Summer's here! So is a global trade war - The just-drinks Analyst

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In his latest missive from the investor coal-face, former analyst Ian Shackleton shares his thoughts on how the second quarter is shaping up, the prospects of a trade war between the US and, well, everybody else and how drinks companies are starting to think longer-term than the next three months.

With summer here (in the northern hemisphere), will the sun have shone on drinks companies in Q2?

With summer here (in the northern hemisphere), will the sun have shone on drinks companies in Q2?

Results reporting season - Here comes the sun

We're now getting towards the end of the second quarter of 2018, and analysts and investors are starting to think about what companies will say with their Q2 reporting in the next month or so. I'm a bit ahead of the curve here, as most analysts have not put out their Q2 preview notes here – so remember, you read it here first.

One of the themes from the first quarter was that pricing momentum for the major FMCG companies had become more difficult, although volume growth was holding up okay. This is likely to continue to be a feature of many companies' results this time around, especially in the US. Equally, with several large retail consolidation moves either underway or waiting to be cleared by the regulator (Tesco/Booker, Sainsbury/ASDA), it's difficult to think that Europe will provide material pricing upside.

On the positive side, the sun has certainly been shining in Northern Europe, which should boost both beer and soft drinks sales. Indeed, at the end of last week, Scandinavian brewer Royal Unibrew came out and raised its full-year profit guidance to reflect the good weather. On the other hand, several media reports last week focused on the supply shortage of carbon dioxide, particularly in the UK but also across parts of Europe. This issue threatens to halt production for both beer and CSDs.

It's also difficult to expect much good news generally from emerging markets, which have been looking increasingly volatile in the last month or so, thanks to weakening currencies and softer consumer spending. At a recent investor conference, Unilever flagged issues in Brazil, where a truckers' strike has also disrupted trading. Of course, beer sales in Russia are pretty strong, benefiting from the World Cup - and, as I write, that's still good news for sales in England.

Where would I be a happy investor today? In volatile times, spirits is usually a reliable industry to back. Pernod Ricard came through its calendar-Q1 reporting extremely strongly, helped by good growth in Asia. Although Diageo and Pernod share prices are both at high points (GBP27 and EUR140, respectively) and valuation is not cheap (mid-20's PER), you can make mine a whisky (although, given CO2 issues, I may not be able to get the ginger ale!).

A global trade war? - What global trade war?

The S&P 500 in the US and the FTSE100 in the UK are currently both within 2% of their all-time highs - and yet, we appear to be on the verge of a global trade war. During my years as an analyst, I was always told that stock markets do not like uncertainty - a global trade war would certainly count as uncertainty.

When I talk with investors, there's a definite feeling that markets are due a correction. I was at a conference recently where an experienced fund manager, who's been around even longer than I have, forecast that we're approaching the end of a 30-year bull market; in particular, the profit growth from increased margins (which, he says, have doubled over the period) is no longer sustainable, and he thought that without outstanding customer service, margins at many companies would struggle to move forward in future.

For me, one of the key drivers of this margin momentum has been a restructuring by many companies of production and supply chains on a global basis - which, of course, potentially makes them more vulnerable to the impact of a trade war.

This is also true in the drinks industry, specifically.

So far, Brown-Forman, through its Jack Daniel's brand, appears to have been hardest hit, thanks to the 25% tariff imposed on American whiskey in a retaliatory move by the EU. The company's share price is down just over 10% as a result, but that might still seem an under-reaction when you consider that about half of the company's revenues are outside the US, American whiskey's biggest market by far.

In spirits, the risk from a trade war is greater for those companies that are reliant on an export model, where brands are manufactured in one location and shipped around the world. For Diageo, although around 45% of its business is in the US, I estimate that only 10% of that is imported Scotch, with most of the group's other brands produced locally. For Pernod, where the US accounts for only 25%, I estimate at least 75% of this is imported. And, for Remy Cointreau, where the US is also about 25% of its business, virtually all of this relates to imported Cognac or brand Cointreau, both of which are made in France.

Net/net, then, this is potentially a bigger issue for the French.

Analysts and investors are less concerned about the risk for beer and soft drinks, which tend to be more locally produced (there's an old saying that it doesn't make sense to ship water over water). This logic is not 100% watertight, though - the Heineken you drink in the US is shipped in from The Netherlands. Certainly, when you look at many company supply chains, they are sourcing raw materials on a global basis.

So far, the global trade war has revolved around some highly-targeted sniper fire - let us hope that the big guns are not brought into play.

Moving to a long-term IR focus

Last week, the Investor Relations Society, the trade body for IR professionals in London, held its annual conference. I always see this as a useful bellwether for sentiment within the IR community. Last year, it was simple: the MiFID ll regulation, which is transforming the way investors work (and which I have mentioned on several occasions), was approaching, and much of the conference focused on the potential changes this might bring. This year, the mood was more complex: The title of this year's conference was 'IR: Future-Proofing Business', and the chairman explained that it was time for IR professionals to think about the longer-term rather the short-term. Their focus, the chairman said, should turn more to company strategy and sustainability issues.

This is highly relevant for drinks companies. They're not in an industry where week-on-week trading is usually that volatile, meaning that focusing on a simple quarter's results can be pretty meaningless. A panel of investors at the conference had a strong message to the companies: Abandon quarterly reporting and plan on a five-to-seven-year timeframe.

Companies like Diageo are fully embracing this approach; it wasn't that long ago that the group ditched its quarterly reporting, investing its time and effort instead on a regular series of capital market events on its divisions and functions. These events are all about educating the financial community on the long-term prospects for the business.

Other companies are making similar moves: Britvic has already taken one trading update out of its calendar, while several companies, such as Heineken, have de-emphasised quarterly reporting. Some parts of the financial community, including some sell-side analysts and hedge funds, do not like this; news events provide a trading opportunity. They are now running against the tide.

Who knows, I may have to stop my analysis of quarterly reporting at some stage, and find some other news to fill my monthly just-drinks contributions!

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