Diageo Is the Flavor of the Month

Whereas soda went with the concept of a "diet" beverage and beer went "lite," distilled spirits have gone "skinny" -- and therein lies a whole new flavorful opportunity.

Diageo (NYSE: DEO  ) may not have been the first large distiller to exploit the niche -- Beam (NYSE: BEAM  ) likely gets the nod for latching on to the growth potential by buying reality-TV star Bethenny Frankel's Skinnygirl brand in 2011 -- but it is certainly willing to dive deeply into the notion that you can drink yourself thin.

More than wine, more than beer, spirits are one of the biggest growth segments of the alcoholic beverage industry, enjoying a 3.4% compounded annual growth rate between 2005 and 2011, according to Demeter Group. That outpaces the 3.4% growth achieved in wine and the 2.2% rise in beer, which has likely only seen growth because of the expansion of the craft beer market. The overall beer market was actually down 1.5% in 2011, but rebounded last year, rising almost 2% as craft brews rose by double-digit percentages.

While wine has enjoyed some heady growth, Constellation Brands (NYSE: STZ  ) is only expecting the segment to match industry growth in 2014 rather than leading the category due to consumer resistance to higher prices despite greater input costs from grapes.

The appeal in spirits is the inclusion of women into what has traditionally been a male-dominated segment. Yet while more women are drinking more "browns," it's in the lower-calorie and flavored spirits market where there's the biggest potential.

Vodka in particular is driving the renaissance, witnessing a 5.2% CAGR since 2005, more than any other spirit, and now comprises more than a third of the entire spirits segment. Whiskey, the second-largest component, shrank from 25% to 22%, but remains well ahead of third-place rum at 13%, unchanged over the seven-year period.

Diageo remains the largest producer in the vodka market, owning 25% of all production, followed distantly by Pernod Ricard at 9%. We're likely to see Beam make a big leap to the top ranks, though, as its flavored Pinnacle vodkas continue to capture large swaths of sales, which is why Diageo countered with Smirnoff Whipped Cream and Fluffed Marshmallow flavors in late 2011 and launched its Sorbet line last year with just 78 calories per serving. At a recent investor conference, the distiller said it sees "amazing opportunities" in various confectionery-flavored spirits.

With the whiskey market dabbling into flavors as well, it gives Diageo rivals Beam and Brown-Forman (NYSE: BF-B  ) an opportunity to encroach on Diageo's 26% share. We're even seeing a resurgence in "moonshine," or unaged whiskey, though I'll admit to nearly keeling over after the first shock of a blueberry mix wore off.

Yet Diageo, as the leading player in the two segments driving the industry, will be more than just the flavor of the month as investors get the skinny on its potential.

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