Posted on | May 7, 2012
Written by | BevNetwork
When Beam paid $605m for vodkas of the marshmallow, whipped cream and gummy variety, investors could be forgiven for gulping.
Some analysts believe vodka, America’s top-selling spirit which accounts for nearly a third of the market by volume and half of its growth, is moving into bubble territory. This is highlighted by an expanding range of flavours, new entrants and flat pricing.
Indeed, Jamie Isenwater, analyst at Deutsche Bank, likens vodka to bottled water – a colourless liquid plagued by price deflation and falling margins – but without its advantage of economies of scale.
“We’re in pretty extreme territory when it comes to vodkas and flavoured vodkas,” he says, pointing to the rising numbers of flavours that include caviar, curry and Jaffa cake.
The vodka market is increasingly fragmented, but Diageo’s Smirnoff continues to lead both globally and in the US. Pernod Ricard’s Absolut is in second place, with Pinnacle – maker of the flavours bought by US spirits maker Beam – providing competition in the US last year.
Those who back flavours, including Beam, say the trend has further to run, and with reason. Stripped of new flavours and marketing, differentiation among vodkas is slim. A blind tasting conducted by Mr Isenwater was won by the own label of supermarket chain Asda.
Beam, justifying the price tag – 20 times earnings before interest, tax, depreciation and amortisation – with the help of cost saving worth a fifth of sales, is unrepentant. It sees vodka as an established and growing market and says the trend to flavours is durable.
“Vodka is an inherently profitable category,” says Matt Shattock, Beam’s chief executive, says. “It’s a product you make and sell quite quickly. You don’t lay it down [like Scotch whisky] and tie up capital.”
Gross profits are marginally below the spirits industry due to slightly lower prices for vodka, but the negligible capital requirement means this translates into higher returns on capital employed.
The flipside, as the naysayers point out, is that anyone can easily pile in. Few know this better than White Rock Distilleries, the private company that sold Pinnacle to Beam – less than five year after selling the not-dissimilar Three Olives to family-owned Proximo Spirits.
Size is no barrier to entry. Mr Isenwater sites Wódka Vodka, which entered the US in 2010 and expects to sell 100,000-plus cases by the end of the year – and has only eight employees.
Of the vodka industry, he says: “Bottling can be outsourced; new media reduces scale benefits in advertising; and working capital requirements are basically zero since you can sell/consume the product as soon as it is distilled.”
Distilling is seldom done in-house he adds, with many buying in alcohol from industrial players like Archer Daniels Midland.
Mr Shattock is unperturbed by White Rock’s ability to make and sell flavoured-vodka companies. “Pinnacle is a differentiated brand; it has found a sweet spot and is a much bigger brand [than Three Olives],” he says, adding that Beam has secured non-compete agreements.
It is sweet, but some analysts think the younger audience to whom these confectionery drinks appeal could bring distillers under increased regulation. “You only need to go on Google and type in “under-age drinking” and “flavoured vodka” to see that quite a few hits pop up,” says Ian Shackleton, analyst at Nomura. “It’s a drink that appeals to younger consumers, and reminds me a little bit of the alcopop ready-to-drink phenomenon in the early 2000s.”
However, he adds that to regulate by means of higher tax, as was the case with the flavoured alcopops, is a trickier proposition for flavoured vodkas given their broader range of drinkers.
It would also be tough to raise prices. While volumes are growing 6 per cent each year, or double the spirits industry, increased competition is keeping a lid on prices, says Trevor Stirling, at Bernstein Research.
“The fragmented nature of the market and low barriers to entry make it difficult to take price,” he says. “Today discounting is decreasing, but you could not say this is a robust category when it comes to pricing.” Investors, witnessing vodka buyers struggle to reach payback on highly priced deals, could find this unpalatable.
By Louise Lucas