Watering Down the Whiskey: Bullish or Bearish for Beam?

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

An offended Bourbon drinker demanding satisfaction

An offended Bourbon drinker demanding satisfaction

The executives at Beam Inc, (NYSE:$BEAM) might want to watch out because 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, 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 start-up 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 Daniels 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 whiskey a little thinner helps Beam to maintain its high sales growth a little longer, then this is a positive for Beam shareholders.  It also suggest 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 underway in Scotland, much of it funded by the major brands like Diageo’s (NYSE:$DEO) Johnny Walker.

But while the economics of the whiskies businesses have never been better, I’d recommend steering clear of bourbon stocks.  Beam and Brown-Forman both trade for 25 times trailing earnings, which is a little too rich for my tastes.  I like spirits stocks, but not at any price.

Diageo is far from cheap at 18 times earnings, but I consider it the safest bet of the three.  I’ve owned shares for years, and I continue to reinvest my dividends.  But I’m not making any major new purchases at current prices.

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