Will You Be in High Spirits Owning This Stock?

A growing market and a stellar financial track record are key reasons why this premium spirits seller is favored over other alcoholic beverage peers.

Apr 15, 2014 at 8:00AM

Source: Brown-Forman

While you might get drunk on any type of alcoholic beverage, the companies selling the drinks have vastly different prospects. The underlying characteristics of the different alcoholic beverage markets are a key factor in determining the future and the invest-ability of the various alcoholic beverages stocks. Brown-Forman (NYSE:BF-B), Craft Brew Alliance (NASDAQ:BREW), and Constellation Brands (NYSE:STZ) are good proxies for the spirits, beer, and wine markets, respectively.

Spirits versus beer
There has been a long-term shift in market share from beers to spirits. According to research by the Demeter Group, the U.S. beer market share fell from 55% in 2000 to 49% in 2011, while spirits increased its market share from 29% to 34% over the decade. In contrast, wine has maintained its share of the U.S. alcoholic beverage market at 16%-17% over the same period. Similarly, a Gallup survey showed that the proportion of beer drinkers among young Americans aged between 18 and 29 years old has fallen dramatically from 71% in 1992-1994 to 41% in 2012-2013.

Spirits manufacturer Brown-Forman has been one of the key beneficiaries, seeing its revenue and earnings grow by 10-year CAGRs of 3.3% and 9.2%, respectively. Besides capitalizing on the increased popularity of spirits among drinkers, Brown-Forman boasts a portfolio of premium spirits brands with its leading brand Jack Daniel's being the third-best-selling spirits brand in 2012 in terms of retail value.

Tennessee Honey, launched as part of the Jack Daniel's product line in 2011, was highly successful and well-liked by consumers. Tennessee Honey was among the top 100 spirits sold in the first year and its sales almost doubled in the second. This successful new product launch bears testimony to Brown-Forman product brand equity and customer loyalty to the Jack Daniel's.

More importantly, premium spirits was the fastest-growing spirits category in the past decade with a 10-year CAGR of 6%, but penetration remains low at 3% of the entire spirits category. According to Nielsen, Brown-Forman has the highest proportion of premium spirits brands among its product portfolio at about 90%, much higher than its listed peers. This makes Brown-Forman the best stock to capitalize on growth in premium spirits.

While the outlook for beer looks bleak, this isn't representative of the entire beer industry. In particular, craft beer has been a bright spot. While the beer industry as a whole has shrunk between 2007 and 2012, craft beer sales actually increased by about 10% every year over the same period. Also, craft beer has a more balanced growth profile, with increased demand driven by both beer drinkers and fans of other alcoholic beverages, such as wine and spirits.

Craft Brew Alliance's diversified portfolio of distinct craft beers makes it one of the best proxies for the increased demand for craft beer. With 2013 retail sales of $115 million, Craft Brew Alliance is among the top-five sellers of craft beer in the country. While its key brands, such as Redhook and Kona, account for most of the sales, there is strong growth potential for its gluten-free beer brand, Omission. It is estimated that 18 million Americans suffer from nonceliac gluten sensitivity, which gives a sense of how big the market is.

While both premium spirits and craft beer promise future growth opportunities, the craft beer industry is comparatively more competitive and more dependent on advertising and promotional activities. It was estimated that about a thousand new craft beer brands were introduced last year, validating the increased popularity of the category.This is evidenced by the difference in profitability between Brown-Forman and Craft Brew Alliance. Brown-Forman delivers about twice the gross margins of Craft Brew Alliance; Craft Brew Alliance's single-digit operating margins pale in comparison to the high double-digit operating margins of Brown-Forman.

Source: Brown-Forman

Spirits versus wine
While demand for wine has remained relatively stable over the past years compared with spirits and beer, the same can't be said of customers' loyalty to individual wine brands. One study confirms a fact that is well-known among drinkers: a 2004 study by Wade Jarvis from University of Southern Australia's School of Marketing indicated that price and grape variety play a bigger factor in the purchasing decision for wine, compared with region and brand.

Constellation Brands is the largest wine producer globally, and its historical financial results reflect the lack of brand loyalty in the wine category. While Brown-Forman has grown its revenues by CAGRs of 4.9%, 2%, and 3.3% over three-year, five-year and 10-year periods, respectively, Constellation Brands' revenues have been far more volatile. Constellation Brands achieved negative revenue growth for both the three-year and five-year periods and registered a meager 10-year annualized revenue growth rate of 0.2%. Similar to Craft Brew Alliance, Constellation Brands' margins are always inferior to that of Brown-Forman. In the trailing 12 months period, Constellation Brands boasted gross margins of 39.9%, compared with 69% for Brown-Forman.

Foolish final thoughts
Brown-Forman is the best alcoholic beverage stock, given its positioning in the fastest growing segment, premium spirits. Its excellent financial track record of having delivered double-digit ROICs in every single year for the past decade, serves as the best evidence of sustainable competitive advantages. Unlike its other alcoholic beverage peers, Brown-Forman also benefits from stronger customer loyalty by drinkers of premium spirits.

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My top pick among alcoholic beverage stocks is premium spirits maker Brown-Forman. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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