Shackleton said a move by Diageo for Fever-Tree may not be "pie in the sky"

Shackleton said a move by Diageo for Fever-Tree may not be "pie in the sky"

This month, our former beverage analyst Ian Shackleton considers how best to grow your top-line, considers that the next round of results will throw up and looks at how his stock picks have performed so far.

  • Buy or build your way to growth?

Earlier this year, I attended a debate hosted by The Worshipful Company of Distillers in London, which had the motion "This house believes that innovation is a more effective tool for growth than acquisition in the spirits industry". After a lively discussion, the final vote showed 64 people in favour of innovation but 68 supporting acquisition.

The result was clearly good news for any bankers in the audience.

When I started as a drinks analyst, it was accepted that the large spirits companies, with their well-staffed and well-supported marketing departments, were in the best position to develop new products for the future. At the time, this was very much the accepted view across the consumer staples landscape, when the likes of P&G and Colgate ruled the world.

In recent years, it has become increasingly clear that the really successful innovations in spirits have come mainly out of small companies – think of Tito's Handmade Vodka, owned by Tito Beveridge, which can now boast sales of over 6m cases per year (and is closing in on Diageo's Smirnoff in the US market). Think also of Casamigos Tequila, owned by George Clooney and friends, which has grown in three years to around 170,000 cases and has now been bought by Diageo (for an estimated 15x revenue!). Think also of most of the super-premium gins, such as Brockmans and Sipsmith (in whom Beam Suntory bought a stake late last year), which have driven the category growth up 26% last year globally (according to The IWSR).

Granted, there are some exceptions, such as Diageo-owned Bulleit Bourbon, which has seen strong growth in recent years. One could argue, however, that for many of the large spirits companies, innovation has increasingly been focused on line extensions, rather than new products. This more risk-averse approach certainly has appeal to public companies, which have to justify short-term returns to their shareholders; the payback on another flavour extension tends to be quicker, and possibly be more assured, than for a completely new innovation.

This is where the smaller companies have an advantage – Tito Beveridge didn't have to decide how to allocate his marketing budget across a portfolio of brands, nor did he have to determine which brand he was going to prioritise – he effectively bet the ranch on his single brand succeeding. No large spirits company, with a large portfolio of brands, can be so single-minded in its approach.

(Of course, we must not forget that there are a large number of single brand start-ups that go on to fail).

In response, some of the large spirits companies have set up their own seed capital funding for small spirit start-ups, like Diageo's Distill Ventures, but the success of this model was questioned during the Distillers' debate by none other than Diageo's former CEO, Paul Walsh - and you'd presume that he would know!

I've recently done some work across the pharmaceuticals industry, and it is remarkable the way in which the pharma industry model has changed: New drug innovation has moved largely out of the large pharma companies into small biotech start-ups, as the latter seem to have a much better track record of delivering success. Sure, if the drugs get through clinical trials and the approval process, then big pharma will buy them and use their distribution muscle to add value.

Perhaps the spirits industry needs to accept that this is also a more effective model for its industry. If so, we should expect more Casamigos-type deals – further good news for the bankers!

  • Still expect a mixed bag in Q2 reporting – Britvic as the outperformer?

The Q2 reporting season is almost upon us, and there are already some mixed signs of how the numbers might pan out across the consumer universe. Reckitt Benckiser and Mondelez both set a cautious tone last week when they downgraded growth estimates, attaching blame to the recent cyber attacks, while C&C Group, with its slightly earlier reporting (its quarter to May), was no better than "satisfactory", despite some good weather in the spring. This continues the theme that has been visible for several quarters now: Top-line growth is becoming more difficult to achieve.

For Diageo and Pernod Ricard, calendar-Q2 represents their year-end; in what is usually a quietish trading quarter, what is much more important with the results announcement is the tone that they set for the next financial year. With signs of recovery in China, there are expectations for Pernod to indicate better momentum, with a higher target for organic EBIT growth (I have seen some analysts expecting a +3%-to-5% target range versus +2%-to-4% in FY2017). For Diageo, analyst expectations appear to be more focused on a raising of the current GBP500m costcutting target.

Meanwhile, Remy Cointreau, with its large exposure to Asia, is expected to see a strong quarter, with sales growth in mid- to high-single-digits.

For the beer companies, the best organic growth is expected at Heineken, with thoughts of +3%-to-4% volume growth in Q2, and certainly some expectations that the good weather in Europe should have provided a boost. Carlsberg, meanwhile, remains a costcutting story, with little overall volume growth, and Anheuser-Busch Inbev is also likely to look subdued at the top-line as the major markets of the US and Brazil remain challenging.

Could it be that one of the best top-line performances in the reporting season comes from Britvic? There's certainly an expectation that the recent good weather in the UK and Europe will drive good sales growth (I've seen estimates of +4% for the quarter), and this already appears to be leading to some analysts' upgrades. After a tough few years, with the headwinds of a threatened sugar tax, higher input costs and a cautious UK consumer, it would be nice to see this stock really have its moment in the sun.

  • PureCircle and Fever-Tree – my stock of the year. So far, so good

I mentioned at the beginning of the year that my current company has an annual competition amongst employees for the best stock pick. As an ex-analyst, I always feel rather exposed; there is an expectation that I will more than outperform the average, and it would certainly be embarrassing to be in the bottom quartile.

As a result, I opted for a recovery play, in the form of PureCircle whose product, the natural sweetener stevia, is used by most soft drinks companies, as well as by many food producers. In theory, this should be a super-growth company. Yet, at the beginning of the year the share price was down from its highs of over GBP6.00 in 2015 to under GBP3.00, mainly due to some issues with US customs.

So, how am it faring in 2017? Well, so far so good. Despite a slightly subdued trading statement in May, PureCircle shares, at GBP3.35 today, are up around 26% year-to-date, which certainly puts me in the top quartile and certainly avoids embarrassment (the FTSE 100 is only up 3% year-to-date).

I'm also pleased to see that the other stock, which I nearly plumped for, the soft drinks company Fever-Tree, has seen its share price up about the same as PureCircle's this year. I had been a bit nervous about Fever-Tree as the stock had seen a stellar performance since its IPO three years ago, up 13 times from the launch price of GBP1.34 to over GBP16.00, and expectations had continued to ramp up.

In recent weeks, I have seen a couple of articles on Fever-Tree that appear to tell different stories. Firstly, the founder Charles Rolls sold a proportion of his shares, which always suggests that he thinks the best has been seen. Secondly, just-drinks commented on a recent analyst report, which suggested Diageo as a potential buyer of the company.

Is this totally pie in the sky? Possibly not. After all, this is the company that has just paid up hugely to buy into growth with the Casamigos brand (see above). Fever-Tree would look quite cheap in comparison. In addition, I did note recently that the company's Distill Ventures arm announced that it would invest in non-alcoholic start-ups.

Could it be Tanqueray and Fever-Tree all round before the year is out?

Ian Shackleton spent 25 years working as a beverages analyst at Nomura, Lehman Brothers and Credit Suisse. He is now a principal at financial communications company Bell Pottinger.