At a time when multinational drinks groups are once again viewing the wine sector with suspicion, Allied Domecq's commitment to a wine strategy and its continued investment in the sector has seemed out of step. Chris Brook-Carter met with Allied Domecq's Warrick Duthy to find out why a product that has proved so problematic for their peers works for them.

Wine has not been the fashion accessory of choice for most in the drinks industry of late. Poor returns, oversupplies and falling margins have all played their part in consigning the sector to a high level of scepticism from the investment fraternity.

While wine was at one time expected to dominate the acquisition plans of major drinks groups for years to come, the likes of Diageo and Foster's, having taken an extended look at the sector, seem to have re-evaluated the prudence of acquiring further wine concerns.

However, Allied Domecq and its CEO Philip Bowman, have never been dedicated followers of fashion. At a time when all counselled that the group must acquire the Seagram drinks business to stand a chance of competing with Diageo, Bowman turned his back on the deal, convinced it was an over-priced offer for a group of brands that were effectively unsuitable for the Allied portfolio.

Having turned down this apparent opportunity to close the gap on Diageo, with the acquisition of high margin brands such as Chivas Regal and Martell, Bowman then revealed his alternative - wine.

First he bought the Champagne brands Mumm and Perrier Jouet at a time when the Champagne industry was still struggling to come to terms with a massive post-millennium hangover. The portfolio was quickly joined by Montana in New Zealand, Bodegas y Bebidas in Spain - deals that coincided with wine world's toughest economic period in the last two decades - and now also includes Clos du Bois in the US and Bodegas y Viñedos Santiago Graffigna in Argentina, among others.
 
For many watching Allied it was a strategy that painted a confusing picture, appearing to amount to random acquisitions in a difficult sector. But, with Allied having weathered a storm that has claimed scalps in more experienced wine groups such as Southcorp, delivering upbeat trading statements and even receiving a general nod of approval from a number of investment banks, critics are being forced to think again.

"Our three-word strategy is 'wines people want'," says Warrick Duthy business development director at Allied Domecq's wine division. "It could be perceived as a bit trite but is intended to be market-orientated."

Put like that Allied's secret to success hardly seems revolutionary, but as Duthy points out, for all the advances made in the last decade by the New World, most wines companies still remain production-led. "In order to get return on investment and cash flow from wine you really have to be market-led," he says. "There's the element of, 'how much, what and where'. What kills wine companies is not getting that right - a lack of cash flow - too much stock means you haven't got wine the market wants."

Allied specifically targeted wine acquisitions with brands in the £5-8 segment, not wanting to be at the low-end of the market, "which tends to be fickle," or among the chateaux-style wines, which, Duthy says, require a high overhead structure to work.

On top of this Allied wanted brands that provided margins of 40% and above, in markets that could deliver growth.

Its New Zealand business Montana is the perfect fit for this strategy, with brands at the right prices and supply tightly controlled.

"Coming from NZ the problem is always going to be a shortage of wine - there's only so much. With New Zealand nearly fully planted and penetration worldwide very low, its not difficult to perceive it being perennially undersupplied," says Duthy.

In Europe, Bodegas y Bebidas was both strong at home and "demonstrated a propensity to brand properly" with its Campo Viejo brand. Meanwhile its various wine assets in California offer Allied a solid branded business and the all important stepping stone onto the US market, which is central to the group's growth future.

"Argentina is more of a long shot," admits Duthy. "They [Santiago Graffigna] haven't been able to demonstrate the brand strengths of Campo Viejo." However, he also believes, while already representing the best value for money of any wine in the world, thanks to the devalued peso, Argentina has "every chance of emulating Australia's success of the last decade."

So far so good. But this simple breakdown of Allied's portfolio fails to explain why Allied has begun to succeed where others have either failed or stayed away altogether.

The first explanation is that the group has not chased volume for volume's sake. "We'd be happy to be halve the size and make more money," says Duthy. "The correlation between size and profit is not a good indicator."

Allied, says Duthy, is not a wine business that soaks up cash. It doesn't own many of its own vineyards, while its focus on improving portfolio mix and profitability, instead of volume, means capital expenditure is relatively low.

As an example Duthy points to Bodegas y Bebidas, which in its five-year plan is not seeking volume increases at all. Indeed the company is happy, he says, to lose its low-end table wines as it grows the premium business to "avoid unnecessary expenditure centred around capacity".

But the key is in what appeared at first to be the random nature of Allied's acquisition trail. "Most wine companies tend to have one or two primary sources and one or two main markets. We have not over-invested anywhere and created natural hedges," explains Duthy.

By spreading its acquisitions across a number of continents and markets, Allied has effectively spread the risk of doing business in a category which is so prone to regional fluctuations of fortune, both through nature and economics. So while the strength of the euro compared to the US dollar is hitting French wine, including Allied's Champagne business, it is a positive boost to the group's Californian operations.

Equally while the strength of the New Zealand dollar is making exports from there tougher, the devalued peso is a boon to its Argentinian wine.

"It is an interesting but complicated web playing with a hedged business. What's bad news for one side of the business is good for another," says Duthy.

So while the vagaries of the wine industry remain a problem, they are far more expensive if you are Southcorp or Mondavi than if you are Allied Domecq.

But it is exactly because the vagaries remain, no matter how cautious the business plan, that doubts still exist over Allied's choice to invest so heavily in wine.

"It is largely about growth," explains Duthy. "Everyone in the alcohol industry has got to think about the environment we market our brands in.

"If you look at global trends there is an increase in wine consumption, driven by an increase in wine occasions. So in the long term it is a shrewd decision by the company to say, 'if we are marketing to consumers and looking for a share of beverage consumption, we better understand the occasions driving beverage consumption and have a portfolio that correlates with the trends."

He goes on: "With wine in our portfolio we increase our chance of a greater share of the beverage market in total."

Looking forward, Duthy is convinced there is no reason why getting into wine should erode margins or returns. And, although the company is unable to provide further details on financial performance until it reports to the market in October, he says the division is both generating cash and meeting targets.

But there is still a degree of caution, with the company focusing on using what it's got better, rather than attempting bold leaps forward in size or ambition. "Acquisitions were a major part of the strategy to begin with, but there is no burning desire to acquire, it's not what we are thinking," says Duthy. "We are focused on doing the right thing by the assets we have. We would only make other acquisitions if it helped us achieve or exceed the five-year plan."

That five-year plan may finally convince the remaining sceptics that Allied is in a position to deliver shareholder value through a mix of wines and spirits.

"It's a balancing act, says Duthy. "Wine businesses do need to be managed on a longer-term basis but doesn't mean you can't get return on investment in the short term."