Big liquor's nasty emerging market hangover
Margaritas made with 100 percent blue agave tequila have been shaken and stirred for the first time in Sanlitun, Beijing's popular nightlife district.
Previously banned because of their methonal content, the first shipment of this top-shelf tequila arrived on Chinese shores in early October. Mexican authorities are hoping this new access, made possible by an agreement reached in June, will turn China into the second-largest tequila market globally, after the U.S.
While it may seem strange to enjoy a tequila sunrise on your way home from the Forbidden City, this story—an upscale Western spirit taking an emerging market by storm—has become the norm, with the success of cognac in China, scotch in India, and scotch and vodka in Brazil serving as models.
The thirst for Western luxury goods, including spirits, from the emerging world's middle class, has allowed brands like Rémy Martin, Chivas Regal, and Smirnoff to flourish in these markets.
"In only five years (2005 to 2010), almost 40 million [Brazilians] rose to the middle class, changing their relationship with our brands and ways of consumption," said Bob Kunze-Concewitz, CEO Gruppo Campari, whose Skyy vodka and Campari brands do well in the region.
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"International brands have clearly been collateral damage."
Now, all that drinking in the developing world has led to a nasty hangover. The weakened economies of the emerging markets—many of which experienced steep currency declines this year—did not spare the premium liquor brands. The slowing economies in China, India and Brazil have put a damper on imported spirits consumption, especially at the top end.
Cognac consumption took a nosedive in China, falling 12.2 percent through the first seven months of 2013, according to the Bureau National Interprofessionel du Cognac (BNIC). Scotch has also fallen on hard times, with consumption declining 21 percent in China and 11 percent in India during the first six months of 2013, according to the Scotch Whisky Association.
Phil Carroll, an analyst at Shore Capital, said that some big liquor distributors, Pernod for example, were hit hard in emerging markets, and some top-end scotch and cognac brands have been struggling in China.
China does loom largest for the liquor makers in the slowdown.
Chris Wickham, an analyst at Oriel Securities, said that not long ago China was viewed as the promised land for luxury spirits. Now it is the greatest liability within the BRICs. It's not only the macroeconomic environment, but Chinese President Xi Jinping's anti-extravagance campaign that has dealt a big blow to Western spirits consumption. Upscale cognac and scotch, as well as the local tipple baijiu, are at the center of the gift-giving and banqueting that the crackdown has been designed to curb.
"International brands have clearly been collateral damage," said Laetitia Delaye, an analyst at Kepler Cheuvreux. "Premium international brands, in particular cognac, but also scotch. One-third of the market has been strongly impacted, with some segments down 50 percent."
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It's been a stiff drink to swallow, given the former, and quick, success for the global liquor brands. By 2012, Martell Cognac sold over a million cases annually in China, the first imported spirit brand to do so. In fact, cognac consumption in the region grew by 8.9 percent that calendar year, making it the third-largest market for the spirit, according to the BNIC.
Scotch was also thriving in emerging markets in 2012, with sales growing 17 percent in India, and 8 percent in China, according to the Scotch Whisky Association. Chivas Regal Royal Salute was a big winner in China, Ballantine's in Brazil and Glenlivet in India.
Never drink again?
The larger trend line gives the liquor companies confidence to believe that consumers in emerging markets will drink again once this hangover wears off. "Putting a lid on it [extravagant consumption] can have an effect in the near term," Wickham said, but added, the "aspiration in the long term is to consume luxury items, imports like Martell, Ballantine's, Rémy Martin."
"There may be bumps in the road, but we believe that the market dynamics are positive, and we are investing for growth," said Andrew Morgan, president, new businesses at Diageo, whose Johnnie Walker, Smirnoff and other brands have done particularly well in emerging markets.
Diageo reported that emerging markets accounted for 80 percent of the total net sales growth of Johnnie Walker in the 2013 fiscal year ended July (overall net sales growth was 10 percent); net sales of its super and ultra premium scotch brands grew by 59 percent in China; and sales of Diageo's super and ultra premium brands in Greater China grew 44 percent, driven by Johnnie Walker and Windsor.
"Emerging markets are inherently volatile," said Shore Capital's Carroll. "These short-term problems are not going to change the long-term plans of these companies. It's about riding out the storm. ... Ultimately, the demand is there."
Morgan said the number of high-net-worth individuals in these markets is set to grow by 400 million people in the next decade and the number of emerging middle class consumers by nearly 1.3 billion, providing an ideal audience for global and premiumized local brands.
"They want to signal their newfound status and personal progress with international brands," he said.
By the end of the 2016 fiscal year, Diageo expects its current 42 percent in emerging market sales to rise to half of its global net sales.
—By Mary E. Keefe, special to CNBC.com
Correction: This story has been updated to correct a misstatement by one of the story's sources.