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Industry Analysis: Beverage
The Beverage Industry is a mature sector and includes companies that market nonalcoholic and alcoholic items. Since growth opportunities are limited, many members of the industry endeavor to diversify their offerings to better compete and gain share. Too, they may pursue lucrative distribution arrangements and/or acquisitions to expand their operations and geographic reach.
Most equities in this group are suitable for conservative investors. The largest companies offer reliable dividends, with regular increases, and above-average Stock Price Stability. There are a few selections for those that are more venturesome. Such issues might serve a particular market niche, for example, energy drinks or developing overseas markets. Generally, the group turns in a steady performance throughout the business cycle, but it will suffer in the most stressful of economic times.
The Nonalcoholic Segment
Historically, two large entities have dominated the nonalcoholic beverage landscape: Pepsi (PEP) and Coca-Cola (KO - Free Coca-Cola Stock Report). They distribute their well known carbonated and noncarbonated drinks internationally via sizeable bottling subsidiaries. The bottlers depend on these two industry leaders to create new products, improve existing offerings and maintain sufficient advertising. Related capital spending amounts to several billion dollars each year. The industry titans often boost their results (and those of their subsidiaries) by purchasing smaller market players or by inking promising distribution agreements. In prosperous economic times, consumers usually favor the most famous brand names. Still, when customers are short of disposable income, they turn to competing, inexpensive private label and lesser-known beverages. Sales are seasonal, not surprising, peaking during warm summer months. Consumer preferences will drive product diversification. Most notably, greater awareness of the causes of common health issues, e.g., obesity and diabetes, has increased demand for bottled water and other low-sugar or sugar-substitute drinks. Too, beverage companies have capitalized on the popularity of energy drinks and ready-to-drink coffee. Product diversification may be achieved through internal or external means. The same goes for geographic expansion. China and Russia, two, of course, very large markets in the developing-nation arena, have gotten much attention. Beverage companies have spent heavily to open new bottling plants and develop distribution networks in these countries. Some carry significant debt leverage, but cash flow is fairly predictable and usually more than sufficient to cover annual interest payments (and dividends) and maturities.
Wine, Beer, and Spirits
The range of wine, beer and distilled spirits offered by brand and type is wide. Demand is somewhat inelastic across good and bad economic times. There is an overall long-term trend of rising affluence around the globe. Thus, more and more consumers are becoming increasingly discerning about what they purchase. Premium alcoholic beverages are gaining in popularity. Investors should consider, though, that this trend is disrupted during recessions, when people trade down to cheaper, low-margined products. As is the case with premium wine and spirits, microbrew or craft beer is very popular with consumers. These beers are priced higher and are quite profitable, as long as the cost of their rich ingredients is covered. Small brewers, paying close attention to quality, expand slowly, but, over time, can win a decent share of business. Big brewers have acquired such operators or developed their own premium beers so as not to lose any sales. Like their nonalcoholic peers, makers of alcoholic beverages invest large amounts of cash in marketing and advertising to build brand recognition. Debt burdens can be rather hefty here, as well, especially when a company is aggressively expanding through acquisitions.
Both the nonalcoholic and alcoholic sides of the Beverage Industry are dominated by a few sizeable players and competition among them is often intense. Changing consumer tastes adds to operating uncertainty. Pricing and margins frequently come under pressure. Also, volatile commodity costs will challenge managements to protect profitability. Good operating efficiency and cost-control practices, mostly on an ongoing basis, are important. Notably, the companies take care to hedge raw material (e.g., aluminum and carbon dioxide) purchases. Missteps in reading the trends of ingredient prices can have a measurable negative impact on earnings. We find that beverage makers with the most established brands produce the widest operating and net income margins.
Much has changed since American Prohibition of the 1920s and 1930s. With the exception of a few counties and towns, the prohibition of alcohol has been repealed in all U.S. states. Industry sales are considerable, and the federal government and states see sin taxes as a good source of revenue. Authorities are also considering tax increases on soft drinks to curb citizens’ sugar (corn syrup) intake and boost revenue. Other governments around the world have also weighed similar tax hikes to shore up their budgets. Incremental taxes have not hurt overall beverage demand, but, to a degree, they have pressured sales of premium offerings. Foreign governments, from time to time, come under pressure from religious/health leaders to limit or ban alcohol consumption or local industry/public calls to restrict alcoholic/nonalcoholic beverage imports. All in all, this industry has a lengthy history of steady single-digit yearly sales and net-profit growth.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.