The business of beer in 2018
Christmas and new year is a good time for reflection and so I duly obliged this festive season when I considered the recent history of the economics of breweries in the UK and the relative strengths of brewery v pub lead models.
Lets start with some background…..
For British beer, the 1980s was a depressing time in so many ways. The number of breweries had steadily declined over decades to number only 191 by 1980. The number of people producing anything outside of bitter or lager was a lot less, as many of the remaining breweries existed due to their success in building up a tied pub estate. This gave them both a guaranteed route to market and a strong asset base to tap into (i.e. sell off) in the low times. It helped that people tended to drink outside the home, but didn't venture much further than their local.
Depressingly in the 80s and into the 90s too many breweries saw innovation as licensing bland foreign brands and launching them into the market as premium with accompanying marketing blitzes. It's a mystery to many how we lionised Fosters, Heineken and Carlsberg while somehow missing amazing Belgian ales that would have fitted in better to a market that still appreciated the concept.
Some of the bigger and medium sized UK breweries at the time were listed companies, but rarely did they seem to use these listings to generate new capital to expand either their business or their shareholder base. The most famous benefit for Young’s shareholders was the AGM in Wandworth and the accompanying beer and sandwiches.
Some of the most visible examples of long standing breweries that are still with us include Shepherd Neame, Greene King, Fuller and Turner and Adnams. It’s no surprise that those who lasted complemented a good estate with a reasonably enlightened view on beer. Most of these long timers have a venerable family tradition and involvement that they carry through to today and this potentially ties the businesses to the markets for longer than might otherwise have been the case. It helps that a good brewery with a big estate of pubs provides a comfortable and stable income that most of the newer breweries can only dream of, or indeed may even be seeking.
Then along came the pubcos who, through a sharper focus on finances, and in particular the debt funding and selling to their pubs at fixed tied prices which enabled them to hoover up vast pub estates. When interest rates were low and business was good, these models were successful for all and the need to differentiate their pubs either with food or beer was low. However, the last decade has witnessed a sharp 35% decline in beer volume sales, along with a rising focus on food, that some of these businesses were less well equipped to deal with.
A good example of a multi-site operator who has stood the test of time, and indeed thrived, is Wetherspoons. It has a clear market in mind and is a very tightly run ship in terms of assessing performance of each pub, staying with what it does well and having a cost focused model that does OK in the good times and prospers in the tough times.
In the last ten years the number of breweries has exploded ten-fold. The vast majority of new entrants, not having spare millions of pounds of real estate or advertising budgets, have focused on the beer first. New breweries must now have amazing beer and direct relationships with drinkers, and ideally both.
New entrants have benefited from the 50% annual growth levels on craft beer driven by wider social trends towards drinking lesser volumes of better beer, less tied houses (three out of four pubs have some freedom on what they can stock) and more independent and (often online) off-sales of beer. In addition, service providers such as distribution companies, brewhouse manufacturers and keg/cask funding have matured to better link more breweries to pubs.
Social media has also transformed the ability of breweries with no marketing budget to reach their drinkers and potential drinkers without resorting to costly advertising channels. In recent years crowdfunding has made it quick and cheap to access investors (and keep accessing them as your business grows). The implementation of the government’s progressive duty system in the 90s, is widely credited as the catalyst for so much of this. All in all, it’s a golden time for ‘having a crack’ at setting up a brewery. There is clearly some risk in this concept, as some breweries will be set up sub-scale with too little brewing, business or sales knowledge but that’s just a reality of business and of life.
An example of this new breed is Brewdog. They have some 50,000 shareholders, serve 60 markets, expand globally through building their own breweries (not licensing) and reinvest in their core brewing capabilities (including big plans for a specialist sour brewery), have a core beer brand that has doubled in size every year.
All of these businesses are very different, or are they?
Well, rather than do a taste test of beers or visiting a representative sample of their pubs, I spent some time over the Christmas, when the kids would let me, boiling it down to the most objective comparison we can think of. If I had a spare £1,000 right now, who would I invest it in?
Latest Annual Financial Results with select Performance Metrics
Some points I noted:
It’s no surprise that the bigger the scale (measured by revenue), then generally the more profitable they are. Brewing and indeed pub owning is a scale business. Fast growing businesses often have low or no operating margins as they are continually investing to grow and when fully grown they can start to throw off cash.
The outliers to the standard model above are Brewdog, with its international focus, which in this sense has more in common with Starbucks (hence the reason for its inclusion…including the eye watering number of venues) that the other more UK-centric traditional brewing businesses. And AB Inbev who are a pure drinks manufacturer and distributor with the very occasional branded pub (Goose Island in Balham) to bolster the brand. Adnams with its traditional focus on beer and less on a pub estate and indeed its unique use of Adnam’s retail stores, is a business not afraid to do things its own way.
Brewdog has achieved revenue and margin scale in recent years through developing a pubs business. It’s not so different to the more traditional brewers than one might imagine but what is different is its explosive growth rate and clarity of plans that may well continue this growth for another 5-10 years. If it does keep the pace going, it could become the UK business that bridges some of the gap to AB Inbev.
AB Inbev have done so through more than a decade of increasingly large takeovers and mergers (and some disposals) of brands. The ability of anyone to build another AB Inbev from the ground up is simply not there. Indeed, the numbers and decline in AB Inbev revenues (even with some noise on necessary divestments), driven by contraction in beer consumption in mature markets, indicates that it is not trivial for them to replicate their current model into the future.
The rest of the breweries, while having a relatively low operating margin level, have very stable businesses which will continue to throw off solid dividends for all shareholders and be heavily backed by the property assets underneath. Indeed, in the general shift from a tenanted to a manged estate, the traditional brewers are all increasing their control over and quality of their earnings.
Brewdog is likely a decade or more away from being a brewery that an investor seeking income from dividends would hold. In addition, in their international expansion Brewdog have signalled a greater reliance on licensing venues to local partners and so it will be interesting to watch the revenue per venue trends into the future.
For any business which is growing or shifting emphasis, as all above (bar AB Inbev) are, then the scale of reinvestment in driving the business forward and propelling more revenue is large.
Investors will only get their returns in the form of dividends into the future or through share price appreciation and capital gains. To do this, all need to have investors who believe in the vision and execution capability of the leaders of the business.
Clearly when you have founder/leaders such as Tim Martin at Wetherspoons or James Watt and Martin Dickie at Brewdog personal support for the leader is present. However the apparent (but maybe less showy) financial success of some of the more traditional and often family lead brewers shows that there is something about continuity and steady success of family businesses that investors appreciate.
I finished this thought over the festive period, just as my kids were calling me off to assemble another Lego gift from their auntie. I found it comforting that if I do end up building an amazing brewery then it is necessary, through good balance and hard work, to keep the three audiences of family, customers and investors happy and satisfied.
And the answer to the question of who would I invest that £1000 in? Objectivity forbids me from answering that especially when I know that there is a game changing brewery setting up in a 1000 year old town centre market, where the region is crying out for great independent beer.
2018, and its challenges around tapping into growth through the headwinds of BREXIT and a challenging economy plusincreased competition will certainly be telling for Round Corner Brewing and for many of the above businesses.
We, in the Round Corner Brewing family, can't wait. Bring it on.