Alcoholic Beverage Firms Have Three Shots for Growth
As the global economy recovers, consumption growth in developed markets is proving very sluggish.
The Great Recession of last year took its toll on the alcoholic beverages industry. Traffic at bars and restaurants was down, shifting some consumption to the less profitable at-home channel, while weak consumer spending led to trading down in most categories. As the global economy recovers, consumption growth in developed markets is proving to be very sluggish. We think there are three ways for companies to achieve growth in the current environment: cutting costs to grow earnings; increasing exposure to emerging markets; and growth by acquisition.
Manufacturers Are Cutting Costs to Grow Earnings
With revenue growth anemic in mature markets, the alcoholic beverage giants are looking to grow earnings by cutting overhead costs such as back-office functions and by making distribution more streamlined. Anheuser-Busch InBev's (BUD) modus operandi is to acquire companies and slash costs. Since the merger of the two beer giants in 2008, the company has realized $1.6 billion of the $2.25 billion planned synergies over a three-year period. We forecast an operating margin of approximately 29% in 2010, which should increase by another 100 basis points over the next five years. SABMiller and Molson Coors (TAP) are pursuing a similar strategy in the United States with the MillerCoors joint venture. The joint venture now expects to save $750 million in annual operating costs by 2012, and we forecast the cost savings to add a further 5 percentage points and 1 percentage point to the operating margins of SABMiller and Molson Coors, respectively.
Emerging Markets Offer Growth Opportunities
Favorable demographic trends, such as falling mortality and urbanization, together with export-driven economic growth, are fueling consumption growth in developing markets. The burgeoning middle classes are knocking back increasing quantities of branded alcoholic beverages, which is leading to high-single-digit growth rates in markets such as Asia and Latin America. Pernod Ricard this week revealed that it achieved revenue growth north of 30% year over year in China, India, Vietnam, and the Philippines. Companies with the strongest foothold in these markets will be best-placed to exploit this trend. We estimate that Diageo (DEO) generates around 40% of its revenue from developing markets. Even Diageo trails Pernod-Ricard in China, however, where the popularity of the company's Martell cognac brand makes Pernod the leading international spirits manufacturer. In the beer industry, SABMiller generates around two thirds of its revenue in developing economies, in no small measure due to its routes in South Africa. As a gateway to other alcohol categories, brewers may benefit first from growing per capita consumption, while wine and spirits makers are likely to have a longer growth trajectory.
Beverage Giants Are Likely to Acquire Growth
Although a great deal of industry consolidation has already taken place, we expect the beverage giants to continue to make acquisitions. We expect most deals to be tuck-in acquisitions of smaller players, such as Pernod's acquisition of Absolut vodka in 2008, or of individual brands. However, we think there are some blockbuster deals still out there. Fosters Group is breaking up its beer and wine segments, and we expect the major global brewers to all be interested. SABMiller is the most likely acquisitor, given that it has a stronger balance sheet than Anheuser-Bush InBev, which is still dealing with the integration of Anheuser-Busch. Boston Beer (SAM) owns Sam Adams, the most popular brand in the "better beer" category, the only growth spot in the domestic industry. Millennials are switching from mass-produced beers to higher-quality crafts and imports, and we don't think the big players can ignore the trend for much longer. SABMiller has launched its craft brand Leinenkugel, and Molson Coors has Blue Moon, but neither has achieved the penetration of Sam Adams. With its market cap being just under $1 billion, any of the industry leaders could swallow Boston Beer.
Molson Coors Offers Upside Now; May Become Acquisition Target
Although our alcoholic beverages coverage universe is generally trading at modest premiums to our fair value estimates, one name may offer investors an opportunity to play all three trends we've identified: Molson Coors. The firm's joint venture in the U.S. with SABMiller is expected to generate $750 million in annual savings by 2012, as manufacturing facilities are integrated and distribution costs lowered. We think the market is missing the value of the joint venture, and the firm is trading at a subdued 13 times our estimate of 2010 earnings per share and less than 10 times enterprise value/earnings before interest, taxes, depreciation, and amortization. If the firm can deliver on its expected cost savings and bolster its operating margins up to the high 20% range, in line with similar-sized competitors, this could prove a catalyst for the stock. Over the longer term, Molson Coors will have to enter new markets organically, which is risky, and given the firm's past failures in this regard, unlikely; make acquisitions, preferably in emerging markets; or itself be acquired. We think SABMiller would be the most likely suitor given the two firms' combined operations in the U.S. and the strength of SABMiller's balance sheet.
Philip Gorham does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.