Warren Buffett Loves Liquor

Liquor is a business that’s once again proving to be recession resistant.

— Roger Conrad, Canadian Edge

When Warren Buffet buys into a new line of business, I get very interested. McLane, a wholly-owned subsidiary of Buffett’s Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), announced on October 29th that it was acquiring Horizon Wine & Spirits, the largest wholesale distributor of alcohol in Tennessee.  This is just the latest expansion into the liquor distribution business, which started in March when McLane acquired Kahn Ventures, a wholesale distributor of wine and spirits in Georgia and North Carolina. Back then, Mr. Buffett stated that he was very excited about:

developing new opportunities to innovate, grow and lead the beverage industry. We expect that the acquisition will provide us with a solid platform for potentially acquiring other similar high quality wholesale distributors.

Warren Buffett’s Love Affair with Alcohol

McLane has also applied for liquor distribution licenses in Florida, Virginia, and Washington state. Buffett has always advocated investing in simple businesses that are easy to understand and liquor is about as easy as it gets. Simply put, people like to get trashed, especially in today’s environment when the economy is weak and unemployment is high. In Berkshire Hathaway’s latest shareholder letter (p.11), Buffett singled out McLane as one of the only Berkshire subsidiaries to thrive during the 2009 “Great Recession:”

Almost all of the many and widely-diverse operations in [the manufacturing, service, and retailing] sector suffered to one degree or another from 2009’s severe recession. The major exception was McLane, our distributor of groceries, confections and non-food items to thousands of retail outlets.

Furthermore, wholesale distributors of alcohol have a near-monopoly in many states, which provides them with a rock-solid competitive advantage. As one analyst puts it:

It’s the type of business he loves — an industry whose product is consumed by tens of millions and that has no chance of being displaced by technology. No matter how advanced Facebook or Google get, it’s hard to envision them being able to pour you a glass of wine anytime soon. Further, U.S. alcohol distribution laws give wholesalers a near monopoly of a popular product in the territories they serve, which is music to the Oracle of Omaha’s ears.

Demographics also are working in liquor’s favor, with wine constituting one of the largest spending categories for seniors at $124 per year. As the aging of America continues, alcohol sales will undoubtedly continue to increase in tandem.

Canadian Income Trust Specializes in Liquor

Unfortunately for investors, virtually all wholesale liquor distributors in the U.S. are privately-held, so it isn’t possible to follow Buffett’s lead. Up in the great white north of Canada, all liquor wholesalers are owned by the government, so no luck there, either.

However, there is an interesting investment opportunity in Canada’s liquor industry on the retail side: Liquor Stores Income Fund (Toronto: LIQ-UN.TO) (Other OTC: LQSIF.PK).  Roger Conrad, editor of Canadian Edge, rates the stock a “buy” up to $16. Liquor Stores is the largest private retailer of alcoholic beverages in Canada by number of stores, and its economies of scale permit it to provide a much larger selection of beverages than the industry average. 

Unfortunately, Canada’s government-owned wholesale distribution network does not permit volume discounts so large retailers like Liquor Stores pay the same wholesale prices for liquor that the smallest convenience store pays (i.e., gross margin is the same for everybody). Consequently, Liquor Stores can only exploit its size advantage through a superior customer experience, as well as by minimizing SG&A (sales, general, and administrative) expenses. As the company stated in its third-quarter SEDAR filing:

Management focuses on differentiating the Fund’s stores from the competition by promoting its broad selection of products, by emphasizing the in-store customer experience, and through marketing and brand development. Many of our stores offer customer education events and merchandise presentations.      

One of the company’s most recent “customer experience” initiatives is to keep its stores open until 2:00 AM. During the company’s Nov. 10th conference call, CEO Rick Crook said:

We are seeing some good results from those 2:00 a.m. stores and customers are saying, yeah, I want to shop at that time for, who knows, varying reasons.

I found this statement hilarious for some reason. Maybe it’s just me, but I’m a bit frightened by people who buy liquor at 2 AM.

Liquor Stores Income Fund is Growing

I admit that Liquor Stores “competitive advantage” is nowhere near as solid as a monopoly wholesale distribution network would be, but it’s better than nothing. And the company’s financial results speak for themselves. Look at its growth numbers between 2004 and 2009:

  • 39% compound annual growth in EBITDA (i.e., cash flow)
  • 35% compound annual sales growth
  • 36% compound annual store growth

Future growth will come primarily from acquisitions. Most of the Canadian liquor industry remains controlled by the government. Only the provinces of Alberta and British Columbia permit private liquor retailers. Consequently, most growth opportunities for the company will be in the U.S.

The company already has a U.S. foothold in Alaska (Brown Jug) and Kentucky (Liquor Barn). CEO Rick Crook told analysts during the company’s Nov. 10th conference call that the company only wants to partner with U.S. “market leaders” and provided assurances that it is “a conservative buyer and won’t overpay” for any acquisitions.

You Gotta Love Canadians!

As an aside, I love the friendliness of Canadians. My favorite part of the conference call was this interchange between one of the analysts and CEO Rick Crook:

Analyst: Hi. Good morning.

CEO Crook: Good morning. How are you?

Analyst: Not too bad. How are you?

CEO Crook: Good, thank you.

I challenge anyone to find a similar exchange during a U.S. conference call!

Canadian Income Trust Conversion Requires Dividend Cut

Like most Canadian income trusts, Liquor Stores is converting to a corporation in January and will be subject to a higher tax rate. Consequently, the company recently announced that it would be cutting its monthly dividend 33% to CAD$0.09 from CAD$0.135. Even with the cut, however, the company’s CAD$1.08 annual dividend will yield a substantial 7% at its current share price, a yield Roger says is “very competitive for any company in this sector anywhere in the world.”  Bottom line, Roger tells Canadian Edge subscribers that:

despite the dividend cut, Liquor Stores is still an attractive bet for modest growth and safe, high income.

I just wish the CEO’s last name wasn’t Crook.

Check Out Canadian Edge

Although Roger rates Liquor Stores Income Fund a buy, he doesn’t recommend it in either the conservative or aggressive Canadian Edge portfolios. Only Roger’s absolutely favorite Canadian stocks make it into these portfolios. To find out the names, consider giving Canadian Edge a try today.

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Malcolm Scott

I am looking for an investor/investors for a revolutionary drink ( alcopop ).

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