Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Many of us have looked to that first drink at a pub or restaurant as a milestone along our journey through various lockdowns and subsequent reopenings. Simple, quick, sociable, there’s sometimes nothing sweeter than the small victory of a refreshing beverage.

Whether celebrating, consorting, commiserating or curling up on the sofa, having something to sip is so ubiquitous that the drinks industry has become a major force in modern consumerism.

Much of its power lies in its breadth. The sector is not limited to any one activity or environment. Sipping a warm cuppa usually signifies a very different sort of evening from one spent with a bottle of wine. There’s a drink for every occasion, and a brand for every consumer.

As we slowly emerge from the third and (hopefully) final lockdown, there’s a clear case to be made for drinks companies benefitting from the reopening of leisure venues. For stock pickers, this may be a good time to look at the sector.

Why drinks?

The drinks industry is often seen as a solid, defensive market. People will always drink, in good times and bad. During market downturns, beverages tend to be among the last outlays consumers are willing to ditch.

Adding to these defensive qualities is the expense involved in creating a new brand versus the value entrenched in established ones. With huge marketing budgets and the ability to supply supermarkets, restaurants and pubs with their products through sheer scale of production, this is one industry where barriers to entry are high, and brand loyalty can be paramount. Big players often gain such a monopoly that small disruptors struggle to get a look in.

At the same time, the drinks market is not one to stand still for long. Tastes change over time, which means the big names must adapt to stay ahead of new competitors looking to get their foot in the door.

Nor was the sector spared the worst of the pandemic. Despite their defensive qualities, drinks companies fell firmly in the firing line of lockdowns, especially those with more exposure to the “on-trade” through bars and restaurants.

While our emergence from the pandemic should breathe new life into some of the sector’s beleaguered constituents, it’s clear that stock pickers need to read beyond the label before deciding where to invest.

A question of eggs and baskets

When looking to invest in the drinks sector, one point to consider is whether you prefer a large company which owns several brands, or one which focuses on a specific market.

Heineken falls into the latter category. Like many of the names on this list, it’s a popular choice for defensive fund managers like Nick Train, one of the best-known backers of booze. Beverages currently make up around 22.5% of his Lindsell Train UK Equity Fund, with Heineken his ninth largest holding.

It’s not all been plain sailing of late for the Dutch brewer. The company has struggled to adapt to a shifting consumer base, which has seen younger consumers move away from beer and towards other alcoholic drinks like spirits. While its share price performance has been far from disastrous, it has lagged the market over the last five years.

In February, with Heineken’s performance weighing on his fund, Nick Train asked for patience from investors. He explained that beverage companies could be one of the best ways to capitalise on the reopening of economies and, with around 40% of its business going through the ‘on-trade’ in licensed venues, Heineken would eventually reap the rewards. His pleas are starting to appear vindicated, with the stock price rising sharply in recent months.

Looking beyond the reopening trade, Heineken has taken steps towards balancing its brand and expanding into a genuinely global business. Its dividend had been growing rapidly too, before the company cancelled its interim payment in the wake of last year’s volatility.

Nevertheless, there is always a risk with brands like Heineken in the competitive world of drinks, given that all its eggs lie in one quite specific basket.

In the same way it makes sense for private investors to diversify their holdings over a range of geographies, asset classes and sectors, many big drinks companies prefer to own several brands rather than concentrating all their energy into one.

The value of that approach is well demonstrated by Diageo. The company is one of the world’s largest producers of spirits and beers and has long been a staple of funds like Liontrust UK Growth and Nick Train’s, with managers drawn to its defensive qualities, well-known brands, and attention to dividend yields.

With a cabinet of names like Guinness, Johnny Walker, Gordon’s and Smirnoff, Diageo typifies the worth of diversifying across brands, relying on at least some of its world-beating names to lead the pack at any one time.

The company’s diversification strategy spreads across geographies too. As well as a strong hold on the UK, Europe and the US, Diageo is also well exposed to Emerging Markets - approximately 19% of its 2020 sales came from Asia Pacific, and 12% from Africa. Capitalising on these regions’ expanding middle classes presents a sizable growth opportunity for Diageo’s up-market brands.

The pandemic also exposed the value of another form of diversification Diageo knows well. Companies dependent on the ‘on-trade’ in licensed venues clearly struggled when pubs and restaurants closed, while those with exposure to the ‘off--trade’ from supermarket shelves profited from the shift to at-home consumption.

With coverage of both the off and on-trade, Diageo would benefit from a recovery narrative, while offering the robust, defensive qualities you’d hope for in case lockdowns persist.

Old versus new

Companies like Diageo and Heineken may feel there will always be a thirst for their products, but that doesn’t mean they can sit back and relax. Tastes change, and so do consumer demands.

Millennials are drinking less than their parents but are willing to pay up for better quality. Market entrants often look to tap into the premiumisation of product lines that demographic changes like these impose, and for investors, the ones that manage it can be very rewarding.

That’s been an issue for Anheuser-Busch InBev. Despite being the world’s largest brewer, with brands including Stella Artois, Budweiser and Corona, the company has seen its share price nearly halve over the past five years. It carries with it a high level of debt and a dividend that now looks unreliable after cuts made last year.

In response, the company has tried to premiumise existing brands and launch new products such as hard seltzers and non-alcoholic beers to appeal to a millennial audience.

The shift in approach appeared to be bearing fruit, with revenue growing nicely over 2019. While the start to 2020 was far from stellar, a strong second half suggests there may be more positive times ahead. AB InBev’s low valuation could be one way to keep the downside risks down if a recovery takes longer than expected.

Nevertheless, AB InBev is struggling to find its feet on shifting sands that new disruptors have begun to call their own.

It took a special kind of company to look at a market dominated by Coca-Cola sub-brand Schweppes and decide it was going to throw its hat into the mix. For many years, investors remained sceptical of Fever-Tree. Even after initial stellar share price rises many investors steered clear, thinking they’d missed the boat. Now, Fever-Tree’s place among the elite is clear. Over the past five years, its stock has risen over 300%.

Despite its darling status, the ‘posh tonics’ maker has had to contend with adversity of its own. Like the others on this list, 2020 left a sizable dent on revenues. There were already fears it was losing its fizz back in 2019, when sales suddenly stalled amid mutterings that the UK had reached ‘peak gin’.

There are other, more entrenched issues. The mixers market is a competitive one and big companies with even bigger pockets are something Fever-Tree has always had to contend with. The risk of higher ingredient costs is another, as is rising costs overall, which has seen profit margins contract by around 20% already in the past three years.

Nevertheless, Fever-Tree’s success is a useful lesson to investors. The drinks industry may be dominated by a handful of big names, but those that rest on their laurels do so at their peril. Barriers to entry are high, but the rewards for breaking them can be lucrative.

Fever-Tree too is unlikely to stand still. The company has always made clear its ambition to expand beyond British novelty to crack the US market, representing a significant growth opportunity for investors. Revenues across the pond rose 23% over 2020, due chiefly to off-trade sales growing “very strongly”.

From the disruptors like Fever-Tree to the staples like Diageo, there’s sure to be a drinks company to satisfy the thirsts of any savvy stock picker.

Important information: Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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