This interview was published for Global Drinks Intel subscribers in February. For details on how to join them, click here.
New York-based Stephen Rannekleiv joined Rabobank in 2006, moving up to specialise in beverages seven years ago. His time not only with the financial services provider but also covering the alcohol industry means that when he talks, we should all listen.
Global Drinks Intel: The days of major M&A in spirits aren’t what they used to be, are they? The transactions we’ve seen in recent years look like they’ll barely move the needle.
Stephen Rannekleiv: And yet, I don’t know that the spirits companies are as infatuated with micro brands as they previously were: Campari didn’t pay a small sum for Wilderness Trail, right? [US$420m for a 70% stake last year] When I think back to the investments the likes of [Diageo-backed start-up accelerator] Distil Ventures was making in really small things, that seems to have cooled off.
On the other hand, some of the most successful investments have been things like Angel’s Envy [acquired by Bacardi in 2015]: The amount of cashflow that something like that can throw off is pretty interesting. But, the days of trying to pick really small winners and losers have gone. Companies are looking to invest in brands that have broken out and can tap into the premiumisation trend.
In spirits, there aren’t any transformative deals to be done. I think people are looking for the bolt-on, but not necessarily at that craft distiller level that we’ve become used to.
GDI: Would it be too cynical to suggest the spirits brand owners view their M&A strategies as an alternative to share buybacks?
SR: All this kicked off with the realisation that the brands they have today aren’t necessarily going to be the brands of the future. At some level, there’s a strategic recognition that they need to be investing in smaller, more premium brands that are going to carry them to the future and give them more pricing power. Some of today’s brands are [price] range-bound, while the consumer’s moving in a different direction.
But, that’s a fair question!
GDI: Why have there been so many wine transactions at the ‘value’ end of the price ladder? More pertinently, why are selling companies finding willing buyers?
SR: If you’re a publicly-traded wine company, you could offload your low-end brands and your growth rate and returns start to look a whole lot better. They’re the types of companies that have done most of these big deals; Constellation Brands and Treasury Wine Estates, for example.
For a privately-held buyer, they can take on these brands that still throw off a lot of cashflow and could provide efficiencies. These brands require very little investment because they already have scale. They also create relevance with wholesalers: These are the brands that keep your wholesalers’ lights on. In the US, that’s a very relevant piece of business.
As long as you’re measuring cash and not margin percentage, it’s a very different perspective.
GDI: The current definition of success for brand owners seems to be protecting margin, which means raising prices. Is this really the right time to be taking price?
SR: It’s a terrible time to be taking price, but what’s the alternative? When you look at the level of cost increases, we’re actually surprised that companies haven’t taken more price increases.
I remember, at the end of 2021, we were looking at some of the cost inflation that wineries in the US were facing. Everyone was saying they were planning on taking price increases but we were thinking there was going to be some hesitancy. We heard the retailers were open to it but, especially in wine, nobody wanted to be the first one, because there’s so much cross-brand elasticity.
More recently, we were asked by a beer company whether a competitor of theirs could avoid taking price increases and still remain profitable. If you’ve had good hedges and contracts in place, you can be a little bit protected, but the cost environment has got really, really ugly.
Yes, it’s a difficult time to pass on price increases to consumers, especially as alcohol is a discretionary good; as a category, it’s going to have more price elasticity than basic staples. Here in the US, price increases have flowed through for beverage alcohol but it’s been far behind the broader CPG category. The soft drinks players have passed through double-digit price increases while alcohol has still been in that lower-to-mid-single-digit area.
Over time, I don’t know how companies can not pass through price increases and remain profitable. It’s a really difficult time and it’s a conundrum for the industry right now, for sure.
GDI: How valid, then, is the reason we were recently given by an international spirits brand owner for taking price “to maintain brand relevance”?
SR: In the sense of they don’t want to be underpriced in the market?
GDI: Well, ‘if one of us is doing it, then we all have to’.
SR: I think that’s window dressing; a by-product. If competitors are all taking their prices up, it’s because they’re being forced to and it’s unlikely that you’re not being forced to as well. That would be my read of it.
The underlying reason that everyone’s being forced to take price increases is we’re seeing massive increases in the cost of glass, transportation, labour and so on.
GDI: Has the alcohol industry transitioned from being recession-resistant to being recession-proof?
SR: I always go back to the first quarter of 2008, when here in the US we were looking at rising unemployment rates and negative GDP growth. At that point, there were some consumers already in panic mode. There were also consumers that were recession-resistant and recession-insulated: They weren’t making any changes.
Certainly, affluent consumers have more of a cushion to absorb cost increases more easily. I hear the same today that I heard in 2008: The affluent consumer is never going to trade down, they’re never going to stop buying. But, in 2008/2009, there was a meaningful pullback from these consumers in their spending on super-premium wine and spirits. That’s what we’re watching for now.
I don’t know yet if the fundamentals have changed or if we’re just in Q1 2008 territory.
GDI: Should we be looking at the history of a super-premium brand from 2008 to 2011 as a case study?
SR: You could argue either way. The challenge is, what else do we have? From my thinking, the only real model we have to look at is the Global Financial Crisis. That said, do you remember the movie ‘The Gumball Rally’? There’s a scene where Raul Julia and John Candy are in a little Italian sports car and Raul Julia says: “The first rule of Italian driving?” He grabs the rearview mirror, rips it off and says: “What’s behind me is not important!”
When we start talking about this, we’ve got nothing except the Global Financial Crisis, but it’s an imperfect metric to gauge what’s going to happen. This recession is going to be so much different. The inflation we have is different, unemployment is pretty low and consumers are facing nominal salary increases.
GDI: Generally, during recessionary periods, super-premium and above does quite well, as does the value end, while the middle gets squeezed.
SR: We have seen some signs that household net worth in the US has come down a little bit, but it hasn’t necessarily affected spending on super-premium. We’re hearing of some changes in the market, but do you remember a time when it’s been harder to read the tea leaves? I hear conflicting stories of what’s happening all the time! Then, we have wonky [year-on-year] comparisons.
We’ve continued to see some pretty healthy growth at the high end but also some signs that consumers are starting to get a bit spooked. It’s all anecdotal evidence, but it points to what you’re getting at.
GDI: From a spirits brand owner’s perspective, is now really the right time for RTDs?
SR: I’m the wrong guy to ask: I never understood what’s so hard about making a Gin & Tonic or an Old Fashioned! There are consumption occasions that RTDs open up, so that kind of makes sense to me. The consumer wants what they want and right now they want convenience.
Maybe what we’re learning is that it’s been the right time for spirits RTDs in the US for a long time, but brand owners didn’t believe the consumer would pay the price differential versus a malt-based RTD. I’d also argue that it took a wine company to make spirits companies see that consumers would pay for RTD spirits: Gallo shocked everyone!
GDI: If brand owners are pandering to the consumer’s laziness, then won’t RTD’s moment in the sun be much longer this time around than the late 80s/early 90s?
SR: To me, hard seltzers are more reminiscent of what we saw in the 80s: Sweet, unsophisticated, easy to drink. Spirits-based RTDs often get lumped together with hard seltzers, which opened the door, but they’re fundamentally different.
GDI: More broadly, then, what in the industry is exciting you, and what are you watching through your fingers?
SR: Category blurring has been fascinating to watch. Wine and spirits – particularly spirits – companies have had to become more focused on things like the convenience channel, where they haven’t really played before. That opens up partnerships with the brewers that have access to these channels, which forces tough discussions with wholesalers. Watching somebody like Sazerac Co go into a beer wholesaler network in a couple of US markets last year is a fascinating piece to watch how that evolves.
Hands down, the energy crisis is causing me a lot of concern. We haven’t seen the full impact of cost increases flow through into COGS yet – We’re still seeing some protection from contracts and hedges, but that really keeps me up at night.
How are we going to manage through this issue of rising COGS with a consumer under pressure? We’re facing a very challenging environment and it becomes really frightening.
GDI: What advice for the longer term would you give to brand owners?
SR: There’s a hope across industries that maybe the energy crisis goes away in a year or two. There’s always that possibility, but hope is not a strategy. You need to plan around what you do if the energy crisis takes five or ten years to resolve. Which components in your cost structure can you try to look at controlling?
One thing we came away with was packaging, which is very energy-sensitive. Can you get to circular packaging systems? Are there things you can do on a local scale to help control costs? Right now, the cost of producing greenhouse gases has a more tangible impact on the bottom line.
Then, there’s premiumisation, which is a train we’ve been riding for a long time. Maybe you want to have some brands in your portfolio that consumers can trade down to? Make sure you’ve got some protection there as well.
When your entire cost base has changed, it’s time to look for creative new opportunities to control costs. It’s time to challenge some assumptions.
This interview was published for Global Drinks Intel subscribers in February. For details on how to join them, click here.
