Friday, January 13, 2017

MGP Is Not Doomed, Nor Is American Whiskey

A report was released today by Spruce Point Management that says investors considering a purchase of MGPI stock "should be cautioned not to extrapolate recent earnings performance. We believe there are numerous business risks and cracks in the growth story that are not being adequately discounted."

Some are interpreting this report as foretelling doom for MGP and, by extension, the presently booming American whiskey industry.

They are mistaken.

Spruce's guidance is that the facts don’t support MGP’s current share price, i.e., investor enthusiasm for the stock is overblown. That doesn’t mean MGP’s business model or, by extension, the American whiskey industry is on track to collapse. It doesn't mean MGP isn't managing its assets wisely. If a stock is overvalued, that doesn’t mean it is not a good investment, i.e., not a good company, it just means its stock is over-priced at the moment. The mistake, if there is one, is with the investors, not the investment.

That's what the market is for, adjusting that sort of thing. There is a level, i.e., a price, at which MGP is a great investment. The report's caution against extrapolation should apply as well to those using it to predict a looming disaster in the industry as a whole.

There have been other recent analyst reports that seem to worry about overcapacity in the American whiskey industry. It is true that the industry as a whole is much more optimistic and consequently much less cautious about investing in future production increases than it has been historically (in the modern era). That may mean that some stocks, such as MGP's, are overpriced at the moment. It doesn't necessarily mean the companies are wrong to expand capacity as much as they are.

One problem is that many people don't understand MGP. It has become the dominant player in the commodity whiskey segment, to the point where many believe they invented it. They didn't. That segment of the industry has always existed. Most of the major American whiskey distillers have supplied that market at one time or another, in one way or another, but always in a very low-key way. It's a small part of their business and they don't like to talk about it. Some of the major participants in that segment, such as Heaven Hill and Sazerac (Buffalo Trace), are private companies that aren't required to be as transparent about their business as are public companies such as Diageo, Brown-Forman, Pernod Ricard, and MGP.

As the majors, private and public, have seen demand for their branded products grow, they have had less capacity to devote to commodity production, which is always subordinate because it is less profitable. Some have gotten out of commodity and contract altogether but that is probably temporary. Commodity production may be less profitable, but it is more profitable than idle capacity.

This seems to be happening often in the whiskey world these days. A short-term, weather-related logging bottleneck gets blown up into a barrel shortage crises. Periodic out-of-stocks in a few fast-growing brands gets spun as a critical whiskey shortage. People predict that the growth of craft distilleries will kill the majors, when in fact the majors are growing faster than anyone and the production of every craft distillery in America doesn't match in a year what Jack Daniel's makes in a week. A few investments in crafts by majors suddenly spells the death of craft.

My caution to readers of this column would be that investors have to look at things somewhat differently than we whiskey enthusiasts do. At worst, all the analysts are saying to investors who have witnessed the industry's recent growth and want a piece of it is, "not so fast." There are reasons to suspect the return on your investment may be lower than you anticipate. You should do the math (or pay the experts to do it for you).

However, if your interest is simply in making sure there is an ample supply of high quality whiskey available at retail at reasonable prices, now and for years to come, you have nothing to worry about. In fact, things probably will only get better.

The trick for producers and, consequently, investors is to predict how much demand there will be for mature American whiskey in, say, the year 2022 (i.e., five years out). The factual basis for making such a prediction, especially for a worldwide market, is very thin. To a large extent it is a wild ass guess. But because of the whiskey aging cycle, those bets must be placed now.

I continue to stand by what I have said for years. If China and India develop as many have predicted, no one will have made enough. If they don’t, everyone will have made too much.


Unknown said...

It's a great time to be drinking whiskey! I'm seeing more and more choices - with the majors and with the start-ups - here in Vermont.

Richnimrod said...

Thanx for that erudite explanation of the reason(s) to ignore the report by Spruce Point. It was at best a tempest in a teapot, and at worst totally useless to us as aficionados of American whiskey (Bourbon!). I was completely unconvinced of any reason for us to pay the Spruce Report any mind at all, even before your timely post; but now feel even more at ease . . . In fact I think I'll pour a nice glass of well-aged Bourbon!

Lucian Lafayette said...

Even during the worst of economic times "escapism" related industries do well. Though the situation was complicated by prohibition, alcoholic beverages and the motion picture industries would have generally been good bets during the depression period of the early twentieth century. Can we see a market correction? Certainly. But that's what diverse investment is for. And that new craft distillery in the next county helps weather the economic crisis as well. It is a great time to be a whiskey drinker.

Punter said...

Sooo... about those 8 percent of MGP's business from Diageo that could supposedly go away according to the linked article: Is Diageo/Bulleit planning to also distill rye at the new distillery (for Dickel also?), or does this mean Bulleit Bourbon has been MGP juice since the Four Roses relationship ended? Do you have any info on that, Chuck?

Chuck Cowdery said...

According to Diageo, the new Kentucky distillery will be able to meet the anticipated demand for Bulleit and maybe not even that. The main thing MGP makes for Diageo is Seagrams Seven. The new Diageo distillery is unlikely to take any business away from MGP.

Punter said...

Thanks, Chuck, I figured they were on the wrong track with that, especially given Diageo's apparently vigorous efforts at expansion. I was a bit surprised to come across both Bulleit Rye and Dickel Rye (as well as Dickel No. 12, in liter bottles) in Germany last month.

Jim Laminack said...

To me the only downturn I foresee in the short to medium term is the me toos that want to make a quick buck by putting marginal whiskey in a nice bottle and try and sell the label rather than the whiskey. I am in the distribution side of the business and we have been inundated with these over the past 3 or 4 years. It seems the vast majority of them do not make it. The problem is it makes the shelf very noisy and maybe even confusing for many consumers. In the end though the cream will rise to the top, consumers' palates will continue to mature and we will have a wide selection of excellent whiskies.

Anonymous said...

Chuck with Smooth Ambler stopping the private barrel option and sighting lack of aged MGP products (8/9/10/11 year barrels) has there been any indication from MGP that they are out or that they have reserved the barrels for the Remus distillery they acquired? It seems plausible but something tells me there is more to the story. Thanks!

Chuck Cowdery said...

Remus isn't a distillery, just a brand, an extremely small one. Not important. MGP has been essentially 'out' of well-aged product for years. With the success of brands such as Old Scout, it didn't take long for them to sell all they had.

Unknown said...


I haven't seen the full Spruce report, but since the NY Post piece quoted my white paper...

MGP could be in a great position to make the transition to self-branded products rather than as a commodity supplier, which would certainly boost their margins and may be driving some of the current valuation. But the report also seemed to mention ancillary business lines, so I'd like to read it before offering any deeper opinion.

Although I expect the number of craft players to continue to increase, as mentioned, I do believe there will also be more exits as the market rationalizes. Five years ago, many concepts with ill-defined strategies were able to make it. Now, having a solid value proposition for the market you're targeting is even more critical, and the cost to building a brand in the more-crowded environment has gone up.

Chinese and Indian demand may well be important drivers at the aggregate, mass-brand level. But changing consumer tastes in the developed world also favor smaller craft producers (even if owned by a major) versus the established brands. So, even if developing-world demand lags expectations, craft producers could do well with the majors taking the brunt of the demand shortfall. Consumers would be the big winners, then!

Michael Kinstlick
CEO, Coppersea Distilling

Tony M. said...

Good post.

Anonymous said...

Having read the report, I don't think the author's message is meant to be an attack on whiskey drinkers or the the health of the market. So, yes, it is likely useless to aficionados of American whiskey, but quite relevant to investors in MGP's stock. Any great company is a bad investment at a high enough price relative to its earnings. In this case, as Punter referred to, the Diageo business becomes an important part of MGP's future success. The report claims that Diageo is 8% of MGP's sales. That said, this is likely a much higher percent of their earnings as MGP doesn't make any money on their commodity food ingredients business. So with Diageo building a new facility the real question that matters is, how much business could MGP lose?

Chuck, why do you say that the new distillery is unlikely to take any business away from MGP? Doesn't Diageo source Bulleit Rye and George Dickel from MGP? I presume MGP could also lose Seagreams Seven, no? And then it seems to be an open question still about where exactly Bulleit Bourbon has been coming from since the Four Roses contract ended - any chance that was MGP for the past few years?

The Shelby distillery is going to be a large facility and I would imagine Diageo would like a consistent story and be able to squash this NPD talk. What would they still use MGP for after Shelby is up and running?

Chuck Cowdery said...

For one thing, the Shelby County distillery isn't going to be that large. (Read this.) Diageo is building it primarily to replace the volume Four Roses was providing. It will do little other than produce Bulleit. Diageo will continue to use contract producers such as MGP. Since the Indiana distillery was built to make Seagrams Seven, that business is unlikely to leave