Where next for the stock market’s drink making giants?

2020 was a difficult year for most of the stock market’s large drinks companies – alcoholic or otherwise. Drinks are sold through two main channels: the ‘on-trade’, which is bars, restaurants and other venues, and the ‘off-trade’, which is shops and ecommerce.

Lockdowns have been a disaster for the on-trade, but some sectors of the market have enjoyed a substantial bounce in the off-trade.

In general, this hasn’t been enough to keep revenues growing though, and because drinks makers tend to have high levels of operational gearing that’s had a disproportionate impact on profits.

What is operational gearing?

When a business has high levels of operational gearing, it means its fixed costs make up a relatively high proportion of its total costs. Put simply, fixed costs are high and variable costs are low.

Brewers are a good example of this. Brewery running costs are pretty much fixed, so you have to sell a certain number of pints just to cover your costs. However, each extra pint sold after that point adds greatly to profits. But when sales fall, the same process plays out in reverse. Profits can quickly drain away.

Revenue & Operating Profit in 2020

Source: Company reports, underlying figures for Heineken & AB InBev, statutory for Diageo.

A return to the pub?

Here on the HL Share Research Team we’re as keen for the pubs to reopen as anyone, and we’re happy to see that the UK might be among the first.

But the drinks makers on the stock market are global companies. So the global trend is far more important than the success of any one country’s vaccination program.

Percentage of Heineken Operating Profit (2019)

Source: Company report, underlying excluding central costs.

However, we think the future for drinks remains bright, even if we don’t know exactly when trading will return to normal. When allowed back to bars, festivals, resorts and restaurants we think people will want to let their hair down – that should benefit the drinks makers.

In the rest of this article we take a whistle stop tour through some of the drinks companies covered by the share research team, and where we think they stand.

This article is not personal advice. If you're not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Alcoholic Drinks

Heineken

Everyone knows Heineken’s flagship brand, but the beer giant also makes over 300 brands in 190 countries. These include Amstel, Sol, Red Stripe, and Bierre Moretti, as well as cider brands like Bulmers.

Heineken’s global footprint means it should stand to benefit wherever the on-trade restrictions get lifted first. The group’s diversified brand portfolio is also a large positive, and we’re encouraged to see the flagship brand put in a good performance in 2020.

Volume fell just 0.4% overall and grew substantially in several markets. The zero-alcohol version also did well and grew double digits in all markets. This area could offer an attractive growth avenue going forwards.

Heineken’s full year underlying revenue fell 11.9% to €19.7bn. This marked an improvement on the first half, thanks to a stronger summer as trading restrictions were temporarily lifted – especially in the European on-trade.

Thanks to a high level of operational gearing, underlying operating profit fell 35.6% to €2.4bn. However, Heineken also wrote down the value of some assets which meant the group suffered a full year loss after tax of €204m, compared with a €2.2bn profit in 2019.

The board recommended a dividend of €0.70 per share, a 58.3% decline on last year, representing 34.9% of underlying net profit. Heineken's policy is to pay out between 30% and 40% of underlying net profits each year.

Heineken doesn’t expect trade to materially pick up until the second half of the year, when it expects a gradual recovery. How much profit it makes is forecast to be below 2019 levels, in part thanks to continued on-trade disruption, especially in Europe.

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Diageo

Diageo is another of those corporate names hiding well known brands. Diageo is primarily a distiller, and owns Johnnie Walker (scotch), Smirnoff (vodka), Captain Morgan (rum), Tanqueray (gin), Baileys (liqueur) and Guinness (delicious).

This portfolio of brands is especially strong, and has supported strong margins in normal times. The portfolio is weighted towards the premium, branded end of the market, so if customers want to go for something above bottom shelf when lockdowns end – and we suspect they might – Diageo will be well placed to benefit.

Diageo’s financial year runs to June. But in the calendar year ending 31 December 2020, revenue fell 13% to €11.4bn, and operating profit fell 22% to €3.2bn.

The group did well in North America, where sales were up 12.3% thanks to resilient demand, market share gains and retailer and distributor restocking. All other regions were down except Africa, which was flat.

Diageo didn’t give us detailed guidance, but it’s now lapping the start of the pandemic which will flatter results. The group does expect North America to carry on doing well and expect Travel Retail to continue to struggle.

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Soft Drinks

Coca-Cola

The big dog. Coke is one of the most recognisable brands in the world, and that will make it a go-to once the pubs return.

In 2020 organic revenue fell 9% to $33.0bn, but underlying operating profits were flat – which management attributed to “effective cost management”. Coke’s business model will have helped here.

Rather than investing in big manufacturing plants, Coca-Cola partners with, and holds stakes in, local bottling companies in what's known as the Coca-Cola System. That reduces the amount of capital tied up in the business and gives the group flexibility it might otherwise lack. Instead, Coke concentrates its efforts on selling the syrups themselves and marketing its brands directly to consumers.

However, Coke lost market share over the year thanks to its traditionally strong position in the on-trade. We think market share is likely to recover once things get a bit more normal.

In 2021 Coke expects to grow revenue by high single digits, and earnings per share by high single to low double digits. Remember though, Coke will be lapping the pandemic so while welcome, this growth is not quite as spectacular as it might appear.

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Fevertree

Fevertree is one of the UK’s recent success stories, and focusses on selling premium cocktail mixers. Explosive UK growth looks to be over as Fevertree has firmly established itself as the market leader in its category. That means the focus is firmly on overseas expansion – which represents a real opportunity. But success won’t come easily.

Overseas rivals will have learned from Shweppes’ dismal attempt to maintain its position in tonics, and won’t be caught sleeping.

Fevertree's full year revenue fell 3% to £252.1m, as the on-trade, which usually make up 45% of group sales, was disrupted by the pandemic.

However, retail sales rose to help offset this, and the group reported strong revenue growth in America and the Rest of the World. Europe was a bit of a laggard and sales only grew 1%. Sales also fell 22% in the more mature UK market. Underlying cash profits fell 26% to £57.0m, as margins dipped.

Fevertree is expecting sales to grow 12-16% in 2021, despite some off-trade demand unwinding as the on-trade reopens.

It’s worth noting that Fevertree trades on premium valuation to match its premium product. The share’s currently change hands for 44.5 times expected cash profits, which leaves little room for disappointment.

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Our verdict

Ultimately, the outlook for beverage companies is almost impossible to map clearly as the vaccine roll-out rumbles on. But overall, we think it’s a resilient sector – once pubs and restaurants re-open, we have faith people will be reaching for their favourite tipples once more.

Of course, each company has its own individual risks and opportunities, and nothing is guaranteed.

Investing in individual companies isn't right for everyone. You should make sure you understand the companies you're investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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