The spirits industry, like other industries, has been hit by the current global economic crisis. Euromonitor International's latest global briefing, 'Global Opportunities for Leading Spirits Players despite the Economic Downturn', looks at how spirits companies are dealing with the current global conditions.

The briefing assesses the impact of the economic crisis on the global spirits corporate landscape, giving an overview of how the leading companies and brands performed in 2008. Jeremy Cunnington, senior alcoholic drinks analyst at Euromonitor International, investigates the strategies companies are and should be adopting to mitigate tough conditions, whilst still pursuing growth over the longer term.

Home comforts

With a number of economies in mature and emerging markets suffering, spirits companies have been focusing on their core markets. As these countries are their main revenue sources, this is a sensible policy. For example, in fiscal 2009, North America and Western Europe combined accounted for around 70% of both Pernod Ricard and Diageo's operating profit.

However, there are dangers of over-reliance on core markets at the expense of emerging markets, which offer the strongest long-term growth prospects. Bacardi and its eponymous rum brand are suffering poor volume performances due to their over-reliance on a limited number of core markets, such as the US, the UK and Mexico. Diageo is paying the price from withdrawing from Asia-Pacific at the start of the century following the Asian financial crisis when it cut back on developing its base in China and sold its local Indian whiskey division to focus resources on its North American and Western European markets. In realising its mistake, Diageo has had to spend increasingly large amounts on re-establishing itself both in India and China, which has significantly eaten into its operating profit for the region and means the company is still behind its rival, Pernod Ricard. The French company remained in both countries, continuing to invest in the region, and is now well placed, especially in India, to capitalise on the dynamic market.

Entering emerging markets no easy task

Emerging markets offer potentially huge growth prospects, particularly in categories which are declining in core markets, such as blended Scotch. Countries such as China, Thailand and Brazil will drive future growth in the category. Other categories which are still growing in core markets, such as vodka and rum, are also growing rapidly in emerging markets, for example rum and vodka in India. Historically, due to lower disposable income in these markets, imported spirits are premium products so often see sharp volume declines when crises hit, as Eastern Europe has shown this year. They are also likely to bounce back relatively quickly as can be seen from blended Scotch in Latin America following the Asia-Pacific crisis in 1997-98 and the Latin American crisis in 2002. Within two or three years of the crises, volumes had exceeded their pre-crises peak.

However, emerging markets, or indeed any new market, as well as offering huge opportunities may also throw up considerable pitfalls, so careful planning is needed. The global briefing looks at all the different aspects companies should consider before deciding which market to enter. For example, any company has to look at whether it has the right product for the market. The most dynamic blended Scotch market, China, is dominated by premium (12-year-old and above) brands. This leaves companies such as William Grant and Edrington, which lack a sizeable premium blended Scotch brand, not being able to target that market with blended Scotch. Instead, they are focusing on developing their premium single malt Scotch ranges in China.

Crisis offers inorganic growth opportunities

The economic crisis has also seen a change in mergers and acquisitions. Before the start of the crisis, businesses were willing to pay very high prices for both companies and brands. Following their respective acquisitions of V&S and Whyte & Mackay, Pernod Ricard and UB Group both had debt levels of over six times the enlarged companies' EBITDA, which is close to the danger level of seven or eight times financial analysts set for companies not being able to pay back the debt. This has meant that companies are looking for ways to lower debt, especially as it is still difficult to refinance at competitive rates.

This has given opportunities to other companies to develop their portfolios, as Campari did with the acquisition of Wild Turkey from Pernod Ricard, and Diageo did in attempting to buy a stake in UB Group. More opportunities are likely to follow in the short term as companies such as CL WorldBrands and Belvédère are also facing severe financial difficulties. Recent deals have been more conservative, with Campari's acquisition of Wild Turkey giving it a long-term debt to EBITDA level of only three times. This is likely to continue for the foreseeable future.

All leading international companies need to work to develop themselves, either through greater international expansion, a broader portfolio, or both. Diageo and Pernod Ricard have gaps in their portfolios while companies such as Campari and Edrington need to broaden their geographic spread. So, while spirits companies are currently likely to focus on core markets and conserve cash in the face of the economic downturn, once the recovery is under way and confidence returns we should see continued investment in emerging markets and, equally importantly, a further round of consolidation.