(By Philip Gorham, CFA) The Great Recession of last year took its toll on the alcoholic beverages industry. Traffic at bars and restaurants was down, shifting some consumption to the less profitable at-home channel, while weak consumer spending led to trading down in most categories. As the global economy recovers, consumption growth in developed markets is proving to be very sluggish. We think there are three ways for companies to achieve growth in the current environment: cutting costs to grow earnings; increasing exposure to emerging markets; and growth by acquisition.
Manufacturers Are Cutting Costs to Grow Earnings
With revenue growth anemic in mature markets, the alcoholic beverage giants are looking to grow earnings by cutting overhead costs such as back-office functions and by making distribution more streamlined. Anheuser-Busch InBev's (BUD
) modus operandi is to acquire companies and slash costs. Since the merger of the two beer giants in 2008, the company has realized $1.6 billion of the $2.25 billion planned synergies over a three-year period. We forecast an operating margin of approximately 29% in 2010, which should increase by another 100 basis points over the next five years. SABMiller (SBMRY
) and Molson Coors (TAP
) are pursuing a similar strategy in the United States with the MillerCoors joint venture. The joint venture now expects to save $750 million in annual operating costs by 2012, and we forecast the cost savings to add a further 5 percentage points and 1 percentage point to the operating margins of SABMiller and Molson Coors, respectively.
Emerging Markets Offer Growth Opportunities
Favorable demographic trends, such as falling mortality and urbanization, together with export-driven economic growth, are fueling consumption growth in developing markets. The burgeoning middle classes are knocking back increasing quantities of branded alcoholic beverages, which is leading to high-single-digit growth rates in markets such as Asia and Latin America. Pernod Ricard this week revealed that it achieved revenue growth north of 30% year over year in China, India, Vietnam, and the Philippines. Companies with the strongest foothold in these markets will be best-placed to exploit this trend. We estimate that Diageo (DEO
) generates around 40% of its revenue from developing markets. Even Diageo trails Pernod-Ricard in China, however, where the popularity of the company's Martell cognac brand makes Pernod the leading international spirits manufacturer.