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Pints and profits? How brewers have fared in lockdown

Continuing our life-after-lockdown series, Equity analyst Sophie Lund-Yates looks at how the pandemic has impacted the makers of our favourite alcoholic drinks.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The pandemic has hit alcoholic drink makers hard, especially the brewers. We like to enjoy our pints socially, but bars and restaurants closed around the world as governments introduced lockdowns to control the spread of the coronavirus. This has had a predictable impact on sales, but a bigger, and less obvious, one on profits.

This article isn't personal advice. If you're not sure if an investment or course of action is right for you please ask us for advice. All investments fall as well as rise in value, so you could get back less than you invest.

The two channels

Drinks makers sell through two primary channels, the "on-trade" and the "off-trade". The on-trade includes pubs, bars and restaurants etc., while off-trade sales are those in shops like supermarkets and off licences.

On-trade sales took the hit during lockdowns, in some areas collapsing to almost nothing. However, off-trade sales rose slightly as people took to barbecuing or Zoom pub quizzes. In general these extra off-trade sales weren’t enough to make up for the fall in on-trade sales though.

Not every drink or company was affected equally. Some have a much larger exposure to the on-trade than others, especially the brewers.

Operational gearing

This table shows the fall in sales for three large alcoholic drinks companies.

We all know Heineken thanks to the flagship brand, but it also owns a stable of others including Amstel and Moretti. AB InBev is the biggest brewer of the lot and brews Budweiser, Stella Artois and Corona among others. Diageo is a little different because it focusses on spirits like Johnny Walker, Smirnoff and Gordon’s – but it still manages to fit Guinness into the portfolio.

Company Half1 sales Half1 underlying operating profit
Heineken -16.4% -52.5%
AB InBev -17.7% -45.0%
Diageo -8.4% -14.4%

The damage hasn’t been spread around evenly – the beer focussed names have suffered more without the pubs, but sales have dropped across the board.

More interestingly, profits have fallen much further than revenue. This is the result of “operational gearing" – which occurs when a small change in sales results in a large change in profits.

Brewers have large fixed costs, and they need to sell a certain number of pints just to cover these costs. But each extra pint they brew after this point costs relatively little, so it adds greatly to profits. Of course, the reverse is also true – when sales fall these costs can’t be reduced so profits can quickly drain away.

Operational gearing isn’t a bad thing, in fact it’s really attractive when things are going well because profits can rise quickly. It’s only when things aren’t going so well that it gets painful.

Unfortunately, this is what’s happened to drinks makers this year.

Where next?

We’ve been drinking beer since the dawn of agriculture and we’re not going to stop anytime soon. And that’s not just HL’s share research team – we think beer will remain popular with the wider public too.

We don’t yet know how well pubs and restaurants will do under social distancing, or whether punters will feel safe enough to go out in large numbers again. We suspect the brewers will manage, but ultimately for normality to resume the virus will need to be under control. We also can’t rule out a second wave of infections, which could lead to more pub closures around the world.

The uncertainty kicked up by the pandemic has highlighted the issue of debt too. Frankly, debt levels were too high to begin with in some cases. Net-debt to cash profit ratios will come down as profits rise again, but in the meantime the need to pay off debt might start restricting the groups’ options. This can interrupt capital expenditure plans, which can limit growth plans.

In particular, we think dividend growth is unlikely in the near future – at least until the debt is brought under control.

Company Current net debt to cash profits Target net debt to cash profits
Heineken 3.5x 2.5x
AB InBev 4.9x 2.0x
Diageo 3.3x 2-2.5x

Ultimately, we still think owning a strong booze brand is very attractive long term. However, the high levels of debt might crimp shareholder returns in the immediate future, and a second wave of infections could put a halt to the recovery. The long-run attractions remain in play when it comes to the brewers, but investors should be prepared for some ups and downs.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. 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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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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