A Toast to Alcoholic-Beverage Stocks

S&P thinks issues in the distillers and vintners group will continue to outperform the broader market. Its top-shelf pick: Brown-Forman

Shares of Anheuser-Busch (BUD) were up sharply May 23 after unconfirmed reports in The Wall Street Journal that Belgium-based InBev (INTB.F) has an interest in acquiring the largest U.S. brewer. Our subsequent downgrade of Anheuser shares to 3 STARS (hold) from 4 STARS (buy) gave reason not to focus on this subindustry for this weekly "Sector Watch" article. Prior to this news, and the subsequent surge in Anheuser's share price, the Brewers group had a constructive relative strength chart, in our opinion, possibly as a result of the market's recent weakness and investors' renewed attention to defensive issues.

If beer is off the menu, what about the harder stuff? There's an old saying, "When the going gets tough, the tough get eating, smoking, and drinking." Market action has been challenging lately, ever since oil prices rose above $125 per barrel. As a result, I wondered if there could be a 'spillover' effect onto the Distillers & Vintners group from the good fortune experienced by the Brewers, either from investors' preference for defensive stocks—or an acquisition angle.

What we found was that in the past 13 weeks, the trailing 12-month relative strength ranking for Distillers had recently risen from "3" (middle 40%) to "4" (top 30%), indicating an improvement in price momentum vs. the overall market. Over the past 13 weeks, the S&P 1500 Distillers & Vintners subindustry index rose 9.3% through May 23, vs. a 2.3% climb for the overall market.

Positive Outlook for Distillers and Vintners

Take a look at the accompanying chart. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the index's long-term mean relative strength.

There are two large-cap companies in the S&P 1500 Distillers & Vintners index: Brown-Forman (BFB) and Constellation Brands (STZ). Esther Kwon, a chartered financial analyst who follows these stocks analytically for S&P Equity Research, has a positive fundamental outlook for the distillers and vintners group, reflecting S&P's view of favorable demographics, strong consumption trends that it foresees, and a possible easing of pricing pressures.

S&P expects modest economic growth in 2008, and therefore looks for consumers to continue to trade up to luxury items, albeit at a moderating pace. With demand for premium beverages expected to rise, Kwon thinks companies offering high-end products and a selection of imported wines will benefit, allowing these companies to capture market share from domestic brewers.

Stabilization in Wine Prices

Kwon believes U.S. distilled spirits shipments saw modest gains for late 2007, following strong growth in 2005 and 2006, on continued innovations and aggressive on-premises marketing to first-time drinkers and the over-50 age group. However, she notes growth has slowed, and she expects this trend to continue in 2008.

While support behind brand investments will likely continue, S&P sees profits from spirits benefiting from pricing power and strong demand.

Despite a possible stabilization in wine prices as grape costs begin to recover, Kwon thinks wine volumes will rise moderately, driven by increased off-premises consumption. She projects further competitive pressures from imported wines from Australia, Spain, and Chile. S&P sees stabilization in grape costs and higher interest expense partially offsetting likely price recovery and improved cost structures from consolidation.

A Continuation of Consolidation Ahead

Given the trend toward moderation in the highly developed markets of the U.S. and Western Europe for distilled spirits products, many of the leading U.S. alcoholic beverage companies have diversified their operations in recent years, both geographically and by product line. Longer term, Kwon believes U.S. alcoholic beverage demand will rise, with most of the growth generated from new product activity and penetration into developing regions abroad. She believes the likely outcome of these trends will be a continuation of consolidation for the global alcoholic beverage group, as companies look to build economies of scale and global capabilities, as well as improve pricing flexibility.

So, there you have it. The group's rising relative strength, combined with a positive fundamental outlook, supports our view that equity prices will continue to be near-term market outperformers. Of the companies mentioned in this article, Brown-Forman is ranked 4 STARS, while Constellation carries a 3 STARS ranking.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

Subindustry Company Ticker S&P STARS Rank Price (5/23/08)
Agricultural Products Corn Products CPO 4 $46
Coal & Consumable Fuels Peabody Energy BTU 3 $73
Construction & Engineering Fluor Corp. FLR 4 $187
Diversified Metals & Mining Freeport-McMoRan Copper FCX 3 $117
Fertilizers & Agr. Chem. Mosanto MON 4 $121
Gold Newmont Mining NEM 4 $49
HyperMarkets & Super Centers Costco Wholesale COST 4 $71
Industrial Gases Airgas ARG 5 $59
Marine Kirby Corp. KEX 4 $56
Oil & Gas Drilling Noble Corp. NE 5 $63
Oil & Gas Equip. & Svcs. Superior Energy SPN 5 $53
Oil & Gas E&P Swift Energy SFY 5 $58
Railroads CSX Corp. CSX 4 $67
Steel Allegheny Technologies ATI 4 $74
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