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Any fizz left in the drinks market?

Millions of pounds invested in brewing giant SABMiller could be looking for a new beverage home once the company leaves the London Stock Exchange
February 12, 2016

The option to invest in a London-listed global brewing giant is about to disappear barring any major curveballs, meaning investors may have to reassess their exposure to certain tipples.

The likely merger of SABMiller (SAB) and Anheuser-Busch InBev (ABI) will form a dominant force in the beer market by creating a company responsible for one in every three beers sold globally. But without a London listing for this powerhouse, where can UK-based investors turn for exposure to the beverage market?

The largest constituent in the beverages sector will be Diageo (DGE), the multinational distiller. The company's global presence is attractive for those who want exposure to some of the fast-growing bodies of consumers in developing nations. But it is important to remember the multitude of factors that management has to face when doing business overseas. This has perhaps come into sharper focus than normal for Diageo recently given it is heavily exposed to Nigeria, a country where currency controls have had to be implemented and restrictions on capital imposed. The outlook worsened at the start of this month when the country's government asked for $3.5bn (£2.42bn) in emergency loans from the World Bank to plug a growing gap in its budget created by falling income from its oil production. This could impact Diageo's sales in the country given a devaluation of the naira is likely, which will push inflation up, and already negative consumer confidence won't rebound amid such conditions.

  

Home brew

With this in mind, investors might look for companies with a more domestic focus.

A company weighted towards home turf is C&C (CCR), which relies heavily on Ireland and Scotland for its sales. The group owns major cider brands Magners and Bulmers, as well as Scottish beer Tennent's. It distributes into the rest of the UK too and has contracts with AB InBev for delivery of some of the latter's brands. Beyond this, it's plugged into international markets with a US and wider international business (Europe, Australia and Asia), but these only equate to around 7 per cent of its £514m revenues at the most recent half-year results.

However, domestic-focused businesses are not free from macroeconomic challenges, such as swings in consumer confidence which can be driven by a multitude of factors. Indeed, in the most recent Nielsen survey, terrorism and immigration were the factors driving consumers' optimism down.

"Consumer concerns about terrorism and immigration have risen considerably," said Nielsen UK & Ireland managing director Steve Smith. "We're watching closely for any effects these demographic and political issues may eventually have on consumer spending.

"In general, big and unexpected events would likely be the most disruptive for consumers."

 

 

Even though most of the other confidence factors listed by Nielsen registered lower levels of concern in the final quarter of 2015, compared with the same period in 2014, the general trend in the UK soft drinks market was not positive in 2015 (see table).

  

UK drinks market2014 (£bn)2015 (£bn)Change (£m) Change (%)

Total carbonated soft drinks

2.542.51-31.4-1.2
Total private label0.170.16-15.1-8.8
Total branded2.372.35-16.4-0.7

  

Craft focus

But another thing going for the Ireland-domiciled C&C is that it also offers access to a growing trend - namely craft brewing. The group has a range of craft ciders - including two leading craft cider brands in the US, Woodchuck and Hornsby's - and is also involved in craft beer in each of its divisions. There is also an element of craft brewing at Diageo, as it owns Irish brewer Guinness, which runs 'The Brewers Project'. This aims to develop new beers and lagers from the Guinness site in a bid to compete with the growing number of alternative choices beer drinkers now have. Indeed, something many pub groups are noticing is the volume of beer they're selling is shrinking slightly as customers opt for alternative brews. But the higher cost of these specialty drinks means revenue and profit are holding up.

In a similar vein to the craft aspect of beer and cider, Fevertree (FEVR) has taken the soft drinks market by storm. The upmarket mixer manufacturer has commanded prices for tonic previously thought impossible. But with little in the way of competition, the business seems to have proved one of those rarities - a successful initial public offering. The stock has risen a staggering 340 per cent since its November 2014 listing with further growth expected after it secured contracts with several supermarkets. This poses a potential problem for the likes of Britvic (BVIC) and the Coca-Cola-owned Schweppes, whose tonic brands face competition like never before.

  

Stiff drink

Britvic, like its closest rival Nichols (NICL), is more than just a mixer manufacturer but it is interesting that at a time when there is such a disruptive competitor like Fevertree, the businesses are developing their international operations. Britvic might only have produced £52.1m of its £1.3bn revenues from its international division at its full-year results in November, but the expansion of this part of the company is a key strategic aim. Last summer, it announced the acquisition of Ebba, the leading manufacturer of liquid dilutes in Brazil. This provides it with access to the sixth-largest soft drinks market and the second-largest liquid dilutes category in the world, according to the company. But again, doing business in emerging markets is lumpy at best right now. Brazil is experiencing a stark economic slowdown and it's unclear how this will affect consumer spending.

Worse yet is selling into a market dogged by conflict. Nichols is going through this at the moment in Yemen, which the group has addressed in recent trading statements. However, of the 22 per cent of sales that are international, less than half come from the Middle East. Also, the international division managed to grow sales by 1.5 per cent, according to the company's year-end trading update, compared with the same period in 2014.

  

Favourites

The strong cash generation and low debt of C&C makes its less than 14 times forward price-earning ratio rating look good value to us and it's hard not to be bullish on Fevertree in spite of its meteoric share price rise. Its asset-light structure - it outsources things such as bottling - makes it a nimble business and its high returns on capital are reassuring.

  

Outsiders

We've no outright sells in the sector right now, but recent negative share price movement at AG Barr (BAG) has caught our attention. We'll be keen to see how its peers fare in light of the recent downward trend in the UK soft drinks market.