As we well know, the Chinese penchant for cognac (and particularly old cognacs) has been driving the industry for some years now. But the current crackdown by the Chinese government on all things extravagant is proving to have a major effect on the current ‘golden age of cognac.
Remy Cointreau, the parent company of Rémy Martin, reported an approximate 35-40 per cent operating profit decline for the 12 months to March 2014. This was much greater than anticipated, and largely due to the lower demand in China for cognac. And of course, this saw the stock price fall by as much as 6.6 per cent on April 17, the steepest fall since 26 November.
So what’s this crackdown all about then? And why is it having such a dramatic effect on the cognac industry?
Crackdown by Chinese government
Well, the Chinese government commenced a major drive on reducing prostitution, drugs and betting in February of this year. This has led to many karaoke and hostess bars in over 30 cities, including Beijing, being shut down. And it’s these venues that see cognac companies making an extremely large proportion of their profits in China.
The reason for this is because high-end cognacs and spirits are enjoyed by the rich businessmen who frequent these venues. And when you realize that so far more than 2,400 such establishments have already been closed, it’s easy to see why it’s having such a huge impact. An enormous 30 per cent of total cognac sales in China are bought by such venues. Sales in this proportion of the market are referred to in the industry as the ‘yellow’ sector. And Chinese President Xiu Jinping’s government is planning to ramp up this campaign even further over the coming months.
“Structural change in the market”
According to drinks analysts, Trevor Stirling and Nicole Thaine, “This latest clampdown is significant for the cognac sector because… it started in southern China where cognac consumption is highest… and it is focused on private consumption and business entertainment, which is much more orientated towards western-style spirits and especially high-end cognac… This is the most profitable channel for the cognac houses in China.”
According to Jonathon Fyfe, an analyst at Mirabaud Securities LLP, these “Recent events in China are not a blip, but instead mark a structural change in the market.”
Total sales to China were more than 27 million litres in 2012. This was over double the amount from 2007, and far exceeded the whisky sales of 21 million litres. And it’s the big players who rely on this income, with 95 per cent of this market being dominated by Remy Cointreau (Rémy Martin Cognac), Pernod Ricard (Martell Cognac) and LMVH (Hennessy Cognac).
Remy Cointreau say they anticipate a “significant double digit decline” in their profits for the 12 months through to March 2014. The full year earnings will be reported in June 5.
So what about Martell and Hennessy? Pernod Ricard, the parent company of Martell Cognac, say that around 20 per cent of their total Chinese sales are to the ‘yellow’ sector. They too have reported that their sales via this channel are also in double digit decline. A Pernod spokesman, speaking to the Financial Times, said, “We’re in the process of expanding our activities with new offerings and geographic footprints. We remain confident in the long term growth of consumption as the population of middle class and affluent consumers continues to grow in China and as urbanization continues.
The company already has strategic plans in place to target different markets. This includes the female market in China.
We’ve yet to hear what Hennessy (LMVH) have to say on the subject. But obviously the crackdown will be having the same effect on their sales as it is on the other large cognac houses.
Slump in cognac sales?
So is this the start of a slump in cognac sales? Can we expect the golden age of cognac to be coming to and end? Well, no-one can deny the effects this crackdown has had on a highly significant area of cognac sales. However, both the population and wealth in China continues to grow on a massive basis. And whilst the extravagance of buying and giving bottles of cognac for thousands of dollars may be over, this doesn’t mean market growth will necessarily suffer. High quality cognac is, and is likely to remain to be, seen as a statement of wealth. And the culture in the country is not going to change because of this crackdown.
Luca Marotta, chief financial officer at Remy Cointreau, has said that future “market growth will not come from one product or another. It will come from demographic developments in China.”
It’s far too soon to estimate the full impact this will have on the cognac industry. Pernod Ricard has warned that sales to China could remain weak until 2015. One thing’s for sure, and that’s that the cognac industry is currently facing challenging times. It will be extremely interesting to see how the large (and smaller) houses react to this situation. And of course, we’ll keep you updated with any relevant news just as soon as it happens.
Sources: mobile.businessweek.com, bloomberg.com, cnbc.com, just-drinks.com, digitallook.com