FTSE 350 Review: Downtrading rears its head for beverages sector

Premium products, such as high-end gins and whiskies, have been lapped up by the burgeoning middle classes in emerging markets. Companies remain active in seeking out new opportunities in this space. Diageo (DGE), for example, recently struck a deal to buy the high-end dark rum brand Don Papa Rum for up to $438mn (£353mn).

But will demand for such products suffer as consumer spending pressures intensify? Evidence from developed markets suggests the answer is yes. Deutsche Bank analysts say that “downtrading is already happening in spirits in the US and Europe”, with data from Nielsen and the National Alcohol Beverage Control Association showing negative annual mix growth. The bank thinks that soft drinks look more resilient than spirits and beer in this macroeconomic climate, which could benefit stocks such as AG Barr (BAG) and Britvic (BVIC).

There is a wider question here about the sustainability of the premium spirits companies' use of high-end products to boost growth. RBC Capital Markets analysts think that spirits growth over recent years will come to be seen as “exceptional” rather than the norm. They have a “marked preference” for brewers over spirits stocks and think the valuation differential will narrow between the two categories. We remain bullish as things stand on premiumisation as a long-term tailwind.  

At a regulatory level, there is disquiet in the industry about upcoming changes in the UK domestic market. The Scottish government is pressing ahead with a deposit return scheme (DRS), which will add 20p to the cost of all drinks sold in single-use containers between 50ml and 3l in size. It is set to go live in August and will impact companies in Scotland and those selling into the country. Investec analysts say that this could increase AG Barr’s annual costs by £3mn.

Whisky consultant and broker Blair Bowman told Investors’ Chronicle that the DRS is “not fit for purpose”, describing it as “the most onerous, most complex deposit return scheme in the world”.

There are also changing attitudes towards alcohol to contend with. A recent report funded by the Canadian government significantly toughened up guidance on drinking levels: 2 drinks per week is now its low-risk recommendation. Such news comes alongside the striking trend of young people drinking less. The IWSR research group says that millennials “in select markets” are now cutting back due to economic as well as health concerns. It remains to be seen just how material such headwinds will prove to be for the industry.