How New Drinks and Categories Are Making Waves in the Alcohol Industry

National Bourbon Day took place earlier this week, serving up the perfect opportunity for an update on the latest developments in the alcoholic beverage industry. On this consumer goods edition of Industry Focus, Vincent Shen and Asit Sharma dive into one of America's biggest beer, wine, and spirits producers, Constellation Brands (STZ 0.06%), and how management's shifting focus is driving them to consider the spin-off of a major business unit.

They also look at the widely successful (and increasingly competitive) craft beer industry, including efforts to capitalize on new categories like alcoholic soda. And for the last round, they turn to SodaStream (SODA) and its new Beer Bar offering recently launched in Germany and Switzerland to consider whether consumers will accept a beer made from concentrate.

A full transcript follows the video.

This podcast was recorded on June 14, 2016. 

Vincent Shen: Happy Tuesday, everyone! Welcome to another episode of Industry Focus, the podcast that dives into a different sector of the stock market each day. It is Tuesday, June 14, and I'm your host, Vincent Shen here to talk consumer and retail with Fool.com contributor Asit Sharma, who's joining us today via Skype. Great to have you back, Asit. I really liked having you on the show last time. I think we have a great one in store for today as well.

Asit Sharma: Awesome! Thanks a lot, Vince. I'm glad to be back. I want to add one thing. It's summer, it's time to get together with friends, throw some delicious food on the grill, and reach for an ice cold ... investment idea.

Shen: There you go. How fitting because for today, I am en-dubbing this as the official Industry Focus happy hour for this week. It turns out today is actually National Bourbon Day, which happens to be my usual drink of choice. It thought it would be fitting for Asit and I to cover some of the latest developments in the alcoholic beverage industry. First, we're going to talk a little bit about the upcoming spinoff in IPO or potential IPO of Constellation Brands' wine business, and then we'll cover some high-growth opportunities in craft beer, some crazy new categories like alcoholic sodas and the newest category, alcoholic flavored water. We'll wrap up with the most controversial story, which I think is just a very great example of innovation in the space, which is SodaStream's Beer Bar, which is in other words, beer from concentrate and the potential for that to be popular in the U.S. although it's launching in Europe first.

But we're going to work through quite a few shelves at the bar so let's get started, Asit. The first company is Constellation Brands, ticker STZ. They're a major player in the industry with about $30 billion market cap. They are the third largest beer producer in the U.S., similarly the biggest multicategory company in the United States. Meaning, they offer the trifecta of beer, wine and spirits, though that might not be the case after we talk about this segment. Then rather, unlike its bigger competitors where they might hone in on a specific beer or spirits specifically, Constellation's management team though it seems like they might be trying to move away from the multicategory. What do you think?

Sharma: Yeah, it's a great point. A lot of our listeners are familiar with Constellation Brands because they watched the stock price shoot up over 630% these last five years. They've done that by building a foundation first at this multicategory manufacturer/marketer in spirits, wine and beer. But in 2013, Constellation Brands bought the Mexican beer portfolio from Anheuser-Busch InBev (BUD -0.53%). As part of that agreement, Constellation Brands got the distribution rights for these beer portfolio in the United States. That enabled the company to take off. Beer has become the predominant business. It's still a very well diversified business, but the beer sales are through the roof and Constellation Brands has invested in new manufacturing capacity, several billion dollars to build new bottling plants, new distribution just south of the border in Mexico. They are starting to lean to toward becoming more of a beercentric company.

Shen: I think something to really kind of drives that home too is the company has spent, when I calculated, almost $5 billion, I think, on M&A in the past three to four years. The bulk of that has been dedicated to beer properties. One of the more recent ones was the Ballast Point deal, worth $1 billion. I think it's one of the largest, if not the largest craft beer acquisition to date. A pretty clear indicator of how focused they are now on that particular category.

Sharma: That's true. What we see in that particular acquisition is the potential in craft beer is phenomenal, because that market is growing very quickly. If you think back 10 to 20 years ago, you had a very limited selected selection. You walked into a grocery store of beers to buy, they were dominated by the big brands. But this all changed in the way people consume beers has meant that those companies which can grab the market share are going to win and Constellation Brands' management is very aware of this. They don't mind putting up big dollars to buy small, sometimes obscure companies, so that they can scale those companies out. Of course, Ballast Point is not really an obscure company; in the West Coast, it's known very well, and among craft breweries, it's one of the larger ones.

But this idea to go in, scoop up a small company and then scale the distribution through a wide system, like Constellation Brands is an attacking strategy, but it's one in the long run which should increase their earnings and help grow their revenues consistently above where the beer market is growing.

Shen: You mentioned the growth rates. Do you feel like that is potentially one of the reasons why the company is really thinking about spinning off what they have in Canada, which is one of the leading wine producers? I think one of the top premium wine names worldwide, actually. Could you just walk us through maybe a little bit what management is thinking with this spinoff, if this really makes sense.

Sharma: Sure. In the company's most recent conference call, management said, "Hey, Canadian wine business isn't getting the visibility we think it deserves." This conference calls are great. You have to almost have a Google Translate for management speak. I want to translate that for you. What that really means is, "Hey, we don't think this Canadian wine business is returning as much to our bottom line as it should, because obviously if this was making good money out in the Canadian market, the would be no need to spin it off." If you look at this business, it was acquired several years ago and has never really been a huge part of the business. Maybe it was destined to grow at a good clip, but that growth never really materialized.

Last year, the Canadian wine business booked about less than $600 million in sales, that's in U.S. dollars. The previous year, it has booked just under $700 million in sales. You actually see a little bit of decline in that business. Now, we have to look at the reason for this. Number one is that the U.S. dollar has really ramped up against world currencies. Anyone who invest in consumer goods knows this because you've seen the reports come back and the companies you hold and they always site dollar strength and foreign currency translation. Those are sort of buzz words; our earnings aren't as great as we expected that they would be. But over the border, the loonie, the Canadian dollar has really depreciated versus the green buck. It's trading just under 80 cents to one U.S. dollar. What that means is, when Constellation Brands translates its earning back into dollar, it takes a big slice off the top.

The other thing which we've seen, this goes back to, Vince, your comment about acquisitions. Constellation Brands management has taken on quite a lot of debt to finance acquisitions and also to build up capacity. The debt keeps growing but so do the earnings, because these are typically smart acquisitions. When you start doing this cyclically like almost every year, you start to look at the other parts of your business and those that aren't growing as quickly, don't look as great to you because they have a limited capacity to pay that debt down. What management really wanted to do here is to trade one thing for another. They like to give wings to these Canadian wine business, let it fly on its own, take those proceeds, pay down some debt. Once that debt is paid down, they're going to reup, they're going to borrow more money and maybe buy some more of these craft beer companies that we've talked about.

Shen: It seems to me like management is kind of just shifting their priorities here and I really like the comment that you made up at the management speak, needing the translator because as you mentioned the need for them to kind of switch to what appears to them the better, stronger opportunity in terms of growth rates and long term success. Overall, do you think Constellation Brands just becoming a more beercentric company?

Sharma: Yeah, absolutely. I think they are. This company has been very careful over the years to spread its revenue out between the spirits business, the wine business and the beer business. But I think we're going to see maybe a three to five year shift where beer takes the lion's share of the earnings, not by a lot. They're a circumspect company but you may see that revenue would be becoming 55, 60, 65% in the next three to five years. We can count on them to sort of swing that pendulum back because this management team is careful about not putting all of their wine bottles into one wine case.

Shen: That's great. That's great. You're talking about a lot of high growth in beer, so let's just move right into that topic and talk a little bit about what a lot of people have referred to as a craft beer explosion. Just a number I pulled from the Brewers Association, which still amaze me every time is how in the past 30 years, in 1986, there were just 124 craft breweries. Now, there's 4,200, more than that actually. Over decades of time, that's incredible growth.

Sharma: Yeah, I mean, this is amazing growth. If you live in an area of the country where craft breweries are coming up, you can see that. I happened to live in Raleigh, North Carolina, and we happen to have sort of a craft beer explosion here and in Asheville which is a major city in the western part of the state. I know in Northern Virginia, you guys see that also. For our listeners who are out in the West Coast, it's no surprise for you. It seems like you cannot walk within your city a few blocks without seeing a new craft brewery in some of these hot spots. Why is this exploding? Few reasons. One is that consumer taste obviously has changed. Millennials have a taste for the artisan product, the craft product. Folks are stepping in both to fill that need, but there are just a lot of people who are jumped in, it's not an expensive business to start. You can start in your kitchen and maybe it catches on.

Although we know that many of those breweries won't last for the long-term, there are a surprising number of craft breweries that are finding local, regional, and some of them national distribution. I'd like to also point to those growth statistics; what surprised me was the size of the craft beer market. In just a few years, it's grown to a $22 billion business. That is now one-fifth the size of the entire beer market in the U.S. That is a mind-boggling statistic.

Shen: It seems to me, I think we've seen this trend quite a bit with some of the mega breweries, think of the more traditional companies that we use to know or use to follow more closely, Anheuser-Busch InBev, I mentioned the Ballast Point deal of Constellation Brands, that a lot of them are trying to buy into this, into this trend, into these growth rates that you mentioned, even though technically when they do, these craft breweries lose their official status as a craft brewer.

Sharma: That's true. When we first saw this happening, it almost seem like something underhanded, because you would find that Anheuser-Busch owned the craft brewery that you really liked. They very quietly bought up some of these small breweries. In fact, Anheuser-Busch bought eight craft breweries since 2011. In the beginning, in the early days, five years ago, they would disclose, "We spent $20 million on a small craft brewery," or $30 million. But as the years have gone on, they don't disclose quite as often. In fact, I couldn't find a number for their latest acquisition which was just a few months ago, doubles back from brewery and that is in Virginia, near you, Vince. I couldn't terms on that deal. You mentioned the Ballast Point Brewery deal that Constellation Brands took on last year, that was a $1 billion deal. That really lifted the veil on what's been going on.

In the interim, these companies are now spending not just tens of millions but hundreds of millions to buy small breweries. It shows you how willing the giants are to pay for growth. This category has a 13% compounded annual growth rate. If you look at the beer business in general, it trends globally at just under 3%. It's just beating inflation. If you had the deep pockets of an SABMiller or an Anheuser-Busch InBev, you probably would do the same thing. If you have the cash on your balance sheet and you can buy the growth, you would also be hoping in a car and traveling up and down the East Coast, the West Coast of the United States and visiting some of these breweries.

Shen: Absolutely. Just a curious thought I had too was the idea you mentioned that how a lot of these bigger companies aren't disclosing the terms of these deals anymore. It seems like there is this arms raise, so to speak, of craft brewery acquisitions. They just essentially want to prevent like just the overall value or the price they have to pay for these breweries to keep going up, if every brewery sees each latest press release, the number keeps going higher and higher for their competitors.

Sharma: Yeah, and this is something they really shouldn't do. Someone should sit down with these management teams and tell them, "You are working against yourself." Because put yourself into a small craft brewery's shoes. Vince, if you and I started business and we decided at some point, "Hey, let's leave The Fool and sell this beer. It's just going bonkers." One of these companies walked in our door and we knew that terms weren't being disclosed, we would not demand top dollar. We would be find and exorbitant sum and name that sum. When you put a cloud over the valuations of deals, it works... it cuts both ways. It makes your competitors also close up their dealings, but for the people who are in the driver seat, the people with the product, it gives them a lot of power because they can virtually name their price. I believe that's what Ballast Point did.

Anyone who thought that this business isn't for real just have to look at that $1 billion price tag for $50 million in revenue. They really should be disclosing this as quickly as they can. "We paid $300 million for XYZ brewery." They would end up paying less in the future on their acquisitions.

Shen: Yeah, I think so too. Moving quickly because we have a lot more to cover here, is some newer categories. We talked about craft beer kind of this newer trend, this recent success that they've seen but they're not... craft beer, that kind of expands into these newer product categories like we're going to talk about now, alcoholic sodas and even flavored water with pretty decent alcohol content. This was started for alcoholic soda specifically, based on my research, seem like they're Small Town Brewery, very small operation, very fitting of the name. They released, and not your father's root beer, and there's an awesome Chicago Tribune article profiling the founders, some of the controversies there too that I think is really interesting.

But basically, this product just released just a few years ago. I think it was back in 2011 or 2012. Then once it reached national distribution, this popularity grew so much that I think within 10 months, it had become the sixth, it made Small Town Brewery the sixth best selling craft brew brand. That is just unbelievable. I think a lot of industry insiders were shocked by how successful they were. It's really launched this new category of alcoholic root beers, alcoholic sodas in general. What do you think about this new offering?

Sharma: Well, kudos to Small Town Brewery for opening up this category. I think I read that their sales on this were $92 million last year, which puts the entire category up to $160 million. It's phenomenal that they have such a huge share of this very new market for alcoholic sodas. I think what this says about this small niche, you see something very similar in the non-alcoholic beverage sector, I'd like to talk about that for just a moment. Let's talk about Coke (KO 0.31%). Coke has an entire venture capital arm. It's called VEB. It's the division of the company that tries to locate small and up-and-coming soda brands or natural juice brands, and once those brands start selling within the low tens million dollars, Coke keeps tabs on them. As they get toward this magical number of $100 million, Coke takes more and more of an interest.

Many of our podcast listeners are familiar with Honest Tea. This is a great example of that; a company which had less than $100 million of sales, but Coke actually ended up completely acquiring. The $100 million mark is a magnet for attention be you a big nonalcoholic beverage company like Coke or Dr. Pepper Snapple or on the alcoholic beverage side, again, the SABMillers, the Anheuser-Busch, Constellation Brands of the world. What this single brewery did was push the category up to the level where it gained quite a bit of attention. Anheuser-Busch has jumped in now with their version, excuse me for saying this on the air, Best Damn Root Beer, and SABMiller is offering Henry's Hard Soda.

But the goal of both of these would be to quickly also get them up somewhere around the $100 million mark or more. I find it fascinating. What's your opinion, Vince? Do you think this is... I have an opinion on how this category is going to grow over the next five years but let me ask you first, what do you think this small niche category is going to do? What's in the next five years?

Shen: I would say originally actually I was a little bit more skeptical. Incredible growth, but I didn't know how sustainable that would actually be. But actually just looking at soda consumption overall, I know a lot of people talk about the fact that an increased awareness of health and what we put into our bodies, our diets essentially is leading to a long-term decline of soda consumption. But the fact of the matter is, the top 20 soda drinking countries that I could find for 2014 from Euromonitor International, Argentina, at about 155 liters per capita. United States is number two at about 154. The next three countries that round up the top five are Chile, Mexico and Uruguay around 140 to 112 liters per capita.

Whereas, in the U.S., beer consumption is only about 76 liters per capita. That's basically a two to one ratio there. It makes me realize that there is this really big opportunity for these companies to essentially cross the isle from the soda consumption to beer and vice versa and that is, just seeing that two to one ratio of soda to beer consumption, I really think the opportunity is actually bigger than my original skeptical eye. But putting the value on it, I'm not quite sure.

Sharma: Yeah, I think those are great points. One thing I would add to that is I follow Coke as an investment, and I noted that despite all the press here and the declining consumption of soda in the U.S. as you pointed out, around the world, it's actually blossoming. I know in India, which is a huge market for Coke, they don't sell on price like they do in the U.S. They sell on volume. They lower the price and they're just trying to gain market share. But it's a popular drink. Soft drinks are popular, whether you agree with that marketing strategy or not, however you feel about sodas and their potentially harmful effects on us as we consume them long term. Warren Buffett would disagree. How do you feel about that? Sodas are still very popular although in more developed countries, they are declining in consumption. They're actually growing in the rest of the world.

Really, briefly, I think in this category, I'm going to make a totally unscientific prediction, that this market of alcoholic sodas is going to double within the next five years. That sounds like maybe a bold prediction but we have to consider... right now, it's only just over $100 million. If a few big players do indeed step in and scale distribution, it's not that big a goal to actually achieve. I think we'll see within the next five years, something like a 20% compounded annual growth rate but after that, I'm sort of with you, Vince. Who knows what happens from there? Does it really become huge or does it taper off and plateau? We'll just have to see. But it's going to grow in these next few years for certain at a good clip.

Shen: I'm glad you brought up some of the other markets as well. Because the fact of the matter is, even that the big Anheuser-Busch deal, their big deal with SABMiller, they talk a lot about trying to target Africa, Asia, South American markets, and those are also happen to be the markets that showed the most growth in soda consumption. Here it is an opportunity, an example of an opportunity here with that they can really leverage those more macro trends for themselves.

Moving onto the last topic. We're running out of time here. Is something I really wanted to talk to you about which is the SodaStream Beer Bar which just a few weeks ago, market reactions seem to be pretty positive, it jumped 5% the day of the announcement, but could you just give us a quick rundown here of what we're looking at?

Sharma: Sure. This a product that's right now introduced by SodaStream in Germany and Switzerland, I believe soon coming to the U.S. Basically this is a concentrate which will emulate beer. The company calls it "beer" but actually it's slightly different. The concentrate has some glucose syrup in it. It has an aroma of hops, so perhaps not really hops in the concentrate. You can put it into your SodaStream and turn out beer. Its got about 4.5% alcohol by volume. It's a light beer in terms of alcohol. It's going to be fairly cheap. The concentrate one liter at today's exchange rates is somewhere under $3.5, which will make about 3 liters of this beer, their first offering in SodaStream's "Beer Bar." This is a new product. Perhaps not truly beer, but an intriguing one nonetheless.

But we are going to see in the U.S. how the SodaStream current owners adopt this. Many people are skeptical. For those of you who read beer blogs or are beer connoisseurs, you've probably heard this product trashed. But as Vince and I, we had a conversation yesterday. Vince pointed out to me and I'll let you take over here, Vince. You haven't seen the review yet in Europe where it's current selling, so we really don't know what the initial indications about this beer are...

Shen: I'd say I'm really curious. Initial launch is in Germany and Switzerland. I think two very strong beer drinking countries. Germany is usually up there in terms of per capita beer consumption. Switzerland I think has some of the most breweries in the entire continent. I think maybe if they can get the product to have a strong reception there, that gives them some street credibility essentially, but I think a big thing that makes this so attractive is when you think about home brewing kit which might take days at the least, usually about weeks to produce your own batch, whereas here you can do it in potentially seconds, and it's very cost effective. You mentioned the $3.50 for that liter of mix to make 3 liters. I think I calculated it out to be about 3.3 cents or so per ounce of beer for this blondie through the Beer Bar, whereas if you were to go buy your standard case of maybe a Miller Light or Bud Light, it comes closer to 5 or 6 cents.

For some people, maybe it's not as discerning, not as concerned with the traditions of how beer is brewed, how it's made, just kind of looking for something that taste good and maybe give them a nice buzz, I could see this potentially working but in the end, I have to say, it's definitely going to be an uphill battle for them to kind of market this out, because ultimately it's a beer from concentrate.

Sharma: True. As you pointed out, there's no accounting for taste. It's hard to say what the consumer latches on to, what really catches fire and what totally flops. Just a couple of quick comments on this. I think this is what SodaStream as a company needs to do. They need to innovate. They have been able to reinvent themselves a couple of times. They started out as a cold soda type purveyor of soft drinks, and now they moved that to healthier categories. To me, they have almost a new lease on life because the Keurig Kold which is made by Keurig, a cold machine, it's been retired by Keurig's new owner, JAB Holding Company. A potential huge competitor which was backed by the Coca-Cola Company is now been mothballed. This on being an opportunity for SodaStream to come up with new innovations like this.

The other thing which we want to be aware of here is that this blondie or Beer Bar is a prelude to an upcoming product from SodaStream due to hit the second half of this year called SodaStream Mix, and that is going to allow consumers at home to mix their own cocktails. This goes back the alcoholic soda, alcoholic flavored water categories that we talked about. You'll be able to make a hundred different recipes with liquor or sparkling wines. That's going to be a really interesting product for SodaStream. We'll have to see, again, if this is something that totally flops. It does have a higher price point. The machine is going to be somewhere, I've heard, priced between $250 to $300. That was one thing that killed the Kold. But SodaStream does have a more loyal clientele who's used to buying their products.

Again, one of these things to anticipate, but the bottom line is the company is doing what it needs to do. It needs to keep innovating. Last year, sales declined by 19.3%. This is the year, next year to stabilize their sales and help them grow again.

Shen: All right. Thank you very much, Asit. We are tapped out for day and time. But you can order another round with us via Twitter @MFindustryfocus, or send us any questions and comments via email to [email protected]. You can also enjoy the other great podcasts from The Motley Fool by checking out fool.com/podcasts. People in the program may own companies to discuss on the show and The Motley Fool may have formal recommendations for or against stocks mentioned. Don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!