Diageo and Fevertree give thanks to the US

One of the most discussed topics to have emerged from the pandemic is whether any of the enforced changes we have made to our lifestyles and routines have become engrained. That deliberation certainly applies to home entertainment, as millions more homeowners have signed up to streaming services to keep themselves entertained during the extra hours spent indoors due to lockdowns. Throw in the rapid growth of telemedicine, eHealth channels and online fitness programmes, and it is easy to see why some people believe that Covid-19 will engender permanent change across many industries.

Certainly, industry analysts have been trying to gauge the likely long-term impact on the licenced trade, but there are any number of considerations to take on board. There is every chance that we could witness a significant drop in the number of pubs and bars simply through attrition. If, as is generally expected, many businesses and individuals adopt home-working practices as a default setting even beyond the pandemic, this will place additional pressure on inner-city bars, pubs and restaurants.

Some of the government’s scientific advisers have recommended that licenced premises should not be allowed to reopen till July. That would prove terminal for hundreds, if not thousands, of hospitality businesses across the UK. Research from Alix Partners shows that the licensed sector recorded a net loss of 5,975 sites through 2020, nearly triple the tally of 2,171 net closures in the prior year. Even if – as some reports suggest - the government adopts a three-stage lockdown exit plan, pubs could still be shut until May, placing many venues and independent brewers under even greater financial strain. The hospitality industry is the fourth biggest employer in the UK, so the material effects of prolonged closures will continue to ripple out into the wider economy through the second quarter of 2021.

With more venues going out of business and the fear of infection still present, it may be a long road back for publicans and restaurateurs. Could drinkers in the UK switch to habits normally associated with our cousins across the English Channel? The shift away from drinking in bars to drinking at home has been happening for years in France, accelerated periodically through economic downturns and one-off impacts like the smoking ban. France has one of the highest alcohol consumption rates in Europe, yet surveys show that three out of five of people only drink at home. That is somewhat at odds with UK drinking habits, in which the pub has remained the focal point for many.

But it is possible that many consumers will have noticed the relative cost advantages of entertaining at home compared to a night out on the town. A switch-away from the on-trade to the off-trade would have significant implications, not only for the drinking dens, but also for the listed beverage companies that supply them.

That point was brought home by the latest interim figures from spirits giant Diageo (DGE) and a Q4 update from high-end mixer supplier Fevertree Drinks (FEVR). Both releases might be summed up as follows: a drastic fall-away in on-trade volumes ameliorated by strengthening sales in North America. The latter point should hearten shareholders in Fevertree as the US is viewed as its chief vehicle for growth in the coming years. Signs of greater traction in such a huge market will assuage fears of reaching saturation point in its domestic market where the remarkable gin revival in recent years has driven Fevertree's rise.

The domestic slump was also evident in a first quarter update from industry peer Britvic (BVIC), as the lockdowns and restrictions weighed on its ‘out-of-home’ division, where UK sales were down by a third.

Diageo recorded organic net sales growth of 1 per cent in the six months to 31 December, despite a significant impact from travel retail and on-trade restrictions. Sales in North America were up 12 per cent, offsetting declines in other regions. Organic operating profit was down by 3.4 per cent, reflecting an unfavourable sales mix. An exceptional tax charge and increased financing costs contributed to a 15 per cent fall in net profits. However, net cash from operating activities was up £700m to £2bn, while free cash flow increased by £800m to £1.8bn, enabling the group to increase the interim dividend by 2 per cent to 27.96p per share.

Fevertree expects to report 2020 earnings ahead of market expectations despite the restrictions placed on on-trade channels, recording a modest 3 per cent decline in global sales for 2020. Core UK sales were down by around a fifth, with on-trade sales contracting by around 60 per cent. Shifts in the sales mix placed pressure on the gross margin, but shareholders can take solace from the improved showing in the US market. The tonic maker said that trading activity in its European markets has not been unduly affected by Brexit issues, and it closed out the year with group cash of £143m.

The market responded positively to both releases. Increased off-licence and supermarket sales have helped to partially mitigate the impact of widespread closures in the hospitality sector, but the switch in the sales mix is placing pressure on margins. Investors need to keep an eye on whether the trends in the sector enforced by lockdowns do lead to genuine structural realignment in the post-pandemic world. We return Diageo to a hold.

Last IC view: Buy, 2,522p, 28 Sep 2020