Market research
Our analyst returns! Ian Shackleton is back to give us his monthly consideration of the latest developments in the drinks industry from an investor's perspective. This month, Ian turns his attention to the saga at Conviviality, the possibility of the Coca-Cola system venturing into alcohol and tells us why Pernod Ricard makes him feel all warm and fuzzy.
Could Conviviality be broken up in the coming weeks?
The curse of Matthew Clark strikes again
Matthew Clark was founded as a wine and spirits merchant in the city of London way back in 1810. So, how come that a company with so much illustrious history has been part of not just one dramatic stock market collapse in the last 20-odd years, but two share price implosions?
For those with long memories, you might recall that Matthew Clark, which had become principally a drinks wholesaling business, went public in 1990. After a rollercoaster ride, which saw the share price rise to over GBP8, before then crashing to GBP1.30, the company was bought out by Constellation Brands in 1998.
There were several acquisitions on the way, and financial performance was impacted, inter alia, by the poor quality of wholesale profits, where margins are tight and working capital control is crucial. In 2015, Matthew Clark was bought again, this time by Conviviality, which had traditionally been a retailer of wine and spirits through the likes of the Bargain Booze chain. In fact, Matthew Clark was the bigger business, and the acquisition was described as a reverse takeover. The Conviviality share price soared from around GBP1.50 to over GBP4 at the end of last year.
And, then the fun stopped. Some directors were buying shares at above GBP3 in early-February, seemingly oblivious to the collapse that was to come. Others kept buying, even as the roof fell in. A profit warning, followed by a suspension of the share price when it was just above GBP1, followed by an unplanned GBP30m tax bill that threatened bank covenants, then the cancellation of the dividend, then the resignation of the CEO, all before an attempt at a last-ditch equity raising - all within 11 days. As I write, the saga is far from finished, but what is certain is that the shares are not returning to their GBP4 heyday. Indeed investors might be grateful if they get anything from their original investment back at all.
What's the moral to this story? Once again, this shows the volatility of the drinks wholesale channel. Conviviality started out as a retail company, which has very different dynamics (although high-street retailing isn't the healthiest place either, if BHS and Toys R Us are anything to go by).
Did the Conviviality management really know what they were doing in wholesaling?
As for Matthew Clark, it looks likely to me that Conviviality will be broken up, with Matthew Clark splitting from the retail operations. And, who might be brave enough to be the owner? C&C Group has some involvement in wholesaling in Scotland and Ireland, so at least they understand the business risks. But, hang on: C&C Group is my stock of the year!
Perhaps that can still work, as the history of Matthew Clark acquirers shows that the share price performs well … for a time. Remind me of that when we start 2019, please.
Make mine a rum and Coke
The Coca-Cola brand was historically touted as a temperance alternative to alcohol. Given the company's Atlanta head office, in the middle of the US Bible belt, I always found that any suggestion of The Coca-Cola Co getting involved with booze was met with a very quick negative response. Indeed, only a few years ago I remember some highly critical comments being made by my Coca-Cola contacts when the bottlers took initiatives that brought them into alcohol in a small way, such as when Coca-Cola Hellenic started distributing Jack Daniels' in some Eastern European markets, or when Coca-Cola Amatil entered into a beer JV in Australia with SABMiller.
What are we to make, then, of the move announced earlier this month where Coca-Cola in Japan will start to sell an alcopop product in the Chu-Hi category? Chu-Hi canned drinks usually have an alcohol content in the 3%-to-8% range, which is more in line with beer than spirits. Now, admittedly, the Coca-Cola model in Japan has historically had differences with other markets; there has been a strong history of innovation and an acceptance that products may have a limited life-cycle. We might be able to argue that what happens in Japan, stays in Japan.
On the other hand, the rest-of-the-world model is now moving closer to that of Japan, with a strong emphasis on new products across the system. And, in James Quincey, Coca-Cola does have a new CEO who appears set to shake things up.
This move could presage a real game-change for the Coca-Cola system, that might have wide implications for other companies across the drinks industry. It has always struck me that the Coca-Cola distribution system, mainly carried out by independent bottlers, offers the best global footprint of any FMCG company, with scale and global coverage.
I can see a huge opportunity to leverage this strength through distributing other products on the back of the same truck. Ironically, PepsiCo's bottlers, which are often beer companies like Royal Unibrew in the Nordics, Heineken in the Netherlands and Anheuser-Busch Inbev across much of Latin America, have exploited this synergy to a greater extent, although often from a position of weakness rather than strength.
There are, of course, complications, in that the bottling companies have independent ownership. On the other hand, as mentioned earlier, we've already seen some of the bottlers getting involved in alcohol. They clearly see an economic rationale here.
And, in the US, where the three-tier structure effectively prohibits beer companies from also being distributors or retailers, it looks quite neat that Coca-Cola has just completed the refranchising of its bottling network, which could open the door for wider product distribution. Indeed, one of the refranchisee partners is Reyes Beverage, traditionally a beer wholesaler that has taken on Coca-Cola's distribution in parts of California.
The plot gets thicker!
Any move into alcohol would probably help bottler profitability quite materially. But, given the strong control that the bottling contracts usually give to the brand owner, I'd see most of the upside accruing to The Coca-Cola Co. As well as to consumers like myself, which might find it easier to get their rum and Cokes in future.
Pernod Ricard still looks a bright spot in consumer gloom
My former colleagues, those esteemed beverages analysts, are pretty depressed at the moment. They are facing all the trial and tribulations of regulatory change caused by MiFiD II, which I have referenced in previous columns.
At the same time, investors are showing very little interest in consumer stocks as a whole, given high valuations, more volatile trading caused by top-line slowdown and higher input costs.
So, which large beverages stocks should investors be looking at? There hasn't been much results reporting in the last month - which may be a good thing as, with a fairly choppy stock market right now, share prices are likely to get knocked back whenever companies put their head above the parapet.
During the relatively quiet time, I spent a bit more time than I would usually listening to Pernod Ricard's investor conference call last week on its EMEA and LatAm operations. I've long been more positive on spirits than beer and was very pleased to see Pernod as the best performing large capital beverages company over the last reporting season. The valuation is no longer bargain basement (current year PER of over 23x, c.10% premium to the average for consumer staples), but the news-flow still looks robust. Even in a region like EMEA, which is mainly focused on developed markets, the company is targeting reasonable growth, whereas the emerging market regions of Latam and Africa still look very punchy.
You've got to admire Pernod for doing things their own way; they've just promoted their Lillet brand to one of their global priority brands. Lillet, a French aromatised wine, doesn't fit very easily into the traditional growth categories in wine and spirits.
But, who knows? The gin revolution might be followed by the aromatised wine renaissance.
