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Brian Sudano, Managing Director & COO of BMC Strategic Associates, New York
18 September 2009

“A third significant player will emerge” – Interview

BWI:
Miller Coors announced they would raise beer prices this autumn. AB-InBev said they would do the same. To many, that smacks of anti-competitive practices. Do you think it’s likely that the Obama administration will clamp down on Big Beer?

Sudano:
No! With recent commodity price increases, the beer companies have experienced gross margin pressures (revenue less cost of goods). Operating margins have grown in 2008 but due to cost reductions elsewhere, not on the product side. Further, over the past decade pricing has lagged the Consumer Price Index. Both companies also have a fairly sizable value-oriented portfolio of brands to address the value conscious consumer. Finally, the top line pricing is just one component. Another way of getting real price increases is to reduce promotional pricing activity. Although overall promotional activity is down in 2009, it is more directed than before. A-B is much more aggressive in strong MillerCoors markets than previously with less spending in strong markets. Further, competitiveness remains very strong as seen by aggressive pricing: “Shock Top Belgian White” (A-B) against “Blue Moon” (Coors) and “Budweiser Select 55” against “Miller Genuine Draft 64”.

BWI:
Earlier this year, U.S. consumers were shocked to hear that beer prices would go up sharply with the government planning to triple excises. Nothing has come of this plan yet. Is such a measure still likely?

Sudano:
Unlikely to happen. The majority of Congressmen signed a document to repeal the 1991 excise tax increase. This was a symbolic gesture and not an effort to truly get the tax increase repealed. What it does mean is that it is unlikely that a major Federal Excise Tax increase is on the horizon soon. However, I would not be surprised to see something occur in 2011 like an inflation adjusted type increase, which would be in the 30 percent range or around USD 0.40 per case. If this were to occur, beer prices would go up around USD 1.00 per case at retail with a modest impact on volume.

BWI:
With AB-InBev and Miller Coors controlling about 80 percent of the U.S. beer market, a duopoly seems firmly established. Any chances of there emerging a "significant other"?

Sudano:
During the economic recession of 2008 and the first half of 2009, the combined A-B InBev and MillerCoors have both outperformed the total market despite controlling 78.5 percent of U.S. volume (based on first half of 2009 total market volume). Until this time frame, A-B and MillerCoors were losing share to the high-end, imports and crafts. However, trading down especially from imports during the past 18 months has resulted in this trend reversing. That said, we believe that a third significant player will emerge. Although Crown Imports (Corona Extra) has lost share during the past 18 months, it continues to outperform overall imported beer and is well positioned to return to growth once the economy strengthens. It currently holds a 5.2 percent volume share and is approaching double-digits on a dollar basis. Yuengling is another company that has experienced strong growth in the U.S. and is beginning to hit scale. The company is the oldest U.S. brewer and has only a 1 percent share of the U.S. market but is growing at a double-digit rate. It also is distributed in only 20 percent of the U.S. and has plenty of geographic expansion opportunities. Further, it is positioned like a craft beer, which is a segment growing at 6 percent in a down market in 2009, yet priced as a mainstream domestic beer, e.g. Budweiser.

BWI:
Heineken USA have recently moved to their fourth president in five years. Which does not exactly indicate that all is well at Big Green. Or at the import category, for that matter. What are the problems faced by imported beer brands today?

Sudano:
The biggest problem with imported beer is the rapid deterioration of the economy. Imported beer has an R2=52 with GDP since 1991. That translates into 52 percent of imported beers volume change can be measured by the change in real GDP in the U.S.; i.e. the weak economy has accounted for the majority of the weakness in imported beer performance in 2008 and 2009. Other factors that have contributed include the continued strength of craft beer (including boutique imported beers) and price gaps between leading imported beer brands and mainstream domestic beer, e.g. Budweiser, of over 50 percent entering into 2008. With price gaps beginning to narrow and the economy expected to improve in 2010, we expect imported beer performance to begin improving with the segment beginning to gain market share again in 2011.

From a competitive perspective, some of the recent initiatives among importers should also help going forward: (1) they have not increased prices as quickly as the major domestic players; (2) they are beginning to increase investment behind marketing programs; (3) many new brands and packages are being imported that are expanding usage occasions and attracting experimenters; and (4) they over-index to the on-premise sector (= they have a greater volume going through restaurants and taverns than the total market does) which have declined sharply with the economy and are expected to slowly recover in 2010.

BWI:
Craft beer volumes in the U.S. are still going up, despite the economic crisis. When do you think will this growth begin to flatten out?

Sudano:
The spirit industry from around 2000 through 2007/2008 was fuelled by new product activity, which accounted for a large part of the industry growth. That was an approximate seven to eight year period in which emerging brands and flavour extensions were a key driver of sustained 3 percent category growth. Craft beer as a category is entirely driven by new product developments, not so dissimilar to spirits during that period. With craft beer in its fifth year of outsized growth, it clearly should continue to outperform for at least the next two to three years. However, I do believe that eventually a saturation point will be reached and the segment will flatten out which is likely to occur within the next four to five years when craft hits around 6 percent of total U.S. beer. Based on current trends, craft will finish 2009 with around 4.5 percent of the U.S. beer business.

To provide a point of comparison, flavoured spirits is around 8 percent of total volume. If you include niche imported beer with craft beer, it would approach around 8 percent of total market if craft were to hit 6 percent share.

BWI:
Given the current economic situation, do you dare make a forecast for U.S. beer consumption in 2009?

Sudano:
Total beer consumption we forecast to be down between 1.5 percent and 2.0 percent for 2009.

Questions: Ina Verstl

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