For Liquor Makers, Cheer Dries Up in China; Liquor Companies Reeling From a Gift Crackdown Likely Won’t See Relief Soon

For Liquor Makers, Cheer Dries Up in China
Liquor Companies Reeling From a Gift Crackdown Likely Won’t See Relief Soon
PETER EVANS
Jan. 22, 2014 11:20 a.m. ET
LONDON—More than a year after the Chinese government banned extravagant gift giving and scaled back state-funded banquets, liquor makers are starting to feel punch drunk.
The crackdown on conspicuous consumption—part of an anticorruption drive led by President Xi Jinping —has hit spirits companies harder than most. Profit warnings, executive departures and restructuring drives have all been linked to the ban.
One potential opportunity for a revival is the coming Lunar New Year celebration over two weeks starting Jan. 31, traditionally the busiest sales period of the year for drinks companies in China. But the omens for a shot of New Year’s cheer don’t look good.
“No significant recovery can be expected due to the Chinese New Year,” Rémy CointreauSA, RCO.FR +0.34% the maker of Rémy Martin cognac, said Tuesday.
China is the world’s biggest alcohol market, making up 38% of global spirits consumption, according to the International Wine & Spirit Research industry body. The country is especially important for cognac makers: Rémy Cointreau derives about 40% of its total profit from cognac sales in China, while sales of the French liquor account for 15% of Pernod Ricard
SARI.FR +0.37% ‘s earnings.
At first, it was Chinese companies—especially those making baijiu, a rice-based white spirit—whose sales plummeted, some by more than 50% last year. But now, international competitors such as Pernod and Rémy Cointreau of France and DiageoDGE.LN +0.45%
PLC of Britain also have started to feel the heat.
Rémy said sales of its flagship cognac fell 35% in the three months through December as the group sharply reduced its shipments to China and tried to run down inventories that have piled up since the crackdown on corruption began.
Rémy said late last year that it expected operating profit in fiscal 2014 to drop 20%. Former Chief Executive Frédéric Pflanz blamed the “situation in China” for the profit warning. He resigned this month citing personal reasons, although some analysts have speculated that poor performance led to his departure.
The Lunar New Year marks an extended period of celebration in many other Asian countries. In China, giving expensive liquor—especially cognac—to gain favor with officials is common throughout the festival.
In the run-up to last year’s celebration, the Chinese government banned soldiers from drinking liquor at official banquets and toned down the lavish parties thrown by state-owned companies. Television commercials for expensive luxury gifts also were banned.
Although official sales figures aren’t released, analysts said spirits sales in China were down during Lunar New Year 2013. This year, many expect sales to fall again.
“It is a critical watershed for the spirits companies in Asia,” said Trevor Stirling, an analyst at Sanford C. Bernstein & Co. A “nightmare scenario” could emerge for Western liquor makers—as it did in Japan during the so-called lost decade of the 1990s—with patterns of entertainment changing for good and consumers reverting to less-expensive local spirits, he said.
The effect of such a shift would be catastrophic for the world’s leading beverage companies, many of whom rely on China to drive growth as Western markets remain sluggish.
Evidence of a slowdown is mounting. Overall spirits volume in China is expected to rise an average of 16% a year through 2016, down from 21% growth between 2006 and 2011, according to data tracker Euromonitor International.
Some of the decline can be attributed to China’s slowing economic growth. The country’s economy expanded 7.7% in the fourth quarter from a year earlier, slower than the 7.8% posted in the third quarter. But executives said the government’s austerity drive is eating into sales.
Pernod Ricard, the world’s second-largest distiller, warned late last year that the situation in China would weigh on profit this year. Diageo, the biggest, said government policies in China led to a substantial decline in sales of its Shui Jing Fang brand of baijiu, which the company bought outright last year.
Warwick Every-Burns, interim chief executive of Australia’s Treasury Wine Estates Ltd.TWE.AU -1.83% , the world’s No. 2 listed winemaker, said austerity measures in China were sapping demand and making forecasting for 2014 uncertain.
“We are observing signs that consumer pull-through in China is softening,” Mr. Every-Burns said, speaking at his company’s annual meeting. Treasury Wine declined to comment on recent sales in China, citing a quiet period before it releases its results in February.
Still, the size of the Chinese market means drinks companies are exploring ways to beat the government’s crackdown on elaborate gift giving. Consulting firms working in China said they had requests from clients in the spirits industry to help reposition their high-end products to fit in with austerity.
“Brands want to move away from signs of being visibly expensive,” said Adam Xu, a Shanghai-based director at management consulting firm Booz & Co. “There is now more of a focus on success than luxury.”