The Good, the Bad, and the Inventory

By Jon Moramarco, Managing Partner, bw166

First published in The Total Beverage Alcohol Overview, February 2024.

Jon is a renowned industry analyst and managing partner of bw166, a market research firm that recently launched the U.S. Wine Industry Partnership with BMO. The partnership has joined together to report on the state of the U.S. wine industry to help wine businesses understand factors shaping the outlook for the industry. Set for release in the spring, the special survey and report will stand alone as a thorough examination of the modern and dynamic B2B U.S. wine market, which is the largest and most competitive wine market in the world. Read here for more details.

Recently, the Bureau of Economic Analysis released their fourth quarter estimate, reporting GDP growth of +3.3% - demonstrating the good news that the U.S. economy is still expanding. And, importantly, highlighting that a key component of the increase was consumer spending.

Consumer spending in calendar year 2023 for off-premise beverage alcohol was $225 Billion (+3.7%), while on-premise beverage alcohol reached $162 Billion (+11.3%) (note: neither of these amounts is adjusted for inflation, which was significant, especially in the on-premise). This is very good news that consumers continue to increase their spending on beverage alcohol.

On the downside, total servings of beverage alcohol entering the market were down -4.6%. BW166 has tracked servings of Beverage Alcohol entering the market monthly on a rolling twelve-month basis back to 2003 and annually back to the repeal of prohibition. The calculation of average servings is as follows:

Beer & Cider – 12 ounces.
Wine – 5 ounces, Wine Coolers – 12 ounces.
Spirits – 1.5 ounces, Cordials – 3 ounces, RTDs – 6 ounces.

This is not a perfect science, especially with ready-to-drink beverages (RTDs), but it gives a directional indication of overall trends normalizing for beverage type. Putting the 2023 decline in perspective, between 1996 and 2019, the number of serving grew annually at a rate of 1.21%. The Legal Drinking Age (LDA) population grew annually at a rate of 1.20%. This means that per capita consumption has been flat during this period. Looking further back historically to prohibition, there have rarely been material differences in servings and LDA growth. The last significant change was a decline in servings of -3.9% in 1991 when a significant federal excise tax increase occurred.

To look at inventories, one measure of calculating potential inventory build is to look at growth in servings versus LDA growth. Between 2019 and 2023, the average annual LDA growth was +.93%. The change in servings was:

2020: +1.20%
2021: +3.06%
2022: +1.22%
2023: -4.61%

Assuming that per capita consumption has remained relatively stable, these numbers indicate a buildup of inventories at wholesale, retail, or within consumer pantries through 2022, with some correction in 2023.

Another metric that indicates an inventory buildup at the wholesale level is the U.S. Census monthly survey of Beer, Wine, and Spirits wholesalers. From 2000 to 2019, wholesale inventory has been roughly 10.5% of trailing twelve-month sales. Some recent metrics:

December 2019:

LTM revenues - $158.8 Billion
Inventory - $17.1 Billion
Inv % of LTM Sales – 10.8%
Estimated days Inv (20% GP Margin) – 49 Days

November 2023
LTM revenues - $187.0 Billion
Inventory - $24.6 Billion
Inv % of LTM Sales – 13.2%
Estimated days Inv (20% GP Margin) – 60 Days

November 2023 :
- LTM revenues - $187.0 Billion
- Inventory - $24.6 Billion
- Inv % of LTM Sales – 13.2%
- Estimated days Inv (20% GP Margin) – 60 Days

The data shows distributor inventories have grown significantly. Historically, the typical reaction of wholesalers would be to reduce inventories to a par level of 45 days; however, several factors need to be considered:

Pandemic supply chain disruptions
- Whether ocean freight or domestic freight, there were significant increases to inventory given the uncertainty of supply.
- With stay-at-home orders, consumers were not spending on travel and out-of-home dining. These savings, coupled with government programs, increased consumers' spending on goods for home consumption. Examples are more premium spirits purchases for amateur home mixologists or increased spending from Wine Clubs. Some of this was consumed, but volume remains in consumers’ homes.
- Factors such as these have created difficulties with traditional demand planning tools, so it is likely both wholesalers and retailers had an elevated assumption of future sales of higher-priced items. This results in higher inventories at wholesale and retail stores, especially of higher-priced items.
Inflation and interest rates
- From December 2020 to December 2023, food and beverage costs for at-home consumption are up +19.1%. Average hourly wages are only up +14.1%. Consumers are feeling squeezed as inflation has exceeded compensation growth. One reaction to this has likely been the destocking of consumers' pantries of beverage alcohol built up during the pandemic.
- The higher interest rates are driving wholesalers and retailers to reduce inventories as well. This is more difficult with higher-priced items that were ordered when the demand signals were higher than reality.
- The higher interest rates are driving wholesalers and retailers to reduce inventories as well. This is more difficult with higher-priced items that were ordered when the demand signals were higher than reality.
- One estimate of how higher interest costs impact wholesalers follows:
  - 2019
    Assume 30-day terms from suppliers and a 3% annual interest cost. The yearly interest cost for inventory was about $199 million.
    Since wholesale is a low-margin business, assuming a 3% operating profit margin, wholesalers were making $4.8 billion operating profit. Carrying cost on inventory was 4.1% of operating profit.
  - 2023
    Assume 30-day terms from suppliers and an 8% annual interest cost. The yearly interest cost for inventory is now about $984 million.
    Since wholesale is a low-margin business, assuming a 3% operating profit margin, wholesalers were making $5.6 billion operating profit. Carrying cost on inventory is now 17.6% of operating profit.

The inventory problems have not been fully corrected, and we will see continued adjustments to inventory in 2024. Assuming a return to the norm on a per LDA consumption basis, we see the upcoming trends to be:

We assume wholesalers will try to get inventories down to 30 days on average to reduce their carrying costs significantly. Unfortunately, this may be significantly more high-priced inventory they cannot quickly sell and reducing other supplier inventory to 15 days. This will lead to out-of-stocks and lost depletions for some suppliers.
Since servings shipped into the market were well below estimated consumption, we should see about a 1% increase in shipments in 2024. It’s impossible to project exactly how this splits between Beer, Wine, and Spirits, but all parties will be fighting for a share of the market.
The 1% growth in 2024 versus 2023 will decrease inventories, and shipments into the market should be back to 2019 levels in total shipments.
In 2025, after inventories have been stabilized, shipments into the market could rebound in the 3% to 4% range. This is simply the effect of normalizing shipments and consumption.
In 2026, shipments of servings into the market would revert to an increase of 1%, in line with LDA population growth.

The inventory issues are unusual in the history of the beverage alcohol industry in the U.S. It should also be noted that the servings entering the market do not take into account potential shifts in "baby boomer” consumption as they age, the apparent differences in perception of beverage alcohol by Gen Z versus older generations, or the negative pressure on beverage alcohol by the WHO or other government entities.

At this point, from a supplier perspective, there is another year of challenges ahead in 2024. One thought to address the challenges is to increase terms for domestic supply to 60 days if a wholesaler agrees to maintain stocks of 45 days for the extended terms. This might reduce the risk of out-of-stock and lost depletions, but the bankers and CFOs may not like it.