Reaction, not action, is ultimately what defines a company’s success

Managing a business is rarely a smooth process. What matters is how a company adapts to unexpected and unpredictable shocks, says Ron Emler, on the back of Treasury Wine Estates and Boston Beer results.

Take coronavirus, the biggest upheaval the drinks sector has seen since Prohibition hit the US in 1920. Even the most intensive boardroom “war gaming” could not have predicted the devastating and lingering effects that covid-19 would have.

When questioned on this, Alexandre Ricard, the chairman and chief executive of Pernod Ricard, admitted that the group’s “Transform and Accelerate” growth programme, which began in 2018, had been further sharpened and refined as a reaction to the pandemic.

Similarly Ivan Menezes, chief executive of Diageo, agrees that his company also had to react in unexpected ways to modify the fallout.

The result is that both groups recently produced results that easily eclipsed their 2019 performances – the last full pre-pandemic year – increasing their market shares, margins and profitability across the category spectrum and in all major markets.

That was against a backdrop of much of the world not being fully reopened and the travel retail sector not expected to return to pre-covid levels for at least a further couple of years. Ricard says it is still only at 40% of its 2019 level.

Last week two very different companies gave the latest updates on how they have coped with bolts from the blue; Treasury Wine Estates and Boston Beer.

As the bigger producer, Treasury was poleaxed by Beijing’s intemperate imposition of punitive tariffs of up to 212% on Australian wines as part of a political wrangle. It lost almost 40% of its market, shares more than halved in value, and the company, which had just come through harvests affected by drought and forest fires, was left sitting on huge inventories of suddenly unmovable wine.

Tim Ford, who had been chief executive for only a few months (and was also rumoured to be facing a takeover bid), took a hard look at the business and within months had given it new direction.

The long troubled US commodity wines arm was sold to Gallo as Treasury moved upmarket with improved margins. And recently came the purchase of premium Napa winery Frank Family Vineyards through a US$135 million takeover to further improve Treasury’s standing and performance in America.

At the same time, the renowned Penfolds brand became a separate division within the company,  targeting premium markets in the US, Europe and Asia.

While last week’s results for the six months to the end of December came in below analysts’ expectations, with profits down 7% on the same time in 2020, this was mostly down to the China embargo.  But the expectations are that Treasury is well on the way to recovery in a different guise.

Although the Omicron variant hit domestic sales (another “unknown” to cope with) the impact was somewhat offset by strong growth in the Americas and ‘premium brands’ businesses, both of which reported a 19% rise in their earnings.

Treasury reaffirmed its intention to maintain a “significant” presence in China in order to keep alive the reputation of Penfolds, despite a sharp decline in earnings from China which slumped to just A$2 million from A$78.2 million a year earlier.

Encouragingly Penfolds revenues outside of mainland China rose by 49.1% despite margins slipping a little.

One company analyst calculates that “50% of the earnings lost in China have been reallocated to other markets” while Tom King, the managing director of Penfolds confirmed: “We are continuing to explore the potential to produce a China-source Penfolds portfolio in the future.”

More immediately some wines will be shipped to China from Penfolds’  European vineyards.

“As borders open up, as tourism begins, as travel starts to open up,” that points to incremental luxury growth across the globe, Ford said during a call with investors and analysts.  “I’m absolutely optimistic. You can see it week by week, it is improving,” he said.

Calculations by Bloomberg support that view.  Despite facing up to USS10 million in extra costs this year, largely due to inflation and supply problems in New Zealand, it calculates that Treasury’s sales of luxury wines this year are expected to surge by 70% from a year previously.

The shares have moved up from the $A9 level at the trough immediately after Beijing announced its tariffs and now stand at $A12, but are still almost 40% below their peak in August 2018.

While the consensus view is that Treasury’s new directions are encouraging, quarterly results from Boston Beer were dismal and showed few signs of resolving its earlier massive over-estimation of the growth rate for hard seltzers.

In the final three months of 2021 it made a loss of 9 cents per share compared with consensus estimates of a US$3 profit and a US$6.78 per share profit in the final quarter of 2020.

Net sales fell by 24.5% compared with 2021. That stemmed from lower production and shipment volumes due to the slowdown in growth trends for the Hard Seltzer category, decelerating to 13% from a whopping 158% in 2020.

While year-on-year growth of 13% in a category would be commendable in normal circumstances, Boston created its own perfect storm.

After enjoying phenomenal growth during the lockdowns of 2020, Boston went nap on the trend continuing to hugely over-produce its Truly brand, the market number two. Boston had originally estimated that the US seltzer market would grow by about 70% last year.

Earlier last year it was forced to pour away product worth some US$66 million and pay compensation to contract producers whose output was unneeded as the seltzer growth rate fell to earth.

Last quarter, Boston’s overall shipment volumes fell 24.5% to 1.5 million barrels, driven by further declines in the Truly Hard Seltzer and Angry Orchard brands. The heavy fall also resulted from more aggressive wholesaler inventory reduction than expected, primarily affecting Truly hard seltzer.

This has been chastening for Boston. While it expects earnings per share this year in the range of US$11 to US$16, that guidance will be highly sensitive to changes in volume projections mainly due to the slowdown in the hard seltzer category and the supply-chain performance against a background of price rises of about 5%.

Boston’s shares are now at US$375, almost 70% below the seltzer crisis hit the company last April. Some shareholders have launched class actions for compensation from the company.

Readjusting to slower hard seltzer growth rates has been painful for shareholders although some analysts believe they may have bottomed out. That said, readjusting to much changed seltzer market profile will take time, especially as ever more big players enter the category.

Maybe the launch of the Truly vodka-based RTD range will provide a fillip.

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