The U.S. beverage sector faces a much different landscape in 2024. Topline growth for both alcoholic and nonalcoholic beverage (NAB) issuers was healthy in 2023, underpinned by strong pricing to offset local market inflation and foreign currency depreciation. Although volumes declined in response to the aggressive pricing actions (and to built-up distributor inventories at the start of the year in alcoholic beverages), most issuers in the sector were able to grow EBITDA and expand margins, albeit still below pre-pandemic levels, as input cost inflation abated and their product mix shifted to higher margin offerings (albeit they remain below historical averages). On-premise demand also saw healthy growth last year, which continued to benefit alcoholic beverage companies but hurt still under pressure at-home coffee consumption. Credit quality across our rated beverage universe improved last year, with upgrades (entirely consisting of alcoholic beverage issuers) outpacing downgrades by two to one. Within NAB, there were no rating changes and one outlook revision in the speculative-grade space to stable from negative.

Our Sector Outlook Is No Longer Positive

Our outlook on the sector has moved to stable from positive. Companies are largely operating within their financial policy targets and will need to invest in innovation to tailor their product mix to meet a more cautious consumer. They will also need to increase marketing and promotional spending to restore volume growth and defend market share. We expect sales growth will fall to more normal levels this year with more muted pricing actions, while volume and market share performance may be uneven across portfolios given the highly competitive environment in certain categories (such as beer and juice). and This will likely pressure more premium offerings given stretched consumer budgets, particularly at the lower end of the income spectrum. M&A will likely remain muted as companies look to integrate recent acquisitions of single brands in specific categories and consider additional bolt-on acquisitions to fill gaps in underrepresented categories.

Baseline modeling assumptions

• We expect revenue, on average, will increase in the low-single-digit area, which is well below recent growth rates. The lower growth rate reflects much lower pricing after significant price increases to offset input cost inflation and is primarily driven by a partial rebound in volumes closer to historical rates as ordering patterns normalize as well as by mix and new product introductions.
• Growth rates will vary depending on companies' product and channel mix. In NAB, those with a larger footprint in the energy, non-carbonated soft drink (CSD), and ready-to-drink categories should perform better. In alcoholic beverage, we believe growth will continue in certain premium beer imports, which should enable companies like Constellation brands to outperform the industry. Spirits companies will have a more muted rebound as consumers remain cautious and on-premise growth slows.
• EBITDA margins should remain flat to modesty higher over the next year, but below pre-pandemic levels. Companies' gross margins had largely rebounded in fiscal 2023 (and year to date for issuers with fiscal year end in the first half of calendar 2024) from lower input cost inflation, but higher marketing and promotional spending will partially offset future productivity gains.
• Free operating cash flow (FOCF) should rebound closer to historical levels with lower working capital requirements.
• Share repurchases and dividend increases will keep leverage from further declining for most issuers.
• M&A will be limited to small bolt-ons and other minority partner investments.

Table 1

Revenue & Mix

Volume growth will partially rebound once companies lap price hikes

In 2024, we expect volumes will return to growth but below trend after normalizing following the impacts of the pandemic and subsequent supply chain disruptions. We believe calendar-year 2023 sales performance was an anomaly because of the unprecedented pricing that took place and the impact supply chain constraints had on ordering patterns. This was particularly the case for alcoholic beverage companies whose distributors built up inventories during 2022 in response to a post pandemic in on-premise demand as pandemic-related restrictions eased in addition to building up a safety buffer of supplies in response to the supply chain constraints plaguing the broader economy.

Many spirits companies suffered high-single-digit volume declines in the first half of calendar 2023 because distributors needed to work inventories down.

Therefore, we believe a volume rebound in the first half of 2024 will be much higher than second half volume growth. However, full-year volume growth will remain only modestly up and likely still below the levels we would have seen if the industry continued to grow at its pre-2019 level over the past three years. This is because we believe consumers will be more cautious with their spending because of lower discretionary income.

Volume was somewhat flat globally for NAB issuers in 2023 given the cumulative effects of price hikes (Coke's volumes grew in the low-single digits and PepsiCo beverages and KDP volumes decreased by low-single digits). Sales also continued to shift to on-premise from off-premise sales. We expect modest volume growth in 2024 though anticipate on-premise slowing as lower income consumers visit away from home establishments less frequently due to budgetary considerations. Prior to the pandemic volume/mix growth for our rated issuers average just close to 3%. By comparison, we estimate 2023 volume declines for these issuers averaged closer to 2.5%. We believe volume should rebound to 1%-2% for NAB companies.

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Growth across issuers will vary based on product mix

Product mix continues to be an important driver of our sales growth assumptions for issuers in the beverage sector. Companies whose portfolios index to faster growing categories will have higher projected growth rates. Tables 2 and 3 below demonstrate the fastest growing categories across the beverage space, how our rated U.S. issuers are positioned in those categories based on their market share, and what our topline growth assumptions are for each respective issuer.

Table 2

Table 3

We believe NAB issuers will experience modestly higher volumes in 2024, though performance will be mixed across their portfolios with innovation, advertising, and packaging (including targeted price-pack architecture) being differentiating factors, particularly given expectations for limited pricing. For sparkling soft drinks, decisions around serving sizes, quantity, and price will be important to restart volume growth.

Chart 3

We assume energy drinks, which grew well above the NAB category overall not long ago, will see moderate sales growth as the subcategory matures. Sales of sports drinks will likely improve in 2024 as PepsiCo completes its transition of Gatorade to direct-store-delivery (DSD) for large U.S. store formats and expands its target customer to include hydration and active individuals generally (as opposed to primarily high performing athletes). We expect bottled water to see generally flat demand as value brands take more share from large premium brands, which are selectively reducing less profitable distribution points.

Still, certain underperforming NAB categories remain headwinds. We think juice sales, in particular orange, will decrease as customers' desire for the health benefits of vitamin C during the pandemic fades. It's possible the long-term secular sales decline will resume because of this on top of consumer aversion to drinks that are high in sugar. Lastly, a few tough crop years due to poor weather will likely sustain high orange juice prices at retail stores, while the citrus greening disease mainly affecting Florida could hurt the taste profile if not effectively managed through blending. Coffee sales are also under pressure as it continues to face a demand shift to away-from-home consumption from at-home, while also facing flat to down percentage decreasing volume growth prospects. This is partially because of a mix shift away from brewed coffee but also lost share to ready-to-drink (RTD) coffee offerings, which remains one of the fastest growing categories in NAB. As such, promotional activity will likely remain elevated for this category. This will keep growth muted to the 1%-2% rate, reflecting a shift to more at-home consumption.

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On-premise demand should slow

We believe away-from-home consumption will soften year over year in 2024, reflecting a combination of tight consumer budgets and less travel and entertainment demand. Depletion of excess savings, higher interest rates, and resuming student loan payments are headwinds to spending. According to the National Restaurant Association's January 2024 Restaurant Performance Index, restaurant operators have reported lower customer traffic over the past several months. Moreover, in recent months there has been an increase in the proportion of operators reporting lower same-store sales (albeit still below the proportion of operators reporting higher same-store sales, with the exception of January, when there was a large spike in operators reporting same-store sales declines mainly due to colder weather). Restaurant operators have mixed outlooks for sales and the direction of the overall economy over the next six months.

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Foodservice demand was robust in the second half of 2023, so we expect the impact of lower on-premise demand to accelerate into the second half 2024 as comps get tougher. This is particularly true for NAB. As restrictions were lifted after the height of the pandemic on-premise consumption far outpaced its historic growth rates. We believe on-premise alcoholic beverage consumption growth will slow in 2024 as travel, hospitality and entertainment activity declines.

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Customers' preferences for premium products will likely shift for alcoholic beverage companies

Nielsen's data shows alcoholic beverage volume growth is decelerating on a sequential basis, which we attribute primarily to pricing actions across the sector. Volume pressure coupled with our view that demand will shift back to off-premise, where consumers will be more cautious about what they buy, will likely lead to more trade-down risk. Therefore, we believe companies will face a mix shift away from premium offerings in 2024. This will keep average spirits company sales growth closer to 3%-4%, which is below historical average growth rates.

Margins Will Remain Mostly Flat

A lower margin product mix will likely offset better operating efficiencies and lower input costs

We expect a more favorable cost environment primarily because we assume input cost inflation will decline significantly after several years of outsized increases. We also assume ongoing productivity initiatives, which are built into most large issuers' annual cost structure plans, could be augmented by increased use of artificial intelligence, machine learning, and digitalization. Still, we still think logistics and labor costs will remain high. In addition, higher inputs for a mix shift to more premium offerings, upfront investments in automation and other operating efficiency initiatives, and lost volumes from strategic lower volume exits will partially offset productivity gains.

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Higher marketing and promotional spending will prevent margins from being restored to long-run historical averages

We don't expect margins will rebound to historical levels until well beyond 2024. Beverage companies continue to spend their productivity gains on marketing and promotion spending to maintain brand strength. Most companies are targeting a 4%-6% increase in marketing and promotional spending annually, which is above normalized inflation levels. This shouldn't be a major long-term headwind as companies should be able to leverage productivity gains once volumes fully rebound. However, with volume still recovering from inflation, we project EBITDA margins will only modestly rebound and remain below pre-pandemic levels.

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Better Cash Flows But Not Lower Leverage

FOCF conversion should improve with lower working capital requirements

The sector's historically good FOCF generation should revert to historical levels as companies lap higher working capital outflows when inventory levels were elevated, particularly for alcoholic beverage companies that built up inventories in response to supply chain constraints. All but one issuer in the sector has posted consecutive years of working capital outflows, which is not typical for this sector that ordinarily has muted annual working capital changes. We project those outflows will materially decline, by more than 50% in most cases, as companies reduce inventories and stabilize payable days outstanding. With stable capital expenditures as a percent of sales and lower projected working capital outflows, we forecast all but one issuer (Constellation Brands, which continues to invest heavily in its brewery expansion) will restore its FOCF to EBITDA above 40%.

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We expect higher shareholder returns for most issuers, which will limit additional deleveraging

Leverage has steadily declined from pandemic peaks for three quarters of U.S. investment-grade issuers as companies have prioritized debt reduction over higher shareholder returns to reduce leverage to their targets (see chart 13). We expect these issuers will increase shareholder returns rather than continued deleveraging. The recently announced annual dividend increases for our investment-grade issuers averaged more than 5% compared with closer to 3.5% in their respective fiscal years before the pandemic started in early 2020 (excluding issuers who had cut dividends to preserve cash flow).

In addition, these companies all have share repurchase authorizations that allow for significant shareholder increases. Therefore, we expect deleveraging will slow down and be limited to issuers whose leverage remains above their targets. This includes Anheuser-Busch InBev and Keurig Dr. Pepper (KDP), the latter of whose leverage remains well above its below 2x-2.5x debt to EBITDA target, largely because it incurred significant working capital outflows to reduce its use of supply chain financing and because recently issued debt to fund an accelerated share repurchase following a secondary offering of its shares by JAB Holdings Co. S.A.R.L.

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M&A Should Remain Muted

We believe companies will target smaller brands for acquisitions as several higher multiple transactions have underperformed expectations

Apart from the market share growth and portfolio diversification benefits from acquisitions of single-brand spirits in higher growing categories (which carry the highest EBITDA multiples for recent acquisitions in the sector), performance of high-multiple acquisitions (EBITDA multiples of more than 15x without synergies) have so far been lower than we expected. The most recent example of this is the Coca-Cola Co.'s $5.6 billion acquisition of BODYARMOR in late 2021. Coca-Cola struggled to integrate this better-for-you sports drink with its Powerade sports drink brand, resulting in share losses as it competes against PepsiCo-owned category leader Gatorade and upstart PRIME Hydration. The two Coca-Cola brands are now being managed by the same team, which launched new marketing campaigns and new flavors last year. We believe Coca-Cola's challenges in the category in part reflect slowing sports drink demand, and possibly difficulties integrating modest sized brands into a large distribution system still focused on sparkling beverages. A few years ago Coca-Cola exited many smaller brands that did not thrive under its ownership, including Odwalla and Honest Tea.

Similarly, after KDP successfully merged its legacy Dr. Pepper Snapple business with Keurig's coffee business, the growth outlook for single-serve coffee pods remains uncertain and KDP has clearly stated a preference for small partner transactions. Underperformance in its coffee segment is partially due to more away-from-home coffee consumption, which we believe will fall in 2024, but also because of higher growth in RTD coffee consumption. Therefore, we believe the higher leverage required to fund such larger acquisitions, coupled with uncertain success given the high degree competition for market share across categories, companies will prefer to focus on more narrow product categories for future M&A.

Table 4

Companies will likely focus more on executing on their recent acquisitions

Companies that have recently closed on acquisitions include Bacardi (which took majority ownership stakes in Teeling Irish Whiskey and Dusee in fiscal 2024), Brown -Forman (Gin Mare and Dipomatico in fiscal 2023), and KDP (minority stake in La Colombe coffee in 2023). A common theme is these transactions were not intended to be transformational, but rather targeted to expand into higher growth categories and leverage the company's existing distribution footprint for incremental sales synergies. Although integration risk of such targeted M&A is low because operations don't have to be combined and organizations restructured, it nonetheless requires sales and promotional resources to successfully execute, which takes at least a full year for such benefits to be realized. Therefore, we do not expect these companies to consider additional M&A next year. In addition, other companies have prioritized improving the organic performance of recently acquired brands that have underperformed and investing in manufacturing and distribution efficiencies over large M&A. This includes the Coca-Cola company with Body Armor and to a lesser degree Costa Coffee and PepsiCo with its North American bottling operations.

Further Rating Stability Ahead For Speculative-Grade Issuers

We expect demand in the sector, specifically for juice (Naked Juice LLC) and alcoholic beverage brewers (affiliated issuers Blue Ribbon LLC and City Brewing Co. Inc.), will be muted in 2024 as secular headwinds reemerge for orange juice and the hard seltzer category remains soft after explosive growth several years ago. Nevertheless, these issuers are demonstrating some traction in executing operational turnarounds, which should offset category volume weakness in 2024.

Naked Juice remedied meaningful supply chain disruptions and share losses when it separated from parent PepsiCo in 2022, however, has now fully restored fill rates and won back about half of its lost distribution. Triton Waters continues to perform well, with its mid-priced offerings resonating with consumers, however rating upside is unlikely given sponsor ownership.

On the alcoholic beverage side, cash flow and credit protection measures for Blue Ribbon LLC and City Brewing Co. LLC, both with low speculative-grade ratings, are still poor. However, City's efforts to attract new customers, expand into adjacent categories (energy drinks and ready to drink spirits), and stabilize previously stressed supply chains should limit downside risk. Blue Ribbon has also recently strengthened its credit profile with strategic price actions that have driven higher volumes of its core Pabst brand. Further, it alleviated near-term liquidity risk by successfully addressing a debt maturity and selling rights to the Pabst brand in China.

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