By Howard Choe
Here's a toast to a classic defensive sector: alcoholic beverages. Despite continued economic doldrums resulting from the jobless recovery, the near-term outlook for the U.S. alcoholic beverage industry -- for brewers as well as distillers and vintners -- remains positive, in Standard & Poor's view. In good economic times or bad, consumer demand for these products tends to be relatively consistent.
We expect that the U.S. brewing industry will benefit from a favorable pricing environment for beer, improving demographic trends, and rising consumption of premium brews. Continued productivity improvements at breweries and high capacity-utilization rates throughout the industry should also aid profits. We project a rise in operating profits of 6% to 8% for the domestic brewing industry in 2003.
The profit increase, though, will come amid tepid growth in unit volume (beer sales are typically measured in barrels). As a result of inclement weather in the first half of 2003 and, to a lesser degree, the sluggish economy, the U.S. brewing industry is likely to see volume growth of around 1% for the year. That's slightly below normalized trendline growth of 1% to 1.5%. S&P believes that continued strong growth of premium light beers and imported beers will fuel the gain.
While it appears that growth in alternative malt beverage products -- flavored alcoholic beverages, hard lemonades, and the like -- has peaked, we believe that modest growth in this segment should continue through 2003.
The U.S. beer industry continues to benefit from the realization of higher net revenues per barrel, reflecting increased consumption of high-margin premium products, the successful implementation of price hikes, and reduced discounts by heavyweight Anheuser-Busch (BUD ) and the leading import-beer makers. Anheuser is likely to continue raising prices in the fall and spring of each year, which should allow for continued margin improvement for the industry through 2004. On average, a 1% increase in pricing generates twice as much profit for brewers than does a similar increase in volume.
Premium domestic beer brands will continue to face stiff competition from fast-growing imports as European brewers consolidate and gain marketing and distribution muscle in the U.S. Consumption trends for imports should benefit from higher disposable incomes and a narrower price gap between imports and domestic premium beers. Faced with prospects for anemic volume growth in the U.S. in 2003, domestic brewers will likely continue to seek foreign investments and export opportunities in an effort to enhance international growth of their brands.
What about the harder stuff? Considering the positive outlook for the economy and solid trends in consumption, we expect continued growth for the spirits industry in 2003 and into 2004, aided by modest price increases, lower interest rates, and synergies and cost savings resulting from the high merger and acquisition activity in recent years. For 2003, we expect operating profits to grow 4% to 5%.
Wine makers, on the other hand, may see a modest decline in operating profits for 2003 as a glut of grapes and a flood of imports has led to heavy price competition. With estimates that the glut could last for at least several years, S&P believes that the industry will continue to face pricing pressures as quality moves down the price ladder. With so many quality wines now available at attractive prices, we believe domestic wine producers will be forced to invest more in marketing to distinguish their brands.
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S&P also believes that, despite the near-term slowdown in import growth, consumption of imported wine may continue to outpace consumption of domestic wine. Thus, U.S. wine producers will be forced to reduce their capacity and overhead to improve profitability.
What are S&P's top picks in the industry? Among the brewers, we think the best choice is Anheuser-Busch, which carries S&P's highest investment ranking of 5 STARS (buy). The top selection in the distillers-and-vintners group is Constellation Brands (STZ ), also ranked 5 STARS.
Analyst Choe follows consumer staples stocks for Standard & Poor's