Analysis

Alcohol's ethical quandary, Pernod Ricard's time in the spotlight and a drinks stock update - The just-drinks Analyst

Most popular

Coca-Cola alcohol launch a statement of intent

Coca-Cola reaps rewards of CEO's innovation bet

Interview - Beam Suntory CEO Albert Baladi

Why are spirits brands still getting women wrong?

Why 'Quality Control' is the name of the beer game

MORE

just-drinks' resident analyst, Ian Shackleton, is back for his monthly look at the drinks industry from an investor's point of view. And, he's just in time for results season.

Are investors finally about to get serious about ethical investing and where does that leave alcohol companies?

Nowadays, we read a lot about the growth of ESG investing - environmental, social and corporate governance - or SR investing - socially-responsible. There's also impact investing, which aims to generate a measurable, beneficial social or environmental impact. You can certainly come away with the feeling that this is having an increasing influence on investment decisions by large institutional investors.

My experience as an analyst didn't expose me too much to these terms. Most analysts are focused on making money for their investor clients, which is usually correlated with expectations on profitability rising in companies if you have a Buy recommendation (or falling, if you have a Sell recommendation). This doesn't leave much time for considering the 'softer' issues, many of which may actually increase costs and, therefore, reduce profitability.

When I did come across portfolio managers focusing on these softer issues, I generally got a sense that they were going through a box-ticking process. I remember spending several hours helping investors fill in a form on Diageo, assessing factors like water usage, employment practices and attitudes to alcohol. I obviously said the right things, as they usually managed to get a tick in the box and were able to invest in the group.

Certainly, there are stories about several investment management firms that, despite having invested quite substantially in an 'ethical investment' department, put this team at the back of the building and don't let them get too involved in the money-making decisions. To be fair, there have always been a small subset of investors, such as Franklin Templeton Investments, which has a policy of not investing in 'sin stocks'. Unfortunately, alcohol does tend to get lumped with tobacco and the arms trade; not the kind of company that you probably want to keep.

Clearly, many companies have been spending significant time and money on these issues, as they rightly identify that it's important to consider the needs of all stakeholders rather than prioritising just their shareholders. A look at the Diageo website, for example, throws up a code of business conduct, not to mention a separate section called "in Society", which addresses topics such as alcohol in society, its effect on communities and its environmental impact.

Increasingly, companies are putting their money where their mouth is, such as Danone who, on its results conference call last week, said that 20% of its long-term bonus plan for management is linked to the company's carbon footprint and that the interest rate on its recent credit facility was partly linked to ESG targets.

Are investors finally going to get more serious about this subject? Last month, the head of Blackrock, one of the world's largest asset managers, wrote a letter to companies where he warned them that they must contribute to society, as well as deliver financial performance, or risk losing its support.

There was also an interesting snippet of news last week, when Mark Mobius, the renowned emerging markets investor, announced he was launching a fund aiming to bring environmental, social and governance improvements to companies in the developing world. Mobius clearly sees these issues becoming more important in investment decisions. He also pointed to the opportunity for such a fund to outperform, given the current growth of passive funds, which tend to index against a market, at the expense of active fund management.

Is Diageo's hard work on ESG matters about to pay off? Possibly, but there's still some risk that alcohol will continue to be grouped with other 'sin stocks' that could be seen as unattractive for investment. Mark Mobius may not be much use to the group either - he spent most of his working life working for Franklin Templeton, so there's a risk he could stay with the 'no sin stocks' policy.

The messages from recent reporting – vive Pernod Ricard

Most of the large companies have now reported their calendar Q4 results. The process has been disrupted, though, by the market correction at the end of January, so most share prices are now down since the start the year. One stock does stand out from the crowd, and that's Pernod Ricard, where the shares are now trading at an all-time high of over EUR135.

What did Pernod do right in its half-year results?

Well, it upgraded guidance for the full year, indicating better growth both at the top-line - the estimated growth range moved from 3%-to-5% to 4%-to-6% - and at the margin. A key driver behind this was a stronger performance in Asia, and in China specifically. You may recall, last month, I expressed my preference for spirits over beer, and these results reinforce that view. In addition, I quoted an analyst with whom I'd been discussing the fact that Pernod's valuation (based on price earnings ratio) was cheaper than Diageo's. His explanation was that Diageo has a greater commitment to both sales and margin growth, whereas Pernod focuses less on margins.

That appears to have changed: The valuation gap has now reversed, with Pernod trading on a higher price earnings ratio (nearer 20.5x 2018 PER compared to Diageo on c.20x).

That's not to say that Diageo disappointed with its H1 results; the group reported a beat overall, although there were a few mixed messages, particularly in North America, and currency movements limited any upgrades. Heineken also produced solid numbers, but then took the edge off by appearing more cautious on medium-term margins. Coca-Cola Hellenic, meanwhile, benefited last year from improved emerging market trading, and the shares responded well.

In terms of overall trends seen across the wider consumer staples reporting, I would identify the following: Firstly, there seems to be more optimism for the future, with much more focus on companies finding new growth through innovation and e-commerce; secondly, emerging markets are on the up, which is particularly visible in spirits; thirdly, there are some cost pressures that can impact on margins, as noted by Heineken; and finally, currency volatility continues to be an issue.

Where does that leave my sector view on beverages and the wider consumer sector? There still appears to be a two-way pull.

There are clearly investor concerns about high valuations when top-line growth has slowed. Consider the share price fall after results for RB - the old Reckitt Benckiser - which was once a stock market darling. On the other hand, analysts and investors are loathe to say 'Sell' too often, as the brand values remain strong in most of these companies and underperformance makes them vulnerable to activist attention and possible bid activity.

In my view, spirits still comes out as one of the most attractive subsectors of consumer staples. And, it's good to see Pernod getting its share of the action.

Stock of the year update - Stay with C&C Group, but they don't make it easy!

The more-diligent just-drinks reader may recall last month when I chose C&C Group, the cider and beer company, as my stock of the year. I thought that the valuation was cheap (12x PER versus most beverages companies on nearer 20x), while there's a good dividend yield of nearly 5% and free cash flow (looks to me over 8%) is also strong.

I also flagged that I was concerned about a stock market correction, so was looking for a defensive investment. This proved a timely call when the FTSE100 came down  by around 8% over a few days at the end of January. Usually, investors are looking for a 20%-type correction in these situations, so there is still a question mark of "is that it?". Many commentators have concluded that stock markets are likely to see more volatility in 2018 than 2017, which seems a fair conclusion, as far as I'm concerned.

To be fair, I'm slightly outperforming the market so far this year, as C&C's share price is broadly flat year-to-date, but this is a company which does not make it easy for investors. The group had already written off most of its disastrous investment in Vermont Cider in the US, but that didn't stop them putting out some further negative news last month, when it reversed the decision taken in 2016 to outsource US distribution to the US brewer Pabst. Luckily for me, the US only represents 1% of C&C's profits, so the share price rather ignored this story.

I'm certainly staying with my call here. Indeed. I'm also on record as picking C&C as a possible takeover target in the next 12 months.


Related Content

The ethical investor is here, how second-quarter reporting season is shaping up and the troubles ahead for Anheuser-Busch InBev - The just-drinks Analyst

The ethical investor is here, how second-quarter reporting season is shaping up and the troubles ahe...

Why 'stuck at home' means 'goodbye premiumisation', how to strip out the stock market jargon and whither 'Environment, Social & Governance'? - The just-drinks Analyst

Why 'stuck at home' means 'goodbye premiumisation', how to strip out the stock market jargon and whi...

Why Carlsberg's time is now, why Q3 is set fair for drinks and why spirits should learn from Neil Woodford - The just-drinks Analyst

Why Carlsberg's time is now, why Q3 is set fair for drinks and why spirits should learn from Neil Wo...

Choosing between beer & spirits in 2019, my drinks stock of the year and activist investors - The just-drinks Analyst

Choosing between beer & spirits in 2019, my drinks stock of the year and activist investors - The ju...

Oops! This article is copy protected.

Why can’t I copy the text on this page?

The ability to copy articles is specially reserved for people who are part of a group membership.

How do I become a group member?

To find out how you and your team can copy and share articles and save money as part of a group membership call Sean Clinton on
+44 (0)1527 573 736 or complete this form..



Forgot your password?