The novel coronavirus pandemic makes Diageo (NYSE:DEO) a riskier investment because of its exposure to the travel and tourism industry.
Credit Suisse analyst Sanjeet Aujla told investors in a note that he favored brewers over distillers right now because spirits are more apt to be consumed in restaurants and bars than beer. He downgraded Diageo's stock to neutral from outperform as a result.
Diageo derives a quarter of its revenue from Scotch whisky and owns the world's bestselling brand, Johnnie Walker. Vodka is the distiller's second-largest spirit, representing 11% of total sales, with brands including Smirnoff and Ketel One.
Diageo stock lost 40% of its value during the pandemic, falling from $170 a share down to $100. It has since regained much of the lost ground and now trades at $150 a stub.
In its last update on the impact of the novel coronavirus on its business, Diageo said the pandemic significantly disrupted its on-trade channel, which includes venues like restaurants, bars, clubs, and hotels. The channel accounts for 20% of U.S. spirits sales and 50% of Europe net sales.
Like many other businesses, the distiller withdrew its earnings guidance for the year and suspended its $5.6 billion share buyback program during the pandemic. The company issued new bonds and said it had sufficient committed lines of credit to make it through the crisis.
Failing to gain altitude
The timing of the analyst's downgrade may seem curious now that restaurants and bars are reopening. But most establishments are reopening only with social distancing protocols, ensuring that they'll operate at less than full capacity. If the number of COVID-19 cases starts rising again -- and some indications suggest that's already happening -- it could put a damper on a rebound and lead states to reimpose restrictions.
The travel industry may have an even longer road to recovery. Even though it never fully shut down during the crisis, there was little incentive or ability for consumers to travel. Lockdown orders and stay-at-home policies made it impractical, and destinations often imposed quarantine rules upon arrival. Some 4.5 million passenger flights were canceled worldwide. These effects might linger.
To make up lost revenue as passengers disappeared, American Airlines (NASDAQ:AAL) and other carriers converted their passenger planes to cargo planes and began making as many as 140 flights per week as cargo carriers. It was the first time in 36 years that American carried cargo, but it wasn't enough to fill the hole left by the lack of passenger flights.
Where American had previously reported over $9.6 billion in passenger revenue, it recorded just $218 million in cargo revenue in the first quarter.
Beer is better -- sort of
Brewers may fare somewhat better than distillers, but they were hit hard too. Although off-premise sales have soared during the pandemic -- with one-week sales hitting $1 billion heading into Memorial Day weekend last month -- it hasn't been enough to offset the decline in sales of draft beer made on-premise.
It's also not actually beer that's selling, but rather flavored malt beverages like hard seltzer. Boston Beer (NYSE:SAM), which makes the second-biggest seltzer brand, Truly, saw earnings hurt by the pandemic -- though that may have been a function of demand for seltzer being so high that the company had to switch to more expensive third-party contractors to fill orders.
Big brewers like Boston Beer and Anheuser-Busch InBev (NYSE:BUD) can better weather the storm because their distribution networks place their beverages in national off-premise chains, like liquor stores and supermarkets. This option is largely unavailable to smaller craft brewers, who rely upon the on-premise sales from their own taprooms and brewpubs.
Pass the bottle
Whether you're a distiller or a brewer, the situation is dicey. But Diageo's global footprint means it's at risk everywhere because of the pandemic.
Betting on adult beverages might not be the best investment to make at this time.