Maker’s Mark Doesn’t Need Diluting — Beam’s Stock Price Does

Southerners are a proud, prickly lot who, not that long ago, used to demand satisfaction for slights real or imagined with pistols at dawn.

So the executives at Beam Inc. (NYSE:BEAM) might want to watch out — their decision to water down their premium Maker’s Mark has offended the sensibilities of bourbon lovers in the South and beyond.

And why would Beam do such a dreadful, dreadful thing?

They’re running out of quality aged bourbon to sell. High-end bourbon has become so popular that Maker’s Mark lacks sufficient inventory to meet demand.

Bourbon is a fantastic business to be in. I recently wrote about the massive competitive advantages that premier Scotch whisky brands have over their would-be competitors. Unlike vodka, which can be produced from anything and has no aging requirements, Scotch has incredible barriers to entry. A bottle of Scotch worth drinking is filled with whisky that has been aged for well over a decade. Not too many startup distilleries can afford to wait that long.

(On a side note, once whiskies are bottled, the aging process stops. Wine continues to age after it is bottled, but it is the only alcoholic beverage for which that is the case. So if you have a good bottle of Scotch or Bourbon you’ve been itching to open, go for it. It won’t have value five years from now as a collector’s item.)

For American bourbon, the rules are little looser. Unlike Scotch, bourbon has no required aging period. But a bottle worth drinking has been “aged to taste.” And in the case of Maker’s Mark, that aging period tends to be about five to six years.

If you’re the executives running Maker’s Mark, what do you do? Shorten the aging period and risk lowering the quality of the finished product? Accept shortages? Raise prices and risk losing customers to other brands?

In the end, management decided that lowering the alcohol content by 3% was the least bad option and that its drinkers would not notice a difference in taste.

Other than risking an honor challenge from an offended white-glove-wearing Kentucky colonel, this would seem the least risky course of action.

Rival Brown-Forman (NYSE:BF.B) lowered the alcohol content of its signature Black Label Jack Daniel’s from 86 proof to 80 proof in 2002. It caused a little grumbling but it did no long-term damage to the brand. In the case of Beam and Maker’s Mark, it should be safe to assume the same. If spreading the bourbon a little thinner helps Beam to maintain its high sales growth a little longer, then this is a positive for Beam shareholders. It also suggests that price hikes might be coming next, which suggest higher margins.

This boom in bourbon demand is happening alongside a boom in Scotch demand. As I wrote in my last article, £2 billion in new distillery investment is under way in Scotland, much of it funded by the major brands like Diageo’s (NYSE:DEO) Johnnie Walker.

But while the economics of the whiskies businesses have never been better, I’d recommend steering clear of their stocks, which are overvalued right now.

Diageo is the cheapest of the three at 18 times earnings, and the one I consider the safest bet. I’ve owned shares for years and I continue to reinvest my dividends … yet having said all that, I’m still not making any major new purchases at current prices.

So it goes without saying that at 25 times earnings, I’ll also be steering clear of Beam (and Brown-Forman, for that matter).

I like spirits stocks, but not at any price.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management.  As of this writing, he was long DEO. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.

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