Of all the beverage products in the world, few enjoy the same staying power as a good beer. Beer is the most widely consumed alcoholic beverage in the world, and it's the third most popular drink overall, behind only water and tea. Behind it all is the brewing industry.
Wherever they're located, brewers tend to operate in a fiercely competitive market, so not all are guaranteed to survive and thrive over the long haul. Those that do, however, can represent compelling long-term investments as they continue to profitably quench the thirst of millions of consumers.
What is the brewing industry?
The brewing industry primarily involves the production, marketing, and selling of multiple varieties of beer. That process entails steeping in water a source of starch such as barley or rice, which is then fermented with yeast, and typically flavored and preserved with hops. Alternative starch sources include -- but aren't limited to -- corn, sugar, potato, agave, and millet.
How big is the brewing industry?
While there are only a handful of publicly traded companies in the brewing industry -- thanks in part to mergers and industry consolidation in recent years -- there are literally thousands of smaller brewers operating throughout the world.
In fact, at the midpoint of 2014, there were more than 3,000 breweries in just the United States. The vast majority are designated by the Brewers Association as "craft" brewers -- a distinction given in the U.S. to smaller, independent brewers with an annual production of beer of 6 million barrels or less, and no more than 25% owned or controlled by an alcoholic beverage industry member that isn't a craft brewer.
Collectively, these U.S. brewers currently serve the largest beer market in the world in terms of revenue, generating overall sales of roughly $100 billion as of the end of 2013. However, China's beer market has technically stood the biggest in terms of volume since 2002, with Chinese brewers producing more than twice the volume of beer in 2013 as their U.S. counterparts. At the same time, the Chinese beer industry in 2013 still represented only 79% of the value size of the U.S. beer market in fixed U.S. dollar exchange rate terms.
Going forward, however, Euromonitor International forecasts that China's brewing industry could grow another 45% by 2017, which could be enough to secure the No. 1 global spot in terms of market value. Meanwhile, many established large brewers are also pushing for growth by exporting to other emerging beer markets, including Latin America, Africa, and India.
How does the brewing industry work?
Several variables are key to understanding how the brewing industry works. First, investors should keep in mind that price fluctuations for the previously described ingredients are a significant factor affecting brewers' cost of goods sold. Anheuser-Busch InBev, for example, regularly purchases roughly 15% of the United States' rice crop every year. Should the cost of rice increase or decrease, it would undoubtedly affect AB InBev's business.
At the same time, brewers can attempt to maintain profit margins in a number of ways if ingredient costs rise, including raising beer prices in tandem, moderating advertising and promotional spending, or striving toward other operational efficiencies. But if they do so too aggressively, they could risk losing market share to other brewers, which might enjoy greater economies of scale and/or consciously choose to keep prices low for comparable products.
Brewing industry companies also typically report growth or declines in volumes, which -- exactly as it sounds -- measure just how much beer the brewer was able to sell in any given quarter. Once again, brewers must strive to balance volume with prices, quality, and marketing for their respective products to maximize both sales and consumer perception of the brand.
In some cases, brewers also report "depletions growth," which is a key measure for how fast their beer travels from warehouses to consumer outlets. Positive depletions growth can be a sign of a brewer's strong sales execution, and efficiency in working with distributors and retailers to move their product.
What are the drivers of the brewing industry?
One of the current primary drivers of the brewing industry in the U.S. is a focus on quality over quantity. To be sure, while the overall U.S. beer market fell around 1.9% in 2013 to just over 196.2 million barrels, craft brewers -- which tend to place greater focus on producing what consumers perceive as higher-quality beers -- simultaneously enjoyed 17% growth by shipping just over 15.3 million barrels. Whether those outsized gains are sustainable over the long run remains to be seen, but for now, most brewing industry growth in mature markets is being captured from the trend toward premium beer.
Even so, that doesn't mean established larger brewing companies can't represent attractive investments. Many of the most popular volume beer brands continue to sell relatively well in both mature and emerging markets. What's more, large brewers are placing increasing resources behind maintaining or growing share in existing markets with what they call "premiumization" initiatives -- or, put simply, creating new beer brands or variants of existing brands which can be positioned as premium beer offerings.
But for all the trends, ebbs, and flows of the brewing industry, one thing seems sure over the long term: Consumers will probably never lose their taste for beer. As long as that remains true, the brewing industry will continue to present compelling options for your portfolio.
Steve Symington has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Boston Beer. Try any of our Foolish newsletter services free for 30 days. 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.