by Charles Sizemore | May 16, 2014 1:25 pm
I have some truly distressing news to report: We’re drinking bourbon faster than distillers can make it. Thus, unless demand abates or prices rise, we’re looking at a whiskey shortage.
As a whiskey lover, this saddens me. But as an investor, it piques my curiosity. Today, we’re going to take a look at how a whiskey shortage might affect distiller stocks.
Regrettably, for those of us who like to live out the songs that Hank Williams Jr. wrote, there is no quick fix to the whiskey shortage. Distillers can’t simply ramp up production to meet demand. In order to legally qualify as “straight bourbon,” whiskey has to be aged by at least two years, and higher-end bourbons are often aged for a decade or more.
(For scotch, the aging is generally a lot longer; see “Diageo: The Ultimate 12- to 18-Year Play.”)
Making it worse, there is a shortage of barrels needed to age the whiskey, which isn’t likely to be resolved for another two years. The barrel shortage — and the skyrocketing cost of barrels that has resulted — has led to a battle in neighboring Tennessee over the legal definition of Tennessee whiskey.
Under Tennessee law, “Tennessee whiskey” must, like bourbon, be aged in a new, charred oak barrel. Diageo (DEO), the world’s largest spirits company and the owner of the George Dickel Tennessee whiskey brand, is agitating for a law change that would allow whiskey aged in used barrels to qualify. Brown-Forman (BF-B), owner of the iconic Jack Daniels brand, views this as close to sacrilege and is lobbying for the definition to remain unchanged.
All of this is being fueled by the surge in popularity of a spirit that, up until very recently, was considered a drink for old men and backwoods rednecks.
My tastes in liquor have always been stodgy. I like a good bourbon or scotch, and I could never get into vodka cocktails when they were popular. Unless you’re James Bond — or a Russian gangster — there’s just something a little emasculating about being seen in public drinking a clear, flavorless spirit. And let’s face it, vodka doesn’t complement a cigar well.
I’m not sure I like the fact that bearded hipsters have embraced my drinks of choice. But as an investor, I’m very interested in how the whiskey shortage looks to benefit the stocks of the major bourbon distillers.
Let’s start with Suntory Beverage & Food Limited (STBFY),which recently completed its acquisition of Beam Inc., formerly the purest play on bourbon. Beam was the owner of the eponymous Jim Beam brand, as well as the higher-end Maker’s Mark and Knob Creek and the lower-end Old Crow. Suntory is Japan’s leading spirits company, though most Americans will be unfamiliar with its Japanese whisky brands, such as Yamazaki and Hakushu. (Note for booze snobs: Japanese whisky—like Scotch and Canadian whisky—is correctly spelled “whisky.” American bourbon, Tennessee whiskey and Irish whiskey are correctly spelled “whiskey.”)
Suntory’s Beam sells more than bourbon—its brands include Canadian Club Canadian whiskey, Teacher’s scotch whisky, Sauza tequila, and Courvoisier cognac, among others—but the Beam empire was first and foremost a bourbon story.
A whiskey shortage should mean better pricing for Suntory’s bourbon brands. But unfortunately, this means relatively little for Suntory stock. The Beam acquisition, while accretive to earnings, is small relative to Suntory’s size. Beam’s sales make up about 12% of the combined entities sales.
As a general rule, I love booze stocks as long-term investments. But Suntory is one that I would recommend avoiding. It relies too heavily on a declining Japanese market, and any stock in Japan is subject to massive macro risk (see “Stay away from Japanese Stocks.”)
Enjoy Suntory’s fine selection of American bourbons. But avoid Suntory stock.
Next up is one of my very favorite long-term holdings: British-based Diageo PLC, the largest and best diversified spirits group in the world.
Diageo recently began marketing its Bulleit Bourbon and Orphan Barrel brand, making it a strong competitor in the small-batch, high-end segment. Going a little more mainstream, Diageo also markets its George Dickel Tennessee whiskey and its Crown Royal Canadian whisky, which—while distinctly not bourbon—compete with bourbon among drinkers of sweet North American whiskeys.
Diageo will enjoy fat margins on its new premium bourbons. Of this I have little doubt. Yet, as was the case with Suntory, I don’t see this having a big impact on Diageo stock.
Diageo is best known for its Scotch brands, and specifically Johnnie Walker. And even while bourbon is enjoying an American renaissance, most whisky lovers outside of America prefer scotch. North American sales for all of Diageo’s products make up only about a third of Diageo’s revenues, but emerging markets make up about half.
Bourbon can be found in trendy bars in the developing world. But it is still very much a niche product outside of America, and Diageo’s primary focus is on strengthening its scotch brands in these markets.
So, while I love Diageo stock and continue to recommend it for long-term investors, I don’t see the bourbon whiskey shortage having much of an impact on it.
The best-positioned stock to take advantage of the whiskey shortage is Brown-Forman (BF-B), the maker of Jack Daniels Tennessee Whiskey, the most recognizable name in North American whiskeys. Brown-Forman also markets Southern Comfort and a handful of other smaller brands.
At the risk of offending whiskey snobs, Tennessee whiskey and bourbon are almost identical products and both suffer from the same factors causing the shortage. And with Beam now under the Suntory umbrella, Brown-Forman is the only stock that can be thought of as even close to a pure play.
Brown-Forman is a wildly profitable company owing to its branding power. Its return on equity was an impressive 37.5% in the trailing 12 months, and its operating margins a fat 32.3%.
But its current valuation—it trades at 31 times earnings—makes me pause. At that price, you are implicitly expecting one of two things to happen:
The first assumption is one I’d be hesitant to make given the whims of fashion. And the second is even less likely. Brown-Forman is family controlled, and in the past the company has very adamant about preserving its independence.
If Brown-Forman had a nice correction, I would recommend snapping up its shares. But while we’re waiting for that to happen, I might instead suggest enjoying a Jack on the rocks this evening to start your weekend right.
Charles Sizemore is the editor of Macro Trend Investor.
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