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Companies in the Beverage Industry display the ability to generate strong cash flow and consistent earnings growth, even in times of economic softness. They sell products that are somewhat discretionary, but are consumed quite regularly and appeal to a wide range of customers. They maintain steady profit margins, and revenue growth is derived from numerous channels such as new products, price increases, mergers & acquisitions, and international expansion, especially in emerging markets.

Effective advertising is important for attracting new customers and keeping existing ones. Global beverage suppliers are required to focus on catering their marketing strategy to each individual country they operate in. It is important to consider the number of countries a beverage company currently operates in, as well as the likelihood of acceptance in new markets.

The stocks featured in this screen display low risk attributes. We chose to include only those with Price stability scores in the 90th percentile and above. Further, the stocks that were selected received above average marks for Safety. Finally, only companies with projected average  long-term annual free cash flow growth above 7% were considered. The six stocks that met these criteria are listed below. Of these, we have chosen to highlight Diageo PLC (DEO). 

 

Company

Ticker

AB InBev ADR

BUD

Brown-Forman 'B'

BF/B

Coca-Cola

KO

Diageo plc

DEO

Molson Coors Brewing

TAP

PepsiCo, Inc.

PEP

Diageo PLC

Headquartered in London England, Diageo was established in 1886, and is one of the world’s largest alcoholic beverage producers and distributors. The company’s operations include distilling, brewing, packaging, and marketing its extensive portfolio. The following 14 brands comprised 60% of fiscal 2012 sales and were allotted 72% of Diageo’s marketing budget: Whiskey: Johnnie Walker*, Crown Royal*, J&B, Buchanan’s, Windsor, Bushmills; Vodka: Smirnoff*, Kettle One, Ciroc; Rum: Captain Morgan; Liqueur: Bailey’s*; Tequila: Jose Cuervo*; Gin: Tanqueray; Beer: Guinness*.

(* signifies the brand has the number one position in the world in its subcategory according to IWSR 2001 and Impact Databank).

Although Diageo has had a strong run over the past five years, its risk-adjusted long term price appreciation potential still stands out. One reason for Diageo’s solid growth prospects is its focus on the Asian market. According to the company, there are 57 million new consumers reaching legal drinking age each year. Combining this staggering statistic with the fact that most Asian countries continue to experience relatively strong GDP growth, we believe that the number of middle class consumers may well double over the next ten years.

Not only should Asian GDP growth lead to a bigger middle class, but the number of high-net-worth consumers in Asia should also increase, even though it already has the highest number out of all continents. This plays on another growth driver for Diageo, premiumization, i.e., developing relatively high-priced products for a more-affluent customer base. High-priced products tend to carry better-than-average product margins. One recent example of premiumization was the successful launch of Johnnie Walker Platinum Label at $85, which has delivered 100,000 cases this spring; and Johnnie Walker 21 Year Old at $100, which has sold more than 50,000 cases since March. In fact, DEO has doubled the value of its reserve brands since 2010. Still, headwinds remain this year as the Chinese government announced an “anti-extravagance” campaign seven months ago, which has affected consumption of all alcohol categories, but especially those used for high-end banqueting, gifting, institutional sales, and business entertainment.

We believe Diageo’s operating margin will continue to expand over the intermediate term thanks partly to its penchant for acquiring emerging market companies that improve overall economies of scale. Indeed, DEO recently created a joint venture to purchase a brewer in Africa. Moreover, the acquisition of United Spirits received approval by the Indian regulatory authority. We are confident that revenues can grow in the double-digit range across the faster-growing markets.

Aside from the positive growth prospects unique to Diageo, the company competes in an attractive industry. Indeed, over the past several years consumer tastes have shifted away from beer toward wine and spirits. This augurs well for DEO since its brand portfolio consists of some of the biggest and most recognizable names in the spirits subsector.

Overall, we think Diageo may interest conservative accounts looking to add an element of safety to their portfolio in this turbulent market.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.