fortune Brands not only competes in wine and spirits, but also in golf and home hardware. The wine and spirits division accounts for 45% of the overall revenue and is the most profitable of the three, with operating margins of 26% compared to 15% for home hardware and 13% for golf. The Teachers brand sold $100 million in 2006. The company had 24 other brands with sales of $100 million or more in 2006. In 2007, total sales were $8.56 billion with $1.1 billion in pre-tax income. The company pays a dividend of $1.68, currently yielding 2.5%. Some of its other liquor brands include Jim Beam bourbon and Canadian Club rye whiskey. Non-liquor brands include Titleist, FootJoy and Moen faucets.

Fortune Brands has undergone a transformation in recent years unloading several businesses and spinning off another Acco Brands (NYSE:ABD) to focus on the most profitable segments of the company. Unfortunately, it should have gone further. A stand-alone liquor business would be far better for shareholders. As it stands today, the other two segments are mired in slowdowns and are creating a serious drag on the stock price. I wouldn't be buying unless the economy recovers or the liquor business is spun off. (To learn how to profit from a spin off, check out Cashing In On Corporate Restructuring.)

Bottom Line
Luxury items are not the strongest investment during economic downturns, due to their cyclical nature. There is usually a tightening of the wallet for the normal consumer, and nonessential goods are the first to go. The best time to buy these stocks seems to be right after a recession. Have we seen the bottom yet? I don't know. What I do know is a company like Diageo, that has the No.1 or No.2 brand in several categories, is a welcome addition to any portfolio, especially when the markets rebound.

For more on investing in alcohol, check out Socially (Ir)responsible Mutual Funds and A Prelude To Sinful Investing.

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.

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