Investing in Alcoholic Beverages? A Sector Analysis & A Value Investor's Perspective!
The alcoholic beverages industry has a storied history, spanning centuries and reaching across the globe.
In recent years, however, the sector’s stock performance has been lackluster, leading some investors to question whether it might hold hidden value.
In this deep dive into the industry, I examine the challenges and opportunities in the industry, including the influence of consumer trends, the unique dynamics of different alcoholic categories—spirits, beer, wine, and the emerging “Beyond Beer” category—, and current valuations.
By considering the business models, growth opportunities, and associated risks, I’ll determine whether this sector deserves investors’ attention right now.
1. Current Market Landscape: Why Alcohol Stocks are Struggling
The alcoholic beverage industry has experienced significant headwinds, with stock performance lagging behind broader market indices.
Major players like Diageo, Pernod Ricard, Campari, Anheuser-Busch, Boston Beer, and others have seen flat or declining returns (even on a “total return” basis) not only over the last 12 months (see chart above) but also over the last five years! (see chart below)
Across the board, spirits companies have struggled to keep pace with the S&P 500. For instance:
Diageo: Down nearly 10% over the last five years
Pernod Ricard: Declined by 17.6% over the same period
Campari: losing 8%
While most of the names in the charts above are global giants in the spirits market (with Boston Beer being an exception), we can observe a similar trend in the beer category:
Anheuser-Busch InBev, Molson Coors, Constellation Brands, and Boston Beer are among the largest beer companies, and their stock performance reflects both a sluggish market for traditional beer products and headwinds unique to each company.
Here’s a look at their one-year performance:
Anheuser-Busch InBev: Losing 29% as the company grapples with shifting consumer preferences and the fallout from recent marketing controversies (Read “Behind the Backlash Against Bud Light” by the NYT).
Molson Coors: Also flat over five years, with possibly limited pricing power and stagnant volumes impacting its bottom line.
Boston Beer: Among the worst performers, down by around 26% over five years
In many cases, these underwhelming results mirror broader challenges within the sector, such as slowing growth, sometimes declining volumes, and maybe most importantly, shifting consumer preferences.
2. Decline in Valuation Multiples for Spirits
For spirits companies, the average EV/EBIT multiple has historically ranged between (around) 20x and 30x, reflecting the perceived stability and consistent cash flows associated with established brands.
However, over the past year, these multiples have compressed, with most spirits stocks now trading between 14x and 23x EV/EBIT, as investor sentiment turns more cautious and macroeconomic pressures weigh on the industry.
This compression in valuation multiples reflects investors’ more conservative expectations for growth and profitability within the sector and significantly contributed to the poor performance of the stocks over the more recent past.
Put differently, the decline in multiples across spirits and beer companies suggests that the sector’s poor stock performance is not solely attributable to deteriorating fundamentals; rather, it indicates a sector-wide re-rating based on lower future growth expectations and possible structural headwinds.
For value investors, this multiple contraction might present opportunities, as long as the intrinsic value of these stocks is significantly larger than the price they trade at (which, as shown, has come down for many stocks).
However, the poor stock performance (partly driven by multiple compression) may also emphasize the need for careful analysis, as multiple contraction can signal long-term secular challenges in a sector, particularly if growth rates and margins do not improve; or even further decline. Value investors often refer to these types of situations as “value traps;” an optically cheap multiple that is nonetheless, and somewhat counterintuitively, not signaling that the stock is actually cheap.
In summary, the alcoholic beverage sector’s stock performance over recent years, highlighted by the underperformance of both beer and spirits companies, appears driven by both challenged fundamentals (more on this later) and a reset of valuation multiples. As investors recalibrate their expectations for growth in the sector, the compression in EV/EBIT ratios underscores a more cautious outlook.
But as explained, the stagnation in stock prices underscores a potential dislocation between current valuations and the actual underlying value within these companies. The discrepancy between alcohol stocks and the S&P 500, which has risen nearly 100% in the past five years, has prompted me to take a second look, wondering if these businesses might be undervalued in a world where cyclically underperforming sectors can yield bargains.
3. Understanding the Business Model of Alcohol Stocks
The business model in the alcoholic beverages industry is relatively straightforward, centering around three core elements: production, marketing, and distribution.
This model enables large alcohol companies to maintain a steady flow of cash and ensures their resilience across market cycles. By focusing on building strong brands, expanding distribution networks, sometimes acquiring companies to leverage the distribution network, and adapting products to align with consumer tastes, companies like Diageo exemplify how the industry captures value from brand equity and consumer loyalty.