UK-listed drinks companies like Diageo are going to have to start talking more directly to investors soon, warns Ian Shackleton

UK-listed drinks companies like Diageo are going to have to start talking more directly to investors soon, warns Ian Shackleton

Former Nomura analyst Ian Shackleton returns today for his first look at the drinks industry in 2017. How well-buffed is his crystal ball?

  • What will 2017 bring for the drinks world?

When it came to forecasting the major political and economic events of 2016, not many commentators can claim to have been successful. In many ways, though, the world of drinks was more predictable: Anheuser-Busch InBev completed its acquisition of SABMiller; both Diageo and Pernod Ricard achieved the promised stabilisation in their results reporting after a difficult few years; and, in the soft drinks universe, The Coca-Cola Co's battle with the health lobby continued against a backdrop of ongoing bottler distribution reconfiguration globally.

Will the year ahead in drinks prove easy to predict? Probably not, considering the size - and scale - of macro uncertainties like Brexit and President-elect Trump. It is possible, though, that parts of the beverage world may yet again "do their own thing" and not follow global trends. There has been much commentary that, for companies as a whole, the likely slower organic growth that many companies have had to adapt to across their businesses will be a catalyst for an increase in M&A, as they seek to buy growth opportunities. That said, in the beer category, after the ABI/SAB deal and the related knock-on transactions - which have opened the door for Asahi in Europe, and given China Resources Beer and Molson Coors full control of JVs in China and the US, respectively - I would predict a far quieter time for M&A. The fact that many of the large beer companies are protected by majority ownership structures both argues against bids being made, as well as reducing the short-term pressure to do deals. As we discuss later, Heineken's response to the ABI/SAB deal has been relatively low key so far, limited so far to its buy-out of the UK pub group Punch Taverns. As for spirits, there has been a consistent belief that 'small is beautiful', with critical mass often being seen as a disadvantage rather than an advantage, This, too, would argue against major M&A moves. And yet, I can certainly see the arrival of former Bacardi CEO Javier Ferran as a more hands-on chairman at Diageo, as being likely to lead to some reshuffling of the group's portfolio. Let's give him time to get his feet under the table, though: Ferran only started in the role nine days ago.

As for the Coca-Cola empire, major bottling moves have now been announced in many regions - in Europe with the formation of Coca-Cola European Partners, in the US with the ongoing refranchising strategy, in Africa with the search for a new partner for Coca-Cola Beverages Africa, in China with its sale of owned bottling operations, and in Japan with the bottler merger. Theoretically, this ought to lead to some reaction from the rest of the industry, especially from the Pepsi system, but I sense that beverages remains a lower priority for PepsiCo than its food interests. And, with the mounting burden of health taxes and other regulations, the attractiveness to a Pepsi partner of buying a mainly-CSD franchise must look questionable.

Considering all this, then, if I was an investment banker, I wouldn't be turning to drink in 2017 - I'd be spending my time elsewhere.

  • UK beer and pubs  - back to the future

When I started as an analyst, my bread and butter was UK beer and pubs. Those were the days, pre-Beer Orders, when over half the UK pubs were owned by brewers: Vertical integration was the order of the day. That all changed in 1990, when the Beer Orders obliged the large brewers to sell down their pub estates, leading to the formation of pub groups like Enterprise Inns and Punch Taverns. And now, the clock comes full circle as the largest brewer in the UK, Heineken, is part of a consortium set to buy out Punch.

The Beer Orders were revoked in 2002, which has opened the door for Heineken to return to a more vertically-integrated model in the UK. And, even though the company will become the third-largest pub owner in the UK, owning over 6% of the country's pub market, the UK Government probably has bigger issues on its agenda today, which argues against renewed regulatory interference.

So, is Heineken stepping forward or backwards? It was easy to take the view that its first pub acquisition in 2011 (the 918 Galaxy pubs owned by RBS) was mainly driven by a desire to resolve tricky contractual arrangements on the supply of beer to the Galaxy estate. However, the Punch deal, which takes the Heineken-owned estate to over 3,000 pubs, looks designed to buy "new market share", with Molson Coors the likely loser.

Does the vertically-integrated model work? Certainly, in the media world, there is much discussion of the benefits of putting content and distribution together (hence the Fox/Sky bid), but the proof of the pudding in the consumer world does not look very convincing. Post-the Beer Orders, some of the large UK brewers attempted to create a more international footprint (eg Bass). Within a few years, however, Bass, Whitbread and Allied Breweries had all been sold to foreign buyers; the joint Carlsberg-Heineken acquisition of Scottish & Newcastle in 2008 completed the rout.

You could certainly take the view that the reliance on the guaranteed sales provided by an owned-pub estate has been detrimental to building brands and customer relationships in a way that most FMCG companies would do.

You could also argue that Heineken is being opportunistic and buying pubs at a time when investor interest had almost disappeared in the sub-sector, and at a reasonable price (under 11x EBITDA, before any synergies). However, I think most investors would have preferred the GBP1.2bn capital sum to be invested into the likely higher returns from expanding in the core beer business.

  • Day of the MiFIds is dawning –  expect major impacts on quoted companies

In financial markets, many commentators have become blasé over the UK regulatory debate on MiFID (Markets in Financial Instruments Directive) as it has been underway for over ten years. However, the 'Day of the MiFIDs' is now less than 12 months away, with the 3 January 2018 implementation date for MIFID ll looking firm. The legislation promises to radically change the traditional relationship between brokers/analysts (sell-side) and investors (buy-side).

There has already been much debate about the likelihood that the unbundling of charges made by the brokers to the buy-side will result in less research and fewer analysts; this looks inevitable, especially given the margin squeeze on the buy-side as their fees also come under pressure.

This is likely to have a knock-on effect for corporate companies. If you are, say, Diageo, with research coverage from over 25 analysts, you may not be too worried about losing a few (25 is too many anyway; how many do you need to get a reasonable consensus of view?). However, if you are Stock Spirits, with only seven analysts (and a question mark over how many of these are 'properly' covering the company), this may become an issue. For the UK market as a whole, many believe that corporates with a market capitalisation of under GBP100m are lucky to have even one analyst providing coverage.

With fewer sell-side analysts, it is likely that many investors will 'go direct' to the company for information, meaning increased workloads for investor relations. Under the new MiFID ll rules, brokers will no longer be allowed to charge for corporate access, which may require corporates to get more involved directly, or to engage a third-party supplier to do this. Both come at a cost. There is also a question-mark about how advisors, such as UK corporate broking, will service corporate clients in an 'unbundled' world, when corporate broking has generally been viewed as a loss-leader product.

There are also wider implications. With the economic model for broker research changing, access to analysts' reports will undoubtedly become more difficult, with the likely death of the PDF, and only designated clients being able to open research documents. This means less access for the press (and that includes just-drinks) to analysts' thinking. All this should, of course, increase the value placed on contributions from ex-analysts like myself (Editor – please note!).

In a world where communication is more integrated and more immediate, there is a requirement in any case for corporates to be increasing their focus on - and resourcing of - strategic communications. The follow-through from the MiFID ll changes is likely to add to that burden.

And, this is not just a UK issue – the basic approach behind MiFID ll is being adopted by the EU regulatory body, ESMA. There is a strong argument that the new UK model will be rolled out worldwide by large. multinational investment groups.

Because of the topicality of this subject, Bell Pottinger will be hosting a breakfast debate for companies on 13 January at 0800 in London. For more details, please contact Ian on ishackleton@bellpottinger.com.