Diageo Puffing Up Premium Tequila Sales

It might not be the Fountain of Youth that famed Spanish explorer Ponce de Leon sought throughout the Caribbean and Florida, but premium spirits distiller Diageo (NYSE: DEO  ) may yet stumble upon a treasure trove of riches through its partnership with rap musician Sean Combs and their joint purchase of the superpremium tequila brand DeLeon.

Source: Diageo.

The distiller and impresario -- who has been variously known as Puffy and Puff Daddy, but these days as P Diddy -- jointly bought the tequila brand for an undisclosed sum, building on their 2007 collaboration in the premium vodka Ciroc, which has since grown into a $100 million brand.

Typically beginning at around $15 or $20 a bottle, the premium and superpremium spirits market expanded at a 10% rate in 2013, outpacing the overall spirits market's 3% growth. Like the craft-beer industry that preceded it, premium spirits drinkers are seeking out better taste, greater quality, and finer craftsmanship, but where a bottle of Boston Beer's (NYSE: SAM  ) superpremium Utopias brew tops out at around $200 a bottle, that's where DeLeon is just getting started. Indeed, some brands of superpremium spirits can easily run north of $1,000 per bottle.

The margins they earn on premium spirits is causing distillers across the industry to expand their capacity to produce them. Jack Daniel's maker Brown-Forman (NYSE: BF-B  ) is undertaking a $100 million expansion program of its Lynchburg, Tenn., facility marking the largest single production expansion in the brand's long history. The program will allow Brown the opportunity to increase production capacity by 15% to 20%, even as its Woodford Reserve family of super-premium bourbons jumped 26% last year.

Beam (NYSE: BEAM  ) has enjoyed a similar spike in sales of its Maker's Mark bourbon, while Diageo itself will introduce two new ultra-premium bourbons, Orphan Barrel and Blade & Bow. And led by Ciroc, sales of premium vodka -- a market in which the distiller owns 25% of all production -- is one of the fastest-growing drink niches, witnessing compounded annual growth of 5.2% since 2005, more than any other spirit.

Source: Diageo.

Yet while the "browns" of the distillates are only just starting to tap their potential, tequila has actually been home to a number of premium and superpremium brands for years, including my personal favorite, Patron, but also Bacardi's Cazadores, Beam's Sauza, Brown-Forman's Herradura, and Pernod Ricard's Olmeca.

Another favorite of mine is Diageo's other superpremium tequila Don Julio, but by buying DeLeon, the distiller is making up for a hole created in its portfolio when its distribution agreement with Casa Cuervo expired last July. While it was only a small portion of its overall revenues, it had been prepared to buy the brand from the family owned business for as much as $3 billion. However, the Diddy collaboration makes much more sense.

To begin with, tequila drinkers have been moving away from the darker tequilas represented by Cuervo, and Combs, with his star power, can instantly give street cred to the DeLeon brand unlike Beam's just-announced partnership with former Backstreet Boys singer Justin Timberlake for a superpremium tequila called Sauza 901.

The acquisition, though, one of many Diageo has made over the past few years, is likely to put to rest once and for all the speculation it might acquire Beam. Ever since it was spun off from Fortune Brands, it was rumored Diageo might want to buy its rival, but having this superpremium brand in its portfolio now undoubtedly makes that moot and suggests we're about to see the sun rise over the distiller's own growth prospects.

Just another tequila sunrise
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