Do we have a winner?
Since lockdowns have largely come to an end, the concerns around brewers and spirit companies has been around the return of customers to travelling, the social scene and what that means for the various types and brands of alcohol. While customers are returning and getting back to the important business of alcohol consumption, other issues are threatening the return of the industry to robust health. Chiefly among them are global inflation and rising input costs. Inflation is a concern because it means there is less left in the consumers’ wallet for a pint after settling the usual expenses. Rising input costs is a concern to the businesses themselves, as they need to carefully manage profit margins with the delicate balance between increasing the prices of their product, while not pushing customers away or to substitutes given the price increases. This phenomenon is called the price elasticity of the product and it’s a measure of how much demand decreases with an increase in price. We would also need to take into account the ‘on-trade’ and the ‘off-trade’, which is another way of asking if the drinks are consumed out at places like bars, or if they are consumed at home. Alcohol consumed out, or on-trade, is more profitable than alcohol consumed at home. While the companies are happy that consumers are out and about and consuming alcohol on the more profitable on-trade, they also don’t want to lose all the gains they made from the increase of alcohol consumption at home (the off-trade) during the pandemic. In recent companies’ results we can see that volumes are coming back strongly across the board, which would be from a significant increase in the on-trade, with the off-trade not falling off too much. With spirits, you have the added benefit of duty free coming back with increased travel. But we haven’t seen the same reaction in share prices of the brewers vs the spirits companies. The spirits companies have significantly outperformed the brewers as can be seen in the below normalised graph taking January 2021 as the starting point. This graph measures the share price movements of Diageo in white (brands include Black Label) and Pernod in blue (brands include Jameson) against Ab InBev in orange (brands include Budweiser and Corona) and Heineken in purple.
We can try and explain some of this difference in performance with the two challenges mentioned earlier, namely inflation and rising input costs. Starting with inflation, once your other expenses increase and you are left with less to spend, are you more likely to give up your beer or your bottle of whiskey? Turns out, this is far from an easy question as it depends on various interlinking factors such as geography and income levels among others. Simplifying it down to the income level perspective for now, what we have seen so far is that inflation is predominantly hurting the middle and lower income levels. Some companies exposed to the lower income consumer are benefiting to some degree due to middle income customers under pressure looking to trade down to save some money. From the results of the luxury companies, we can see that the upper income has not been affected nearly as much. So those buying premium are still buying premium, and while you have premium beers, this doesn’t quite compare to premium whiskey in its prestige. Having said that, the percentage increase in prices for the brewers has been higher than for the spirits companies and the volumes have not suffered! So why are they underperforming? One possibility is that the market is looking forward and expecting beer drinkers to start hurting from all these price increases, and another reason is the input costs.
The input costs of brewers and spirits companies are quite different. One thing to note is that the input costs are not just the raw material the product is made from, such as barley. A significant input cost for both industries is the packaging of the item. While beer comes in glass like spirits, it also comes in cans – lots of cans. These cans are made from aluminium, the price of which has skyrocketed (as can be seen in the graph below). While it has come off its highs, it is still significantly above historical levels, and this puts a lot of cost pressure on the producers. Investors may be asking how long the beer industry can continue passing on this cost to consumers.
Having said that, spirits companies are not out of the woods as Europe faces gas shortages. Glass furnaces need gas, and a shortage of gas means a shortage of glass. It will be interesting to see how this unfolds. So, the main question is then, where to from here? Do spirits companies continue to outperform or do the brewers start to stage a comeback?
The beer industry is not broken, but when will it begin to turn? Input costs for beer are still increasing. They are not increasing at the same rate as they were, but they are still increasing. Brewers also hedge their costs roughly 6 months out. This means that to protect themselves, they enter into agreements that will give them the cost price of an item today in six months’ time. This can work for or against them. In this instance, with costs coming down, it is working against them. They will have high input cost increases for probably another 9 to 12 months. In the meantime, they increase prices to offset the cost increases. We need to see if those prices stick and if they start pushing consumers away. If they can maintain their pricing and demand, then when input costs start to decline, their profit margins will open up and they will do well. If it becomes apparent that this is the most likely outcome, this will be reflected in an upward movement of the share prices.