Beer, moats and markets

Below is a talk I gave about long term trends, and the links that both banking and brewing have with religion. And the idea of economies of scale and defensive “moats” around businesses.

Thank you for having me to speak. Today I am going to talk about long term “economic moats” around beer companies. And by long term, I don’t mean decades, I mean centuries.

I have been interested in beer companies for a long time. In fact, my first investment, when I was 18 years old, was a Suffolk brewer called Adnams. I was working in my gap year and I put about 2 months salary into buying the shares. Actually it wasn’t my idea, it was my father’s idea, who was a stockbroker. He also put me into a Uzbekistan mining company, and that did not do so well. And also an M&G income fund, which did ok, but had high fees and underperformed the market severely in the 1990s.

So that is one reason. The other thing is that there is this behavioural finance WYSIATI “What You See Is All There Is” heuristic. People think they understand beer, because it is advertised so much, you see it everywhere, it is ubiquitous. A bit like banks, people thought they understood banks pre-2007, they had their branches on street corners that no one went into, and big glass towers in Canary Wharf. And they took our money on deposit on that rate and lent it out to people at a higher rate of interest. What could possibly be so hard to understand about that? Well, we now know there was a lot more going on behind the scenes.

So anyway, I have been interested in beer companies as investment.

Because I studied theology at university, I always wondered about the division of Europe into beer drinking North European protestant countries, and Mediterrean wine drinking Catholicism. That’s not a hard and fast rule, Ireland and Eastern Europe is beer drinking and Catholic. If you think that is a bit spurious, there is a deep connection with religion and alcohol, going back centuries. The monasteries were actually the centres of the beer economy in the Middle Ages. Only in the 13^th Century did brewing evolve into commercial activity, before then the monasteries gave beer away for free! There were so called “church ales”, celebrations and feasts of the church where peasants were allowed to drink large quantities of beer for free, which obviously presented a considerable barrier to entry for anyone who was a commercial brewer. But the beer given away for free tended to be weaker alcohol content, lower quality beer. The monks also sold their better quality brew in so called “monastery pubs” and also sold to wealthy noblemen.

As an aside. This different pricing for different groups rather reminds me of what some companies do today. For instance, if you are a student you pay a lower price for Microsoft Office, if you are a home user you pay a higher price, and if you are a company you pay even more. Or free versions of watered down Bloomberg app on the iphone, but if you want the full strength Bloomberg anywhere, you have to pay £2000 a month.

What really drove the development of the commercial brewing industries, and what gave commercial brewers an advantage over the monasteries, was tax. That is, the local rulers and kings were keen to collect tax revenue. But they couldn’t tax the monastic production of beer, particularly if the monasteries were giving their product away a lot of the time. It is rather hard to tax an institution that doesn’t produce top line revenue, because it is giving it’s product away for free. Besides which the monasteries were very hard to tax anyway, because the rulers relied on the church for their legitimacy. That is, if you annoy the religious authorities, the Pope might excommunicate the ruler. Excommunication freed your subjects form their oaths of allegiance. On Sunday, the priests would tell everyone at church, not only the ruler, King Henry or whoever, but they themselves, your subjects are going to burn in hell for eternity. This would probably be described in graphic and grisly detail. And you think banks have power over sovereign rulers today, by threatening to move their headquarters overseas! Well, that seems a weak threat in comparison to what the Popes used to threaten rulers with.

That was how it used to work, so there was tension between church and state, especially when it came to sharing revenue between church tithe and secular taxes, but they relied on each other too for legitimacy. As a result of the privilege position of monasteries not having to pay tax, local rulers were keen to favour private brewers, who did have to pay tax on beer. So, in one sense a competitive advantage enjoyed by the monasteries turned into a disadvantage because of the need to pay taxes.

The way the nobles collected tax, was to specify which flavourings could be added to beer. This flavouring was called “GRUT” – which was a mixture of herbs used both to mask the flavour of lower quality beer and to preserve it for longer. A little bit like the Coca Cola syrup, the exact recipe for grut was kept secret. All the brewers, had to buy their grut from local ruler, brewing without grut was forbidden. If you brewed beer without grut people would be able to tell by the taste, word would get out and you would get a visit from the tax man, which in those days was probably likely to end badly.

If you think about the power relationship between the breweries and the nobles, it was much easier for the nobles to tax the breweries by demanding they use their special ingredients, which they could charge an artificially high price for. The alternative was to knock on the door of the brewery, and demand to know how much beer had been sold and try to collect the money in that way.

The reason we don’t have beers with grut in them today is that hops was found to a better tasting and more effective preserving the beer. You can imagine that the local ruling elites fought hard against this trend, because they would lose tax revenue, so it took several centuries for the use of hops to become widespread.

The historic event that was the greatest help for the commercial brewers against the monasteries was…the Black Death. The Black Death which swept across Europe for several years between 1347 -1352, and killed a third of the population, that doesn’t sound helpful to commercial activity. But before the Black Death, incomes were too low to sustain large commercial beer operations. After the Black Death, poor people had bargaining power, and there was wage inflation, particularly wage inflation amongst the poorest and most populace groups. We are coloured by our experience of the 1970s, and tend to think of wage inflation as a “bad thing”. Maybe it is. But bad things (such as the Black Death) can have good consequences – the opposite is true too! What do poor people do when they get a pay rise?…they spend their money down the pub! The second, related post Black Death trend, was that there was migration from the farms in the countryside, to the cities and urban dwellings. This was also because people could find more opportunities to earn money in the cities, rather than work the land at subsistence pay for the local landlord. So bigger towns created a concentrated market of drinkers for the brewers, a concentrated market that had a higher disposable income. And also a concentrated market of workers and raw materials such as grain. And the third trend, was that the beer might actually have been healthier than the alternative in cities, which was foul and polluted water. People preferred beer because there was much less chance of nasty bugs in it.

Later on, in 16^th Century when the reformation came many of the monasteries in Northern Europe were privatised by the state. Henry VIII in England, “dissolved” the monasteries, which is an interesting choice of words. Effectively he sold them to the highest bidder, and with this the brewing industry became privatised too.

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So all that was just introduction. An interesting history of how commercial brewing developed, and replaced religious institutions who were giving the stuff away for free, as an early kind of “welfare state”. By then urban populations were drinking around a pint per person per day on average, which is 4x higher than consumption today. And by the way, everyone drank beer, from monks and nuns to small children to what we would think of as your more normal beer drinker: the manual labourer.

But then the competitive environment between commercial brewers becomes even more interesting. I think looking at 16^th century beer industry gives us some fascinating insights about investing today.

But first I think I should say a word about sources: I have taken most of this from a collection of essays by different academics in a book called The Economics of Beer, Edited by Johan Swinnen, particularly the essays in the history section of the book, for instance Beer, Production, Profits and Public Authorities in the Rennaissance by Richard Unger. And I have also used Bruce Greenwald’s book, Competition Demystified to use a framework to understand exactly what was going on, and is still going on now.

Greenwald, how many of you know who he is? Modern Value Investor at Columbia University. Anyway, he takes the traditional Michael Porter framework, those 5 forces, and basically says, most of them are not durable competitive advantages. For instance, if you have lower input costs for some reason, that’s not going to last. Your competitors will work it out, and the suppliers will start selling to them. Or superior production advantages, or brand or whatever won’t deter new entrants, competitors will still have a go at doing things better and cheaper.

INSTEAD the only sustainable competitive advantage, the only “economic moat” is a combination of I) economies of scale, AND II) customer captivity. An incumbent firm defeats new entrants because it has lower costs, or thanks to customer captivity, higher revenue – and together these two determine sustainable profitability.

OK – so that is the theory. How does this work for brewing? How does this work for banking, which I know I haven’t talked about at all, but will get on to.

So, after brewing was privatised and commercialised, what happened next? The principle change over time was the increase in scale of the brewers, which led to rising capital costs. As the use of hops became more prevalent, the superior quality of the beer showed through in two ways, it last longer AND it could therefore be shipped further. Therefore the catchment area, or the size of the market would increase for brewers that made the investment in production machinery.

One difference worth mentioning, that was different from other economic activities at this time: brewing had a high ratio of capital to labour. By the16^th century, the biggest lump of capital, was the brewing kettle or copper. Kettles had to be in a fixed place, so breweries took on the appearance of something permanent, massive and expensive. Copper was the best material and it was expensive, and required substantial investment or upfront costs. The unit was indivisible, and so for a sizeable investment brewers need to increase production so that they could reap economies of scale.

It is very hard to get data on the profitability of the 16^th century beer industry, but what you can see is the size of kettles increasing. For instance in Leuven, (in Belgium or Holland?) size of the kettle doubled from 850 litres to 1700. I think I am right in saying that the largest kettle was in Munich, built in 1568 and could hold 4,800 litres. And also you can see consumption increasing, so the market was growing.

By the way Greenwald argues that growth of a market is actually BAD for maintaining deep moats around your business. The reason is because your competitive advantage is based on relatively high fixed cost. However as the market grows, and fixed costs by definition are constant, become less important. Instead variable cost rise as a proportion of total costs. Although it might seem counter intuitive, most competitive advantages are based on economies of scale in local and niche markets, where either geographical or product spaces are limited and fixed costs remain proportionately high.

Now let me just say something about regulation. Governments had been very interested in overseeing the beer industry for a long time. The rulers were more interested in the tax revenue, than protecting small brewers or preventing large brewers from becoming monopolies in their local area. Because of the high fixed costs, which larger, more efficient brewers with economies of scale benefited from, capacity increased but many small breweries in the 16^th century went out of business. This was encouraged by the authorities, who would rather regulate and tax one large brewer than 12 small ones.

However, bear in mind these small brewers were a political force in towns too. So there was a battle of lobbying, with small brewers trying to get the government to legislate for maximum kettle size, and dictate the upper level of scale economies. The government would then come under political pressure from larger brewers, who were fewer in number, but wealthier, and perhaps had their interests more aligned with the state.

I will give you a specific example of this. In 1548, a petition from the prominent citizens of Delft, inspired the ruler of Holland to set up a commission to investigate the brewing industry. The petition said that brewers could double their production from 4,000 litres at a time to 8,000 litres at a time. The commission went to Delft, Leiden, Haarlem, Gouda, Rotterdam and Schiedam and asked questions like how much beer they brewed each time, how many barrels, type of grain etc – and the report produced in 1550 showed conclusively that there were economies of scale in the brewing industry.

Eventually the large brewers won out. The fight was ultimately between large brewers interested in larger markets, and smaller brewers interested in supplying the local market. So while there were all these religious battles going on in the 16^th century, there was an equally fascinating battleground between small number of expansion minded brewers with large sunk costs, and smaller but more numerous brewers. The larger brewers tended to become more successful, and the Dutch Revolt when the rule of Phillip II and the Holy Roman Empire was overthrown, actually played into the hands of the large brewers, who were all influential locals.

There is a modern day equivalent of these large capital costs for brewing equipment. And that is national advertising, on TV channels, marketing campaigns, such football sponsorship which is also indivisible. Therefore large national and international brands can use their economies of scale to advertise on TV, at the expense of local brands. And the other social trend that benefits large brewers is when disposable incomes are under pressure, there is trend to buy canned beer from super markets, and drink at home. You probably wouldn’t buy a can of Adnams in the supermarket, but are more likely to ask for it if you went down a local pub, where it would be, and might even be the only choice of bitter on sale. So the local brewer is harmed proportionately more by the closure of pubs.

But getting back to my story about how beer went from a locally made product, to more international markets. Some of the smaller brewers tried to persuade the government to put tariffs or higher taxes on beer brewed outside the area. And early form of protectionism, which didn’t work, because the local breweries were losing power. One way the Germans responded to this, was with Beer Purity Laws. Which stated how beer could be brewed, and that various ingredients that the Dutch, Belgiums and Eastern Europeans put in their beer, made it illegal to sell beer in German states. That was a much more successful form of protectionism, and lasted right up until a few years ago, when the European Union told the Germans they had to be Europeans and drink other countries beer! Or, at least, allow other countries to import their beer, and see if German consumers would drink it. Then what those clever Germans did to protect their beer industry, they passed laws requiring beer to be served in returnable glass bottles, which were expensive to transport long distances and so they protected their industry that way instead.

Of course, if you are in running a business with an economic moat around it, one thing you need to be sure of is that the returns go to the owners of capital, rather than the workers. This nearly happened to the Washington Post, which was a 500 bagger for Buffett, great business, but they very nearly went under when the employees went on strike. So what did the owners of breweries do in the 16^th century? To prevent workers from bidding up wages, a worker had to get a statement of release from his old employer. Without that bit of paper, he could not go to work for his new employer. Can you imagine that happening in investment banking today?

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So that leads me on to banks. And what all this has to do with banks. Well there are similarities with the competitive environment but also a very large difference.

Similarities – the way banks developed was with local competitive advantages. Branches and local relationships. Only very recently have we had these global banking behemoths. And the management of these leviathans like to claim that they have economies of scale and competitive advantage. If you accept Greenwald’s idea that absolute size is irrelevant to competitive advantage, it is the size relative to local market and captive customers, then you have to ask yourself:

Where are the economies of scale and captive customers in banking?

In Global Banking and Markets? Don’t think so! Banks argue this is a scale business, with the bulk of the returns going to the top 5 players, but you can see that actually no bank has managed to sustain competitive advantage in Global Markets, or FICC or whatever you want to call it. And those banks that have tried to grow market share too aggressively, and be top of the league tables either organically in the case of UBS or via acquisition in the case of RBS have blown up, spectacularly. I was at Credit Suisse when they bought DLJ, and it was a laughable deal. 1 + 1 did not make 2. 1 + 1 did not even make 1. It made less than that, as the combined entity sank down the league tables to below where the two banks had been as standalone entities previously.

But you do have these economies of scale in local branch based and SME banking. This looks like it has much better prospects for economic moats and monopoly like returns. About 15 years ago the UK government commissioned the Cruickshank review, and Don Cruickshank was asked to look at making SME banking more competitive, because the market shares of the biggest 4 UK banks were so concentrated and had steady over time. The Cruickshank Report identified UK bank overcharging on business bank accounts by between 3 and 5 billion pounds. Gordon Brown largely ignored the report, probably because he had been “got at” by the lobbying of the large banks.

Actually I don’t think you should be too hard on Gordon Brown, he was faced with a conflict of interest and he made the wrong choice. A Columbia business school professor Charles W. Calomiris and his co author Stephen H. Haber – have come up with a very interesting argument to explain why political rulers are so scared of standing up to large banks, despite the fact that breaking up large banks would be politically popular. They have an upcoming book called Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Calormiris and Haber analyse the history and come up with an interesting idea.

The crux of the problem, they say, is that all governments face three inherent conflicts of interest when it comes to the regulating their banking systems and how banks compete. I don’t want to make too much of this, but as the church power faded, the State was faced with a similar kind of reliance / tension between itself and the banking industry. The conflicts of interest that Calormiris and Haber identify ar

• First, governments supervise and regulate banks while looking to them as sources of government finance.
• Second, governments enforce the credit contracts that discipline debtors on behalf of banks while at the same time hoping that those same debtors will vote for them
• Finally, although governments must spread the pain among creditors in the event of bank failures, they also simultaneously look to the most significant group of those creditors — bank depositors — for political support.

So let’s look at the history of banking and particularly different regulation in England and Scotland. Because due to separate regulatory regimes, Scottish banks were much less likely than English banks to fail or impose losses on their debt holders. Between 1809 and 1830, bank failure rates in England were almost five times as high as those in Scotland, a reflection of the Scottish banks‘ greater size, competitiveness, and portfolio diversification.

The Bank of England set up in 1694 and the Bank of Scotland one year later in 1695. Back then England and Scotland were separate kingdoms with separate parliaments but were ruled by the same sovereign, William III. At that time, William was hunting for a way to finance his war against France. Since Scotland was poor and remote, the king realized that he would gain little by creating a monopoly Scottish bank to help finance his military exploits he just ignored it. And instead relied on England to generate war funding. The charter of the Bank of Scotland prohibited it from lending to the crown without an act of parliament; the Scottish parliament was quite conscious of the problems that could arise if the Bank of Scotland were turned into a vehicle of public finance.

Thus, from the king’s point of view, it was easier to adopt a policy of laissez faire with respect to the Scots and simply use the Bank of England (as well as other English companies) to finance the war.

So began the English banking system’s history as a crony enterprise. Until well into the nineteenth century, the banking industry was structured to lend to the Government. From 1694 to 1825, the Bank of England was the only English bank that was allowed to take the form of a joint-stock corporation, in which the company is owned by shareholders. All other banks had to organize themselves as partnerships limited to six partners, which kept them relatively small. Other banks were also subject to strict usury laws, which discouraged them from expanding their circle of borrowers. But the English government effectively exempted itself from those laws, thereby channeling credit to itself rather than the private sector. This repressive banking system constrained capital accumulation by the private sector during the early years of the Industrial Revolution, as investment was financed out of the pockets of tinkerers and manufacturers rather than through bank lending.

Merchants and manufacturers complained about the scarcity of credit that resulted from constrained bank chartering, which resulted in a reliance on small country banks as the main source of private credit, and so the Bank of England attempted to mollify them by committing to buy the short-term debt obligations issued by other banks and brokers to finance trade. But this only made England’s fragmented system of banks even more unstable, because it created moral hazard and bad incentives. Knowing that the Bank of England would buy their bills regardless of the circumstances, country banks and other small lenders had little incentive to behave responsibly. As a result, English banking was prone to boom-and-bust cycles, and England suffered frequent major banking crises in the eighteenth century and quite a few in the nineteenth century, as well.

In sharp contrast to England, Scotland, by the middle of the eighteenth century, had developed a highly effective and competitive banking system, which served savers and borrowers well. In Scotland, the government allowed for the free chartering of banks, whereas south of the border the Bank of England had a virtual monopoly. The brewing equivalent would be one huge near monopoly brewer, which did have economies of scale. But this brewer had poor shareholder returns because it had to sell much of its beer to soldiers and other employees of the state below cost .

Also unlike in England, in Scotland, the banks were able to link their urban headquarters with branches that operated in areas that could not otherwise have supported banks. The advantage that the Scottish banks enjoyed was not having to compete against a monopoly, that had been put in place by the State to finance it’s wars. Scottish banks pursued profit-seeking strategies that provided credit to all sectors of the economy.

So this is a slightly different way of thinking about economic moats. Competition among Scottish banks was fierce during the nineteenth century, but this spurred the banks to invent new services such as interest-bearing deposits and lines of credit. Scottish banks enjoyed remarkably narrow spreads (roughly one percentage point) between the rates of interest charged on loans and the rates they paid on deposits. Nevertheless, they earned respectable rates of return for their shareholders, indicating that they were well managed.

The Scottish system served the public well, too: Despite the more competitive environment Scottish banks were less likely than English banks to fail or impose losses on their deposit holders. Between 1809 and 1830, bank failure rates in England were almost five times as high as those in Scotland, a reflection of the Scottish banks‘ greater economies of scale and competitiveness. The value of bank assets per capita in Scotland was 7.5 pounds, compared with just six pounds per capita in England.

So let’s return to the recent past, when investors thought there was a serious threat to the economic moats of banks from the internet, because customers could just move online and compare interest rates much more easily. One of the biggest economic moats banks enjoy is regulation of deposit taking. It is fairly easy to lend money, but you can’t lend money to people, if you haven’t first raised the funds on the liability side of the balance sheet.

About 15 years ago there were lots of internet banks with silly names like “egg”, “goldfish”, “marbles” and “smile” which were going to destroy traditional banks with branches. The supermarkets (Tesco, Sainsburies, Safeway) could also see the attractive returns on capital that banks were earning, and so they set up supermarket banks and started attracting deposits and making loans. They thought they had some advantages against banks too, for instance they could put branches in supermarkets rather than on expensive high street corners. But they didn’t make much impact either.

Probably the most successful new entrant into the UK, was ING Direct. A Dutch bank. I worked for ING at the time that they entered the UK market, first offering market leading deposits on the internet. ING Management were really surprised at just how competitive and price sensitive the UK market was. They entered with market leading deposit rates, and saw very rapid growth but as soon as they fell out of the league tables, so called “rate tarts” moved their money elsewhere. So although they were a lower cost business, they could not make decent returns because they did not have captive customers. On line deposits tended to be larger sums, and people were prepared to shop around for the best deal. So I’m not sure you would call that a success, the UK banks still had a big moat around their branch based deposits businesses and also around their SME lending businesses.

BUT the returns on assets of the UK banks did fall for a decade across the sector. And we can also see it in pricing information, mortgages were a 2% net interest margin product in 1998, while ten years later banks were offering mortgage at 30bp above base rate. So instead of internet banks and supermarkets something did happen.

And the answer, was, of course, HBOS and Northern Rock could access the securitisation market. The former building societies, in part encouraged by a certain Gordon Brown, were pricing loans much more aggressively than the traditional clearing banks. And this seemed to be sustainable – and it is something I got wrong – at least partly got it wrong, but I want to explain why I got it wrong. It appeared HBOS and Northern Rock had lower costs, due to lower branches and better back office systems, and they could sustainably grow and take market share from bigger banks which had grown so large they had become operationally inefficient. That went on for a decade. It was initially self reinforcing, both Northern Rock and HBOS claimed they had a “virtuous circle” strategy, around making more loans, with lower costs, which increased profits, from which they funded more lending. So it is easy to see why people like me thought it was sustainable, particularly in the case of HBOS (I actually turned seller of Northern Rock in 2005 and wrote another sell note in 2006, because I thought their pricing of mortgages was becoming self destructive).

But rather than lower operating costs, what was really driving the growth was lower funding costs and access to short term debt markets. HBOS and Nrk didn’t need those expensive branches, because they could raise money in the wholesale markets and through securitisation. And much of this money was coming from overseas. So this cross border flow of capital actually changed the competitive landscape. The split between fixed and variable costs changed, clearing banks with more branches and higher fixed costs were at a disadvantage.

It is as if the local brewers in the 16^th century suddenly had access to sources of cheap and plentiful grain, plus better technology to get more production from their lower fixed costs. Previously would have been tiled in favour of large historic capital expenditure on beer kettles. But the lower input price of raw materials, funding for banks, meant that smaller competitors could make the same amount of beer, but with lower fixed costs.

So that is why the former mortgage banks became terrible traps for value investors. The cheap short term financing was a trend that could vanish overnight. “buy” a bank because it is growing at 10% a year and on 9x earnings (which was HBOS in 2006) was a terrible investment decision. I got this one wrong. In fact you would have been better of buying the “expensive” banks on a price to book or p/e basis, because these banks were more conservatively run and less reliant on wholesale markets.

And the irony of this is of course that securitisation destroyed shareholder value in the UK pub industry. Not just companies like Mitchells and Butler and Punch Taverns, but also the traditional brewers like Marstons and Greene King. In 2005 Marston securitised approximately 70% of its managed and tenanted estate. Greene King securitised half of our pubs at the time (both managed and tenanted) the same year. And this was just the wrong time in the business cycle to increase leverage, and it made these companies less resilient to the downturn. Of course, there was no equivalent of a “bank run”, but too much debt capital financing went into the industry, and that inevitably put pressure on return on invested capital. That is the paradox of investing, the better an industry looks from a value creation perspective, the more likely it is too attract capital, not just from new entrants, but from existing players leveraging up their balance sheets, which then destroys returns.

The second point to make, is that analysts tend to worry about “new entrants”. Actually what we should have been worried about in both banks and beer companies is new capital going to existing players, who increase leverage, then compete too aggressively and destroy returns. Equity shareholders think very differently to short term debt holders who can rush for the exit, and have no need to stick with a company long term. What would have happened if Northern Rock had said 15 years ago, “ok, we are not going to fund through securitisation and wholesale markets, let’s do a MASSIVE rights issue and increase our equity base by tens of billions”. Shareholders would have asked what they would do with the money? And would not have been very pleased with the answer, we are going to chase market share and drop prices for mortgages from 200bp to around 20bp.

So now for some stock recommendations – based on these insights that:

• Big does not equate to economies of scale, and a moat around your business.
• If you are small, but dominant in a local market, you can have a deep protective moat around your business.

The absolutes don’t matter, it is size relative to the market which matters. RBS GBM was huge, almost a trillion pound of assets alone, but it never had, and never will have competitive advantage in Global Investment Banking.

Bank of Georgia has a third of the Georgian market, ok so that is 4 million people. But we know that it can compete, because HSBC and Soc Gen lost market share and retreated from Georgia, a small country on the periphery of Europe was not worth their management time. As long as Georgia doesn’t attract wholesale funded equivalent of Northern Rock, then the bank has a deep moat around it’s business.

And beer stocks. Well Diageo is trading on 5x revenue. Adnams of Southwold, where there has been a brewery since 1345, that is since before the Black Death, is trading on 1.2x revenues. And I think that is fairly substantial “economic moat” around the Adnams business. 30X earnings is not traditionally value territory. But let me do that analyst trick of saying, ignore that ratio because it looks expensive, and focus on is trading on 1.2x revenue instead. Of course, that is because the margin is so much lower than Diageo, but do we really think that Diageo’s margin is sustainable? What happens if governments stop alcohol advertising on TV, or prevent them from sponsoring sporting events. Alcohol companies have been criticized for irresponsible portrayal of alcoholic drinks in adverts. In Europe and many other countries, advertising watchdogs have been coming down heavily on alcohol advertising. Most of these countries impose legal restrictions on advertising of spirits on television and radio.

I am not sure that premium spirits alcohol brands like Smirnoff, Johnnie Walker, Baileys, Captain Morgan, J&B really do have competitive moats around them. High margin, luxury brands require scarcity value, rather than large marketing spend. What happens, for instance, if Adnams introduces it’s own brand of 12 year old English whisky? It will definitely have scarcity value.

So despite the challenges that Adnams faces, it has high market share in it’s local market and will at some stage be able to expand margins, because the sector is seen as unattractive from a capital allocation perspective. And the brewery has been around since before the Black Death – so I would say that it is trading on a good price to revenue for a business with sustainable competitive advantage.

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