Ditching China could be disastrous for Cognac

Losing interest in China at the first sign of trouble could prove disastrous for Cognac, Richard Woodard discovers

Poor Cognac sales have impacted crystal manufacturers, but all is far from being lost

It’s been a bad year for the crystal manufacturers. The Chinese thirst for luxury Cognac had previously spawned a never-ending succession of high-end Cognac launches: aged eaux-de-vie whose heritage and provenance demanded only the finest hand-blown bottles. A year on from the Chinese government’s crackdown on extravagance and corruption, reports in Cognac suggest the local market for elegant crystal decanters has halved.

The slump in Greater China dominates the 2013 shipment figures supplied by the Bureau National Interprofessionnel du Cognac (BNIC). Globally, the decline is manageable enough, with volumes falling 4% to 161.4m bottles and value edging up 0.2% to a record €2.4bn.

But the figures from the Far East are more eye-catching; the combined markets of Singapore, China and Hong Kong – which best represent the true picture in Greater China – are down more than 6m bottles to 52.2m, little higher in volume terms than a resilient US.

What makes the oriental downturn all the tougher for the Cognac houses, however, is the nature of business in Shanghai and Beijing. For many Cognac consumers here, VSOP is entry level, XO is a weekend treat and the likes of Richard Hennessy and Louis XIII affordable luxuries, which also serve as a means to oil the latest business deal.

If the slump in this business following the government crackdown was expected, its depth and its duration were not. Double-digit declines for major brands, especially Martell and Rémy Martin, have followed and are likely to continue well into 2014.

Hennessy too has taken a hit – XO down about 20% – but LVMH’s canny introduction of VS level Hennessy Classium has helped to soften the blow. Martell’s launch of copycat Martell Distinction late last year is a nod to Classium’s recent growth.

China sturdier than first thought?

With profits and revenues nosediving, you might expect executives in Cognac and Jarnac to be popping the Prozac to ward off the gloom, but while they’re not exactly jumping up and down with excitement, many are taking a philosophical view.

“I am not worried,” says Alexandre Gabriel, president of Cognac Ferrand. “We are comparing 2013 and a slight decrease of sales to a record previous year. It is a normal thing that you have periods of strong growth and periods of pause. It is a normal cycle and no reason for alarm.”

This insouciance is partly explained by the breadth of the Chinese opportunity, which in the long term is unlikely to be destroyed by a state crackdown on conspicuous consumption. Cognac Tiffon CEO Frédéric de Cazanove points out that Cognac sales remain concentrated in the south-east of China, while Tiffon’s volumes are confined to independent liquor stores – leaving it with future opportunities in other sectors.

Meanwhile, Martell’s Elisabeth Ricard highlights the increasing spending power of the middle classes, who are unaffected by the government action. Martell’s launch of Distinction – and the success of rival Hennessy Classium – are also evidence of this. Classium’s trend-bucking growth comes thanks in part to success in the “modern” on-trade – nightclubs in particular – and among a younger demographic. Distinction, meanwhile, has been blended to match seafood and the hotter cuisine of north and central China, targeting new regions and new consumption opportunities.

The Cognaçais should both look to opportunities afforded by emerging markets while retaining a focus on China

China opportunities still exist

This comes as no surprise to Hine MD François Le Grelle, who highlights the opportunities in the increasingly wealthy north and west of China, where consumers may have heard of Cognac, but aren’t necessarily rich enough to buy VSOP or XO on a regular basis. At a cheaper price, Cognac can even compete directly with local spirits, he says.

Le Grelle sees the boom of the past four or five years as a seeding period for Cognac in China, to be followed by a future where market consolidation, rather than breakneck growth, is the name of the game. “I think we took advantage of an opportunity to do some business and make some cash,” he says. “If this cash is used for the future, then nothing is wrong. If it’s considered as an immediate profit and nothing else, then some people could be in trouble.”

The worst thing, he believes, would be for brands to lose interest at the first sign of trouble. Far from that, the new Hine – the company was bought by French family concern EDV SAS last year – is keen to make some “prudent” investments in China while there is a lull. “It’s the best period to do so with more and more people afraid of the market,” Le Grelle argues. But Asia is far more than just China. Martell’s Ricard points to the brand’s recent growth in Malaysia, where it is market leader, and in Indonesia and Vietnam, both countries with huge potential.

South East Asian opportunity

“There are a lot of very promising new markets for Cognac,” agrees Philippe Jouhaud, sales and marketing director at Bacardi-owned Château de Cognac, owner of the Baron Otard and D’Ussé brands. “Of course, the Asian markets, despite the current situation in China with the anti-corruption campaign, remain very attractive, and markets like Vietnam are still markets to watch, but the appeal of the category has now expanded to other regions, and markets are emerging in Africa,” Jouhaud comments. “Countries such as Nigeria or South Africa are becoming very attractive markets, and there are a few other, smaller markets such as Angola, Ghana and others that are also to follow.”

Le Grelle agrees on Africa, but cautions that the markets are deceptively complex, contrasting former French and British colonies in terms of levels of category knowledge. Consumers in countries like Nigeria and Ghana, he says, “have a good understanding of what Cognac is”, but volumes are likely to remain small for some years to come. South Africa, he adds, remains in the shadow of Distell’s dominance of the local brandy sector (the company has also owned Bisquit Cognac for the past five years).

David Baker, managing director of Brandyclassics and Hermitage Cognacs, meanwhile argues the key to success in the Far East may lie in establishing more defined age statements for Cognac. “Much has been done of recent to provide new branding and presentations but we still seem to be offering the same VSOP and XO concepts that we have offered for the last quarter of a century,” he says. “Age statements, even in a general description, offer the customers with something more unique than the ubiquitous VSOP whose contents have generally deteriorated as demand has increased.”

Recovering volume by lowering Cognac prices could prove disastrous for the industry

Recovering lost allure

What of Latin America? Economic growth and an inherent love of brown spirits make the region potentially lucrative for the Cognaçais, but the category is a long way behind Scotch whisky and local success stories such as Buchanan’s and Passport. For Le Grelle, however, that’s not necessarily a problem. He acknowledges that Cognac can never compete with blended Scotch in volume terms but, given Hine’s premium positioning, is keener to draw parallels with brands like The Glenlivet and Glenfiddich. “For a product like Hine to have single malt it’s very helpful because it’s an opportunity for people to discover foreign spirits, aged in casks,” he says. “There is some comparison.”

And there is also the US, the heartland of global VS consumption and a friend to Cognac through good times and bad over the past couple of decades. Pernod Ricard recently launched Martell Caractère in California, aiming it squarely at the state’s Hispanic community. Given that Martell is already the leading Cognac brand south of the border in Mexico, Caractère could provide a bridgehead to repeat the Stateside success story in Mexico City and Guadalajara in the years to come.

The US now counts, alongside Western Europe, as an established and mature Cognac market. As the Asian boom eases in the near future, these sometimes neglected destinations will undoubtedly re-acquire a little of their lost allure.

They’ve always been a key feature of Bacardi’s Cognac business, with good recent performances by Baron Otard in Germany and Belgium combining with the US rollout of D’Ussé to leave the company less exposed to Asian fluctuations. “The traditional markets may feel less attractive to many Cognac producers, but they have been quite stable in the last years, allowing us to maintain a very stable and safe volume base,” says Jouhaud.

Courvoisier too has historically remained heavily focused on these countries, maintaining its position as market leader in the UK thanks to heavy investment in campaigns such as its current Here’s to Now initiative.

Good harvest needed to reduce prices

But any switch of focus to mature markets across the entire category carries risks as well as opportunities, reckons Chris Anderson, Maxxium UK marketing controller for Courvoisier. “The challenges posed by China have affected the overall Cognac category and, as a result, many companies are looking for other markets to utilise this surplus liquid,” he reports.

The temptation to panic and dump Cognac on mature markets at a loss could prove disastrous at a time when the open market for eaux-de-vie remains inflated by demand in Asia. Le Grelle reckons availability of certain crus – Grande Champagne of 5-6 years old being a prime example – is still extremely slim or of poor quality. It will take continuing declines in China and a good 2014 harvest to secure a fall in prices, he believes.

The key is for the Cognaçais to keep their nerve as the Asian markets mature and evolve. Jouhaud sums up his thoughts on what might be the greatest challenge for Cognac in 2014: “Overreacting to the current situation in China by discounting heavily in other parts of the world to compensate for business lost there,” he warns. ”Cognac is a category that has to be built in the long term, Cognac consumers are status-driven and it would be a mistake to panic and try to recover volume by lowering Cognac prices. It would be a short-term reaction that could affect the category in the long term.”

The downturn in China is bad news for the entire category, but some companies are more exposed than others to the vicissitudes of the market – as an analysis of the fortunes of the “big four” brands – Hennessy, Martell, Rémy Martin and Courvoisier – on the following pages illustrates.

Hennessy

Global volumes were down only 4% in the first three months of 2014, thanks to a 10% volume rise in the US, plus a 13%-plus value increase (thanks to a price rise in early 2014). In China, Hennessy sales fell 30% by volume, 27% by value. LVMH CFO Jean-Jacques Guiony told analysts that the impact on XO in particular was “probably a bit worse than expected”, with sales down about 20%. Much of this was caused by the government’s anti-extravagance measures, resulting in destocking by distributors (Guiony estimated in early April that they had 10-15 days of stocks).

The bright side? VSOP sales are slightly up and sales of VS expression Classium are strong, with the modern on-trade (e.g. nightclubs) offsetting declines in the

Chinese restaurant sector. Hennessy’s business in China remains skewed to higher-value expressions: 70% VSOP, 20-25% XO, 5-10% Classium (VS).

Martell

The brand’s sales in the six months to the end of December 2013 were down 8%, despite 9% sales growth in markets excluding China. IWSR estimates that China accounted for 60% of Martell’s global volumes in 2012, while owner Pernod Ricard points out that the market provides 75% of Martell’s global value. As well as pursuing growth in other markets, Pernod is also attempting to diversify in China, launching Martell Distinction in late 2013. A VS product priced at roughly €30, it’s designed to match seafood and the hotter cuisine of northern and central China.

Rémy Martin

Brand owner Rémy Cointreau issued another profit warning in mid-April, predicting a 35-40% slide in full-year profits which is largely due to the downturn in China. The company said its full-year sales to 31 March 2014 were down 13.5%, with Rémy Martin revenues falling 23% over the same period. It’s estimated that the brand generates at least half its profits from China, and Rémy Martin also accounts for some 75% of Rémy Cointreau’s total sales. The above pictured Centaure de Diamant was released as a core expression this summer by the house to select European markets, in what seems like a bid to recover falling revenues from China. At £800 it forms the pinnacle of Rémy’s portfolio in the UK, France, Belgium and Russia.

Courvoisier

Historically the weakest of the big four in the Chinese market, Beam-owned Courvoisier’s core business remains in Western Europe. This is reflected in a slight 2% sales decline for the brand in 2013 and, while Beam’s sales as a whole in the Asia Pacific/South America region were down 9%, the company blamed this on lower sales in Australia and challenging comparisons in India.