Canandaigua Morphs into a Downmarket Dynamo

The scrappy marketer proves that going blue collar is more profitable than serving the blue bloods.
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Canandaigua Brands (CBRNA) is the cocky contrarian everybody loves to hate. Known for its upscale beers and its downscale wines and spirits, the audacious marketer is cutting across the grain once more with its acquisition of a clutch of Canadian whiskies jettisoned by a flailing Diageo (DEO) - Get Report.

The payment of $185 million for a string of the liquor giant's castoffs (think

Black Velvet

, a $10-a-bottle concoction) may not be seen by the spirits world as the smartest of marketing moves. But the proof of Canandaigua's marketing prowess remains that its annual sales growth is at least double that of its larger and more staid brethren. If Canandaigua's strategy continues to be successful, it could expose some serious flaws in the conventional wisdom that drives wine and spirits companies today.

For Diageo's part, company spokesman Jack Shea said its brand divestitures were intended to "focus resources on core brands." That's a nice way of phrasing the ugly reality of the desperate need to shed excess brands acquired in the 1997 merger of

Guinness

and

Grand Met

that became Diageo.

The merger left the company with such an unwieldy

brand portfolio that the lesser marques were in danger of being forgotten. Shea said the sale would allow the company to concentrate its brand support and marketing efforts on brands with the highest profit margins, those with the greatest growth potential and those with international, as opposed to regional, markets. This is the high-road strategy that the other giants, such as

Seagram

(VO) - Get Report

and

Allied Domecq

, are emulating.

But growing liquor brands is a tough row to hoe in the spirits arena no matter which way you plow, because overall global sales are flat to declining. According to the

Adams Jobson Liquor Handbook

, spirits sales in the U.S. have dropped to around 138 million nine-liter cases in the 1996-98 time span, down from 148 million cases in 1992.

Globally, things are about the same: Diageo reported overall wine and spirits case sales were up only 1% in fiscal 1998 over 1997, while Seagram's case sales in the same period were off 1%. Allied Domecq won't reveal its sales growth: Its overall fiscal 1998 revenue was up barely 1% -- but that includes income from such food subsidiaries as

Burger King

. Of the majors, only

Brown-Forman

(BF.B)

was able to post any kind of growth: Total wines and spirits sales increased by just 3% in FY98 over the previous year. For all of these companies, liquor represents an overwhelming proportion of sales.

The companies try to put a good face on the issue by claiming that their more expensive brands have been growing at very healthy rates. By illustration, in the FY97-98 time periods, Seagram says

Captain Morgan Rum

jumped 40%; Allied Domecq noted a 20% growth in

Sauza

tequila; and Diageo, well, the best it could boast about was a 4% increase in

Smirnoff Vodka

-- a brand it is having to wage a

court battle to retain.

The implication most spirits marketers want to create is that even though overall sales are flat, the future is bright because people are shifting to more expensive brands and all spirits companies have to do to increase returns is to follow the market upscale.

But a micro look at the market leads elsewhere. First of all, the latest report from

Shanken Communications' Impact Databank

estimates that for the top 25 premium/super-premium brands -- defined as those selling for more than $10 per 750ml bottle -- growth was a mere 1.2% from 1997 to 1998. This is like the wine industry analysts who claim terrific growth for the premium varietals, while they ignore the fact that the under-$10 segment of wine (80+% of the market) is barely growing at all.

And just like wine, the market at the upper levels is highly fragmented with scores of players, each of which has just a percent or two of market share. Clearly, taking the high road is not the cure-all, and Canandaigua is the best example of this. For FY98 over '97, Canandaigua saw spirits volume and sales rise 5.8% and 8.9% respectively -- all this on downscale brands such as

Fleischmanns

and

Paul Masson Grande Amber

. So it makes sense for it to spend $185 million to pick up Diageo's castoffs.

To pay for the acquisition, Canandaigua is using part of a previously scheduled $200 million bond offering. The 8.5% senior subordinated notes are rated B+ by

S&P

and B1 by

Moody's

.

At $2.6 billion in 1998 sales (including the December 1998

Matthew Clark

acquisition), Canandaigua is a pipsqueak compared with most of its spirits competitors: Diageo did about $23 billion in 1998, Seagram $15 billion and Allied Domecq $7.5 billion. But if it can make its downscale, low-road strategy continue to work, it just may pave a blue-collar path that others will reject at their own expense.

Lewis Perdue is the editor and publisher of Wine Investment News, which covers the 22 publicly traded wine and liquor companies. While Perdue does not hold any positions in the companies discussed in this column, he is the chief technology officer (on a consulting basis) to the e-tailer Wine Society of the World, which may, from time to time, discuss purchasing or other agreements with wine companies. He can be reached at

lperdue@ideaworx.com.