FTSE 350: Reformulations and unholy spirits

The largest of the constituents, Diageo (DGE), sits between AB InBev (EBR: ABI) and Pernod Ricard (EPA: RI) in the global pecking order of alcohol companies, with marquee brands such as Johnnie Walker, Smirnoff and Guinness within its portfolio. So there is only a limited overlap with, say, AG Barr (BAG), whose main claim to fame rests on its status as the producer of Scotland’s alternative national beverage.

Irn-Bru probably doesn’t enjoy the same global recognition as the Diageo brands, at least outside expatriate Scottish communities. But it appears impervious to changes in wider consumer trends, apparent even as AG Barr reformulated its soft drinks in response to the introduction of a sugar levy on carbonated drinks. The soft drinks company markets around 20 other brands, but none enjoys the iconic status of AG Barr’s flagship bevvy.

As this issue went to the printers, AG Barr released a post-close update for its January year-end. Industry analysts will focus on marginal profitability, after a relatively poor performance at the half-year market was blamed on a short-term strategy designed to place “volume performance ahead of value”; ergo the pursuit of market share at the expense of unit profitability. The company also said that interim comparisons may not be as illustrative as previous periods due to the introduction of the levy, together with CO2 shortages and the “long, hot summer” of 2018.

The reformulations undertaken by AG Barr (and others) in response to the introduction of the levy are a feature of the industry from a risk management perspective, but even if soft drinks manufacturers are forced to respond to an increasingly health-conscious customer base, prospects for global sales remain encouraging. Recent market research from WiseGuyReports ascribes a value of $117bn (£90bn) to the global soft drinks market. And it is expected to grow at an average rate of 4.2 per cent annually through to 2026, by which time it could be worth $157bn.

Food and beverage companies need to adapt to changes in consumer preferences. AG Barr and fellow FTSE 350 constituent Britvic (BVIC) have witnessed increased demand for premium-brand soft drinks designed for adults who eschew alcohol, although they are also used as mixers for cocktails and short drinks. The experience of Aim-traded Fevertree Drinks (FEVR) shows that it is possible to straddle both worlds.

Nevertheless, about a fifth of the adult population in western markets don’t touch alcohol, a proportion that increases among younger consumers. It is instructive to note that Diageo has secured a majority stake in Seedlip, the world’s first distilled non-alcoholic spirits brand, and recently invested in US tipple Ritual Zero Proof, which is promoted as the first alcohol-free brand to serve up a realistic alternative to gin and whiskey.

Diageo’s financial clout enables the group to gain a foothold in any nascent corner of the drinks market, but it is not as though everybody is sobering up. Demand continues to build in emerging market economies, while consumers are trading up the value chain across a range of spirits, mirroring previous effects in the whiskey and gin markets, although this may be having a negative effect on beer volumes.