Monday, January 23, 2017

Daddy, Where Does Alcohol Come From?

Alcohol, specifically ethanol, is the stuff we drink. Beer, wine, whiskey, vodka, tequila, schnapps, it doesn't matter. The alcohol itself is all the same.

But where does ethanol come from?

Yeast. Yeast make alcohol. How they do it is pretty amazing.

Yeast are micro-organisms, living things. Like all fungi, they have some plant characteristics and some animal characteristics. Yeast make alcohol through a biological process. Sugar, dissolved in water, is ingested by the yeast organism. The sugar is metabolized, generating energy for the organism's life processes such as reproduction. The waste product it discards consists of alcohols (primarily ethanol) and carbon dioxide.

This process is called fermentation.

Since yeast eat sugar, it is easier to make alcohol from sugar sources (fruit, honey, sugar cane juice) than from starch (grain, potato). Saccharification is the process of converting starch into sugar, thereby making it something yeast can eat. It is a prerequisite for making beer and whiskey.

Grains are seeds. To grow, new sprouts need sugar, just like yeast do. So at the beginning of the germination process the new sprout produces diastatic enzymes that convert the starch surrounding it into sugar. The process of sprouting grain to capture those enzymes is called malting. Any grain can be malted but barley is particularly good. The enzymes produced are so effective that a relatively small amount of malt (about 10%) will convert a mash of unmalted grains.

In Scotland, the law requires that only barley malt be used in the production of whisky. In the United States, enzymes derived from other sources may be used and sometimes are, but most whiskey makers use malt. Some use both.

Enzymes are proteins that promote chemical reactions. All chemical reactions within cells are controlled by enzymes, so enzymes are also involved in the biological process by which yeast make alcohol. You might think that modern science could just synthesize all of these different chemicals and make alcohol in some kind of machine. Maybe it can, but all of the alcohol we drink is still made the old-fashioned way, by feeding sugar to yeast.

All of these processes take place in water so before anything else can happen the starches have to be dissolved. First they are ground to the consistency of corn meal, then water is added. Most starches have to be cooked to fully dissolve. This is especially true of corn, the main ingredient in bourbon whiskey.

Some solids, mostly cellulose, remain undissolved. Most brewers and some distillers discard the solids. Bourbon makers typically do not and they continue through the distillation process. What is left after all of the alcohol has been removed can be used to feed livestock.

Finally, it should be disclosed that I am not a scientist, just a scribbler, but one with a strong interest in most things having to do with the production and consumption of ethanol. It is a subject about which there is great interest and also much misunderstanding. I hope this helps.

CLARIFICATION (1/24/17): In Scotland, the law requires that only barley malt be used in the production of whisky, for saccharification purposes, and for the production of malt whisky. Scotland also produces an enormous amount of grain whiskey for blending, using unmalted wheat, corn, barley, or any other available grain. The enzyme source for that whiskey also must be malted barley, but the rest of the mash can be and usually is unmalted grain.

Friday, January 13, 2017

MGP Is Not Doomed, Nor Is American Whiskey

A report was released today by Spruce Point Management that says investors considering a purchase of MGPI stock "should be cautioned not to extrapolate recent earnings performance. We believe there are numerous business risks and cracks in the growth story that are not being adequately discounted."

Some are interpreting this report as foretelling doom for MGP and, by extension, the presently booming American whiskey industry.

They are mistaken.

Spruce's guidance is that the facts don’t support MGP’s current share price, i.e., investor enthusiasm for the stock is overblown. That doesn’t mean MGP’s business model or, by extension, the American whiskey industry is on track to collapse. It doesn't mean MGP isn't managing its assets wisely. If a stock is overvalued, that doesn’t mean it is not a good investment, i.e., not a good company, it just means its stock is over-priced at the moment. The mistake, if there is one, is with the investors, not the investment.

That's what the market is for, adjusting that sort of thing. There is a level, i.e., a price, at which MGP is a great investment. The report's caution against extrapolation should apply as well to those using it to predict a looming disaster in the industry as a whole.

There have been other recent analyst reports that seem to worry about overcapacity in the American whiskey industry. It is true that the industry as a whole is much more optimistic and consequently much less cautious about investing in future production increases than it has been historically (in the modern era). That may mean that some stocks, such as MGP's, are overpriced at the moment. It doesn't necessarily mean the companies are wrong to expand capacity as much as they are.

One problem is that many people don't understand MGP. It has become the dominant player in the commodity whiskey segment, to the point where many believe they invented it. They didn't. That segment of the industry has always existed. Most of the major American whiskey distillers have supplied that market at one time or another, in one way or another, but always in a very low-key way. It's a small part of their business and they don't like to talk about it. Some of the major participants in that segment, such as Heaven Hill and Sazerac (Buffalo Trace), are private companies that aren't required to be as transparent about their business as are public companies such as Diageo, Brown-Forman, Pernod Ricard, and MGP.

As the majors, private and public, have seen demand for their branded products grow, they have had less capacity to devote to commodity production, which is always subordinate because it is less profitable. Some have gotten out of commodity and contract altogether but that is probably temporary. Commodity production may be less profitable, but it is more profitable than idle capacity.

This seems to be happening often in the whiskey world these days. A short-term, weather-related logging bottleneck gets blown up into a barrel shortage crises. Periodic out-of-stocks in a few fast-growing brands gets spun as a critical whiskey shortage. People predict that the growth of craft distilleries will kill the majors, when in fact the majors are growing faster than anyone and the production of every craft distillery in America doesn't match in a year what Jack Daniel's makes in a week. A few investments in crafts by majors suddenly spells the death of craft.

My caution to readers of this column would be that investors have to look at things somewhat differently than we whiskey enthusiasts do. At worst, all the analysts are saying to investors who have witnessed the industry's recent growth and want a piece of it is, "not so fast." There are reasons to suspect the return on your investment may be lower than you anticipate. You should do the math (or pay the experts to do it for you).

However, if your interest is simply in making sure there is an ample supply of high quality whiskey available at retail at reasonable prices, now and for years to come, you have nothing to worry about. In fact, things probably will only get better.

The trick for producers and, consequently, investors is to predict how much demand there will be for mature American whiskey in, say, the year 2022 (i.e., five years out). The factual basis for making such a prediction, especially for a worldwide market, is very thin. To a large extent it is a wild ass guess. But because of the whiskey aging cycle, those bets must be placed now.

I continue to stand by what I have said for years. If China and India develop as many have predicted, no one will have made enough. If they don’t, everyone will have made too much.

Tuesday, January 3, 2017

Beam Suntory Bungles Booker's Price Boost


What else can you call the Beam Suntory decision to raise the price of Booker's Bourbon by 100 percent and then, a few weeks later, to amend that to a mere 50 percent increase?

The previously announced production cut was not rescinded. Will it be? Who can say?

Only one thing could have forced Beam Suntory managers to backpedal on their original decision, heavy pushback from customers--not you and me but wholesale and retail customers. That should not have been a surprise. Capable managers don't announce such major, radical changes without first gauging the likely reaction of the distribution chain. To publicly make such a decision only to be forced to roll it back almost immediately is beyond embarrassing. It makes consumers, customers, and investors question the basic competence of the managers who are making, and un-making, those decisions.

The goal of the original plan was to push Booker's into the unicorn class, as exemplified by anything with 'Van Winkle' on its label, products that are so in demand and so allocated that retailers hold lotteries to choose the privileged few who get to buy one. Unicorns also drive an underground secondary market where bottles can fetch many times their suggested retail price.

Many doubted Beam could create a unicorn by fiat and they were right. Beam couldn't. What is striking is how quickly and strongly the answer arrived.

Some Booker's limited edition releases, such as the 25th anniversary bottling and more recently Booker's Rye, have enjoyed that kind of demand but regular Booker's never has. Booker's always has been released in batches but the decision a few years ago to give each batch a name and story, rather than just a batch number, was successful, as was the creation of the Booker's Roundtable, in which whiskey scribes (including yours truly) help select certain batches. Even so, stores rarely run out of Booker's and it is frequently on-deal. These facts made many question the wisdom of the original increase.

Instead of the intended image upgrade, Beam Suntory has made the brand look like a grasping wannabe, damaging rather than enhancing its status. Booker's is an excellent product with a proud legacy. Its stewards have failed it this time, big time.

Everybody makes mistakes and reversing course, as embarrassing as that can be, is better than stubbornly pushing forward, so Beam Suntory deserves some credit for that, but not very much.

Beam Suntory has had a great run. Thirty years ago it was a smallish subsidiary of a tobacco company and had only one major brand. Today it claims to be the world's third largest premium spirits company. The Booker's bungle won't sink the ship but it makes one wonder if the folks in charge over there in their new River North offices are really ready for prime time.