Diageo Reignites Serving Facts Debate

FILED DECEMBER 1, 2009

Dear Client:

Diageo issued a statement this morning reminding the industry that it (along with the National Consumers League, and 75 other public health and consumer organizations) first petitioned the U.S. Treasury Department's Alcohol and Tobacco Tax and Trade Bureau (TTB) on December 16, 2003 to allow a standard "alcohol facts" panel on its beverage alcohol products. In all, they want the TTB to allow alcoholic beverages to feature standard serving information such as alcohol per serving, servings per container, and calories, carbohydrates, fat and protein per serving – much like food labels. Currently, the TTB won’t let alcohol companies voluntarily include serving facts on their labels. TTB opened a public comment period on the proposed ruling in 2005 but a decision has not yet been made. The proposal that TTB is currently considering would not require producers to display the amount of alcohol per serving or the definition of a standard drink.

A serving facts panel is controversial in the industry for several reasons, with “equivalency” at center stage. One, Discus, Diageo and others spirits companies support the “standard drink” argument that says wine, beer and spirits are equally as potent if they are poured correctly. The standard drink definition is a 12-ounce serving of beer, a 5-ounce glass of wine, and a 1.5 ounce drink of 80 proof distilled spirits (either straight or mixed). Opponents are generally against “standardized drinks” because they claim no one actually follows the allotted measurements when pouring a glass of wine or mixing cocktails. Trade groups such as the California Wine Institute and the Beer Institute have said in the past that labeling the amount of alcohol per serving could confuse consumers and would not be closely followed on-premise.

In a statement from Diageo’s, Sally Greenberg, executive director of the National Consumers League said: “TTB has more than earned a new name: 'The Take our Time Bureau.' Endless delay in issuing rules for transparency in alcohol-product labeling has kept consumers in the dark about alcohol and calorie content and has stymied public health efforts to combat intoxication and weight gain. This is yet another example of TTB's cavalier attitude about the real risks of alcohol consumption.”

SPIRITS DISTRIBUTORS SHOW IMPROVED OPTIMISM, SAYS UBS

With regards to the US spirits industry, UBS analysts Melissa Earlam and Kaumil Gajrawala said in a report to clients that they “expect depletions growth to be flat to very low single digits heading into 2010, but expect weak price/mix as consumers continue to trade down to lower-priced brands and larger package sizes.” Here are some highlights of the report:

UBS sent surveys to 259 spirits distributors across the US to gage their confidence in the industry. A total of 35 surveys were completed, which included both large and small distributors covering all regions of the country. Nearly 60% of respondents expect volume to be flat over the next three months versus the same period last year, while 46% expecting pricing to decrease. However, the majority of spirits distributors said they’re the same or somewhat more confident now than they were 3 months ago. A total 43% believe on-premise volumes are stable when compared to the last three months. Thirty-seven percent see on-premise trading getting worse, while 20% are seeing an improvement.

Meanwhile, a majority of spirits distributors believe heavy promotions and discounting will likely continue and potentially get worse in the next 3 months. UBS noted that there was a consensus among distributors and other industry members that “this is the most promotional holiday period they remember seeing.” Furthermore, 83% of distributors said consumers are purchasing more lower-priced brands than they did the same period last year. As a result, distributors expect to see continued poor price/mix over the next 3 months.

Distributors also seem anxious that brand equity could take a hit from heavy discounts. However, UBS believes “comments from the companies about their intentions to increase advertising behind the brands may ease this concern.” Lastly, respondents to the survey were split on whether inventory levels will remain stable, increase or decrease year over year.

In all, distributors seemed to have improved optimism, which UBS thinks is a result of “(1) improved macroeconomic data and (2) increased visibility on how the holiday selling period will play out.”

STATE OF THE SPIRITS INDUSTRY – MORE FROM UBS

Based on Discus data, UBS analysts Melissa Earlam and Kaumil Gajrwala predict that on-trade sales will fall -4% in 2009 after falling -2% in 2008 in the US. “The trend in the on-trade has deteriorated progressively since 2006. In our view, there would need to be improvements in consumer confidence and unemployment levels in order for volumes to return to 2006 levels.”

“We introduce a new forecast for the US spirits market in 2010. We assume that volume growth will be somewhat more moderate in 2010E, with price/mix coming through more positively, though at a very gradual rate. We assume 1% volume growth (in line with US population growth), 0.5% pricing growth and 0% mix growth, as we assume only a gradual recovery in the on-trade in 2010E...we therefore assume 1.5% value growth for US spirits in 2010E. This marks an improvement compared to 2009E, but is well below trend value growth of 5.5% 2000-2009E CAGR.”

“In the mid-term we believe that the US spirits market can comfortably deliver 4% organic sales growth. This comprises 2% volume growth driven by 1% population growth and 1% spirits per-capita consumption growth. We forecast 2% price/mix growth, with pricing comprising 1.5% growth and 0.5% mix.”

UBS believes favorable demographic trends in the US, such as faster growth from Hispanics and African-Americans will benefit the spirits industry.

AN ISSUE OF PRICING. Not only has consumers trading down led spirits companies to offer discounts and promotions, but large corporations face competition from smaller companies “who benefit from trading down to their lower-priced brands.” This includes Heaven Hill, Sazerac, Luxco, White Rock and even Constellation’s spirits brands. The negative mix for spirits has averaged -1.8% over the last 12 months, and in October averaged a -3.8% decline. Meanwhile, the negative mix for beer has averaged -0.8% over the last 12 months, and in October averaged a -2.5% decline.

According to UBS, Diageo management “sees opportunities for taking price for Smirnoff, Captain Morgan, Crown Royal, less so for Baileys and Tanqueray, which are in more difficult categories... Ivan Menezes would not specify the time frame for raising prices, flagging it could be Q2 to Q4, however, the company appears to be in a position to move very quickly.”

Other major spirits companies have said that they’d like to increase prices in the coming months too. But before price increases can be taken, the on-premise must stabilize and consumer confidence should see a boost.

A POSSIBLE RISK IN REDUCED A&P SPENDING. UBS believes “there could be a risk of reduced brand equity if this period of high promotional activity and lower advertising spend for spirits continues for an extended period.” They see the biggest risk in vodka “where differentiation is less apparent to consumers than in other product categories...partly due to vodka’s main use as a mixer instead of being consumed straight, but also due to the low differentiation in taste compared to other categories.” Blended whiskey, bourbon and cocktails have also been heavily involved in promotional activity.

TNS data for the first 9 months of the year shows that Diageo, Pernod and B-F have cut spend on advertising faster than the category average. Average ad spend has fallen by 7% for alcoholic drinks; however, Diageo’s spend has fallen 17%, Pernod has reduced it’s spend by 12% and Brown-Forman has cut by 24%.


Until tomorrow, Megan

“Laughter gives us distance. It allows us to step back from an event, deal with it and then move on.”
Bob Newhart

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