Drink giants’ risky new plan: quantity not quality
The author is a Reuters Breakingviews columnist. The opinions expressed are her own. Refiles to fix typo in paragraph one.
By Aimee Donnellan
LONDON, Oct 2 (Reuters Breakingviews) -The titans of the alcohol world may soon start peddling cheaper booze, and in much greater volumes. Until fairly recently, giants like $80 billion Diageo DGE.L and $40 billion Pernod Ricard PERP.PA focused on a strategy known as “premiumisation”, which involved flogging pricier spirits and beers to make up for the fact that punters were drinking less. A consumer spending squeeze, however, warrants a rethink, which is probably bad news for investors.
Premiumisation became an industry buzzword over 20 years ago. Back in 2000, Guinness maker Diageo sold off its food business to focus on dearer drinks instead. More recently, in 2016, Danish brewer Carlsberg CARLb.CO relaunched its Export brand in an effort to “premiumise” the product and reverse declining sales amid the craft-beer boom. The same year SABMiller, which Anheuser-Busch InBev ABI.BR absorbed, said that in London the premium segment accounted for 25% of total beer sales.
The strategy made financial sense. Consumers were flocking to pricier drinks, ranging from artisanal spirits to locally brewed beers. The evidence suggested that brands with more of an aspirational appeal, like Don Julio tequila, would outgrow mass-market ones like Smirnoff vodka. The pricier drinks are also more profitable. Take Diageo. RBC analysts reckon that the Gordon’s gin maker’s operating margin is 7 percentage points higher for premium brands than the group-wide average.
There was also a socially responsible feel to premiumisation, which allowed brands to argue that they were encouraging restraint by selling better-quality alcohol at a higher cost. That ticked a box for environmental, social and governance (ESG) investing, which was particularly popular in 2021.
The big drink groups are still putting money behind premiumisation. In July, Pernod Ricard sold its international wine brands so it could focus more of its efforts on its premium champagne and spirits. In December 2023, Aperol maker Davide Campari Milano CPRI.MI bought premium cognac brand Courvoisier for $1.2 billion as part of its expansion into “super premium” drinks.
But the strategy is looking wobbly. Last November, Diageo CEO Debra Crew revealed that customers in Latin America were also feeling the pinch from higher interest rates, and were similarly opting for less expensive booze. RBC reckons that the proportion of sales that Diageo gains from high-end brands fell from 29% in 2023 to 27% this year and could decline further in the future. If the proportion of premium drink sales eventually fell to 20%, the same analysts calculate that Crew’s target of 5% to 7% medium-term revenue growth would slip out of reach. The operating margin would also likely suffer.
The pain has shown up in valuations, which have slipped from their pandemic-era highs. Diageo, Pernod Ricard, Campari, Heineken HEIN.AS and Carlsberg all trade at lower forward price-earnings multiples than they did in 2021 and large parts of 2022, according to LSEG Datastream figures. That reflects broader growth worries, but the fading premiumisation trend is a key part of the picture.
Brewers arguably have some immunity, since premium beer typically costs only around $1 per drink more than the mass-market stuff. That’s a much smaller price gap than in liquor, suggesting consumers could keep paying up for fancier brews. But the cracks are still showing. In August, although the growth of Carlsberg's premium outstripped its cheaper beers in the first six months of the year, CEO Jacob Aarup-Andersen said the $17 billion group’s higher-end consumers were trading down to cheaper beers.
If consumers are feeling pinched, there’s little the drinks groups can do to entice them to pay up. The logical response, therefore, is to focus back on cheaper liquors and beers instead. Diageo, for example, could start ploughing more of its marketing budget into selling Smirnoff vodka over its Don Julio premium tequila, and do the same with Johnnie Walker Red Label whisky instead of its more premium Black Label. Campari can do the same by spending more money promoting Aperol, and brewers like Carlsberg and Heineken might shift resources to promoting basic lagers over the premium stuff.
This strategy, however, poses two problems. First, flogging cheaper drinks risks hurting margins. Second, the strategy essentially amounts to focusing on quantity rather than quality, hurting the companies’ ESG credentials. Brewers and liquor makers have generally escaped the same level of scrutiny that tobacco companies attract, partly because the alcohol industry has made a show of championing responsible drinking. If they abandon that stance in a bid to keep their top line rising, the sector could attract more government attention.
Luckily for alcohol CEOs, investors seem less focused on ESG targets than they did in the past. But there’s no escaping the possible financial hit from “de-premiumisation”. The old strategy, focused on higher-margin brands, gave the companies a growth strategy that also helped to protect them from the effects of rising inflation. For investors, the new world might sting like a cheap whisky.
Follow @aimeedonnellan on X
CONTEXT NEWS
Carlsberg on Aug. 14 gave a gloomy outlook for the Chinese market, where beer drinkers are increasingly opting for cheaper brands rather than expensive ones, prompting its shares to hit their lowest level since March 2022.
"We're still performing solidly in China. But within premium we're seeing high-end premium consumers migrating down to more affordable premium brands," said CEO Jacob Aarup-Andersen on a call with journalists.
Drinks groups' falling forward price-earnings ratios https://reut.rs/4eDHjM8
Falling operating margins expected between 2022 and 2025 https://reut.rs/3zHmjFz
Editing by Liam Proud and Streisand Neto
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