China's clampdown on prostitution in nightclubs and bars will hit cognac producers, analysts have warned, as Beijing continues its clean-up of the world's second-largest economy.
Bars and karaoke venues are often fronts for illicit activities like prostitution or other forms of illicit sexual activity in China. The crackdown on the so-called "yellow" sector, which follows on from measures to stop extravagant gift-giving and corruption amongst top Chinese officials, saw over 2,400 venues shut down in the six days following the start of the operation on February 10.
The luxury retail sector has been hit hard by the gift controls, and now analysts are worried that luxury cognac producers could take a hit from the prostitution clampdown.
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"There are high-end outlets and they tend to offer high-end liquor and people going are in the mood to treat themselves," Trevor Stirling, European beverage analyst at Sanford Bernstein, who released research on this topic on Monday, told CNBC in a phone interview.
While the effect could be short-term -- venues may find a way to reopen -- the damage done to consumer confidence in visiting the venues that may be suspected of illicit activities is likely to linger, Stirling added.
"People are going to be cautious about going to these bars because they don't want to be caught in a police raid."
Vodka at risk?
LVMH's Hennessey, Pernod Ricard's Martell and Rémy Cointreau's Rémy Martin, have 94 percent of the market share in terms of volume in China, according to data from Euromonitor. Rémy Cointreau has the highest exposure to China with an estimated 50 percent of profits in the country coming from its ultra-premium Cognac Louis XIII alone, Stirling said in a note.
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LVMH told CNBC it would not comment as it is releasing financial results this week. Pernod Ricard and Rémy Cointreau did not reply to a request for comment.
While anti-extravagance measures are likely to weigh on cognac makers this year, they are likely to recover in 2015, analysts said. However, the knock-on effect could be felt within other alcoholic beverages.
"This latest series of measures will start impacting categories less related to higher ends of bureaucracy in China but more with aspiring middle classes," Spiros Malandrakis, senior alcoholic drinks analyst, at Euromonitor said in a phone interview.
"We will not see massive declines but a slowdown in previous growth rates in a number of categories like vodka."
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Light at end of tunnel?
The continued crackdown on corruption in China comes as economists worry about the potential for the world's second-largest economy to hit the 7.5 percent growth rate touted by the government. Fears of a China slowdown have concerned some luxury brands, while others have appeared confident of strong growth.
While the prostitution crackdown is likely to end soon, Winston Chesterfield, associate director at Ledbury Research, said the heyday of "uber" spirits is waning and brands will have to focus on the burgeoning middle class.
"There will be permanent collateral damage to some of these brands because they won't have the size of sales they had before in places like strip clubs and brothels," Chesterfield said in a phone interview.
"Brands now have to hit the middle class in China and need to understand where they will buy their cognac from and how to target that. There is an evolution here but it is much further down the line."