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Too much to drink

8 September 2008

(Conde Nast Portfolio.com)

A lot of dead cacti in Mexico are causing a headache for the maker of Southern Comfort and Jack Daniels.

The liquor company Brown-Forman said today that quarterly earnings fell 7.5 percent after the cost of dead or dying agave, the blue cactus-like plants that are the main raw material for tequila, erased $16 million of its profits. Its shares fell sharply as did that of a bigger giant in spirits, Diageo, which said that its earnings fell 8 percent in the second half.

Brown-Forman got its plants when it acquired Casa Herradura of Mexico, the maker of premium tequilas Herradura and El Jimador, for $876 million in 2006. As a result, the company has long-term contracts with growers of the agave.

“Most of these contracts require us to plant, maintain, and harvest the agave, plus compensate the owners based on specified percentages of the crop at the prevailing market price at the time of harvest,” the company said in regulatory filing.

About a quarter of its crop was unusable, and the company wrote down $22 million.

“The loss of agave plants has reduced our inventory, but we do not believe this will constrain our ability to build our tequila brands to their full potential,” said Paul Varga, Brown-Forman’s chief executive.

Aliza Rosenbaum on Breakingviews.com argues that this is a lesson for why distillers (and perhaps all food and drink producers) should choose to buy their primary ingredients rather than grow them. This is what Diageo does, for example.

“Granted, raw materials like grapes and barley remain subject to price fluctuations, but they [distillers] can avoid extra capital expenditures and focus on what they do best: producing and marketing,” she says.

An excellent point. Yet agave is a notoriously volatile crop. Remember the “tequila shortage” of 2000? No? Well, at the time there was widespread concern that not enough Mexican farmers were planting agave after a glut in the early 1990’s. That glut was quickly drunk off as consumption boomed even as Mexican production of tequila nearly doubled.

The agave takes eight years to mature, and bad weather, disease, and insects can do a lot of damage at that time. And now it faces another threat: ethanol, which is driving up prices for a rival crop, corn.

Many agave farmers are giving up agave and switching to growing corn, the Arizona Republic reported recently. White corn is selling for about 18 cents a pound in Mexico, while agave is selling for 2 cents a pound, the paper says.

To manage that kind of agricultural risk and price instabilitiy, it would seem to make sense for Brown-Forman to have some long-term control over a key commodity even with the danger of an occasional bad harvest.

by Jeffrey Cane

One Comment leave one →
  1. MaryOGrady permalink
    8 September 2008 10:07 am

    Just out of curiosity, what destroyed the agaves?

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