Alcoholic Sodas on the Rise? Definitely Not Your Father’s Root Beer!

Besides craft beer, the last few years have seen a huge rise in popularity for categories like ciders as companies turn to new products to offset the often slow, or stagnant growth of the broad industry. Now, small, innovative breweries have given soft drinks their own interpretation with alcoholic sodas. In this segment from Industry Focus: Consumer Goods, Motley Fool analysts Vincent Shen and Asit Sharma talk about the root beer that started it all and how industry leaders approach investments in new offerings like alcoholic soda.

This podcast was recorded on June 14, 2016. 

Vincent Shen: 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 are 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?

Asit 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 $116 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 1.35%). 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 (BUD 1.35%), 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 are 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 No. 2, 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 2:1 ratio there. It makes me realize that there is this really big opportunity for these companies to essentially cross the aisle from the soda consumption to beer, and vice versa. And that is, just seeing that 2:1 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 big Anheuser-Busch deal -- their big deal with SABMiller -- they talk a lot about trying to target Africa, Asia, South American markets, and those 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.