Cheap Beer Isn't the Answer

Earlier this week, I stopped in at the neighborhood Applebee's to watch my Steelers get manhandled by Peyton Manning and company on Monday Night Football. In between Pittsburgh punts and Indianapolis touchdowns, I took advantage of the house special -- $1 domestic drafts -- to sample several favorites from the Budweiser and Michelob beer families. Sadly, such low-priced promotions are growing increasingly harder to find and will likely be even rarer in 2006.

Yesterday, Motley Fool Inside Value selection Anheuser-Busch (NYSE:BUD) reaffirmed that another round of price hikes is on tap for the near future. According to CFO Randy Baker, a "favorable" domestic pricing environment is expected to pave the way for a widespread 2% to 3% increase next year. Similar comments were made ahead of price increases implemented late last year, and it wouldn't surprise me to see them repeated again in the future, as the company seeks to counter volume growth as flat as a mug of brew left out overnight.

Beer is for breakfast
In a scene from the movie Cocktail, a beer request placed by a young Tom Cruise is met with this memorable line from the bartender: "Beer is for breakfast. Drink or be gone." While that may or may not be the prevailing attitude at every watering hole these days, many drinkers have definitely been shying away from anything made of malted barley, opting instead for a glass of wine or a more potent cocktail. At the beginning of the year, beer controlled a 56.7% share of the overall alcohol market, down from nearly 60% less than a decade ago. While I haven't seen any updated figures, there has been little to suggest a sudden reversal in the gradual trend.

As the industry leader, Anheuser-Busch is, of course, struggling to cope with this weak demand, which has led to four straight years of declining per-capita consumption. However, rivals including SABMiller and Molson Coors (NYSE:TAP) have also seen sluggish growth rates. Last year, total domestic beer volume -- of which the big three account for more than 80% -- edged up just 0.5% to reach 199.3 million barrels. Of that total, Anheuser-Busch shipped 103 million barrels, a thin (and decelerating) increase in output of just 0.4%.

Can I buy you a drink?
To revive stagnant volume and tack on to its dominant 50% market share, Anheuser-Busch has increased its "on-premise" promotional budget this year and extended heavy discounts to customers. Considering that incremental price changes have more than twice the bottom-line impact of corresponding volume changes, the company made a calculated gamble -- forgoing profits to win back customers.

As we near the end of the year, it seems the strategy backfired. As expected, lower prices -- along with rising costs -- have weighed heavily on net income. Just yesterday, management cautioned that full-year earnings were likely to come in at $2.42 to $2.45 per share -- an 11% decline from the $2.73 earned last year. This from a remarkably consistent company that, until recently, had posted double-digit bottom-line gains in 24 consecutive quarters.

Despite the deep discounts, though, the volume meter hasn't budged. In fact, domestic shipments through the first nine months have actually slipped more than 2% to 78 million barrels. Last quarter, a 1.4% decline in sales to wholesalers helped drain domestic beer revenues by 2.7%. On the positive side, sales to retailers have ticked up 0.7% so far in the second half, a misleading number that would be even stronger had retailers not stocked up ahead of planned price increases in last year's third quarter.

Nevertheless, improvements measured in tenths of a percent are not exactly cause for celebration. Most of the ineffective discounts will be discontinued next year, except for targeted promotions of certain brands in select markets. While there have been signs of improvement in recent months, shareholders are probably anxious to close the books on what has been a challenging year.

Reaching the undecided voters
I'm certainly not presumptuous enough to think that I have all the answers here. However, as a beer enthusiast who has planned entire vacations around the local breweries -- and as a loyal customer -- might I suggest a change in tactics?

To reiterate comments I made back in January, wine and spirits could one day be a far more dangerous adversary than traditional mass-market brewing rivals, so focus your considerable resources on slowing their advance. Otherwise, there's a distinct possibility of winning the battle but losing the war. How about conveying a marketing message designed to stimulate renewed interest in beer itself -- rather than just promote an AB brand. (Though, in all fairness, I will say that Miller's attack ads are even more misguided and nearly as offensive as its metallic-tasting beer.)

Quite simply, this is an election -- but not from among Budweiser, Miller, and Coors. Those results are already in. Half of all beer consumed in this country -- including six of the top 10 brands -- is manufactured by Anheuser-Busch. Why spend time trying to reach partisan drinkers who have already decided their beer of choice and are usually unlikely to stray? In short, beer drinkers have, for the most part, already cast their vote.

In that case, the undecided voters who must be courted are the ones drinking wine, martinis, and cosmopolitans. It seems unlikely that current marketing resonates closely with this group. I'm reminded of a scene from Blues Brothers, in which a bar owner proudly claims to play both kinds of music -- country and Western -- blissfully unaware of the existence of jazz, rock, classical, or any other type. Likewise, many non-beer drinkers think beer is limited to three classes -- Budweiser, Coors, and Miller -- and don't really like any of them.

The mission, then, is one of education, to explain that there are dozens of beer styles with differences in color, aroma, and flavor that range from subtle to profound -- and to point out that those who may have disliked the beer they swilled in college might really appreciate a bock, a stout, or a hefeweizen. The objective is not to persuade the swing voters that Bud Light is better than Miller Lite, but to convince them that beer can be better than wine. Ultimately, the goal is not about fighting to maintain a 50% share of a declining market but about fighting to breathe life back into the market itself.

A glass of the good stuff
This effort will be much easier if you roll out a wider selection of high-end beers for people to choose from. New products can do what price reductions failed to accomplish -- stimulate demand. There's a reason why retailers and supermarkets in my area can't keep Coors' pricey Blue Moon Belgian White Ale in stock. Granted, that's anecdotal evidence at best, but the explosive growth of the craft brewing industry underscores the fact that consumers are willing to pay more for a premium product.

With beer drinkers clamoring for distinctive, high-quality products, there has been a sharp 7.1% jump in volume this year at the nation's 1,300 brewpubs and microbreweries. At a time when the industry giants are struggling to differentiate themselves and win back customers, results at regional companies like Boston Beer (NYSE:SAM) have been worth toasting. Last quarter, the company behind Samuel Adams reported that shipment volume climbed 11.5%, which, coupled with a stronger revenue-per-barrel figure, helped revenues and earnings advance 15.5% and 38%, respectively.

Shareholders are thirsty for more
My suggestions notwithstanding, Anheuser-Busch has managed to get along fine over the past 100 years without my help, and I'm confident it will continue to do so. The company's pricing power, distribution capabilities, and operating margins are simply superior. Along with the steady earnings improvements, it has generated enough cash to raise dividend payments for 28 consecutive years. With recent consolidation boosting results in key international markets and forecasts calling for a $200 million reduction in capital expenditures next year, expect more of the same going forward.

The demise of beer has been exaggerated by many. As noted earlier, three out of every five American drinkers prefer it above all other alcoholic beverages. Still, drinking patterns are cyclical, and the gradual encroachments made by wine and spirit marketers must be addressed. If beer needs an image enhancement, who better than the king himself to oversee the makeover?

Motley Fool Inside Value analyst Philip Durell is always on the lookout for quality companies trading at "Happy Hour" prices. To learn more, order up a free trial.

Fool contributor Nathan Slaughter could use a frosty wheat beer about now. He owns none of the companies mentioned.