Description

We have two shorts that we think are timely, actionable, and have similar profiles - today we are posting the first. In summary, we believe both have dramatic downside (potentially zeroes), are liquid and have billions of dollars of market cap, yet are neither speculative story-stocks nor option-like equity stubs. Both have been beneficiaries of tight end-market dynamics that have made commodity/replacement-cost businesses appear to be competitively advantaged. Those supply/demand dynamics have already begun to unwind, creating timely opportunities. 

The first idea is short American whiskey prices (we have nothing against the product itself, but are quite bearish its value!). The cleanest and most attractive way to play it is short MGPI. The company reported today and declined 15%. While 15% down may seem like a questionable entry-point, we think just the opposite (particularly if the constructive sellside defends): having followed the space and the company for far too long (nearly a decade), we think this is the tip of the iceberg and the time is now. Given the timely nature, we are posting this somewhat short-form. For more background on the company, please refer to prior VIC write-ups (it has been written up long and short over the years). 

The critical insight is a massive (and growing) inventory of whiskey sitting in barrels. However, analysts and investors are mistakenly focused on the (slightly excess) inventory of bottles at the distributor and retail level, given this data is more readily available from traditional resources. As referenced further below, based on our analysis, we estimate:

• The U.S. currently has an extremely elevated ~11 years of whiskey in barrels versus a normalized/healthy level of just 5 years. 

• Despite these very elevated inventories, we are continuing to produce whiskey at a rate of over 2x demand, leading the 11 years to continue to trend higher. 

  • The ongoing excess production is a function of major capital projects (i.e. bringing on distillation capacity) in recent years and thus likely to be sticky. 

• Our work suggests prices for whiskey barrels have already begun to crack. 

In addition to MGPI, we also think short Brown Forman is a very attractive way to express the theme (albeit not as clean and clear-cut as MGPI). 

MGPI distills (i.e. manufactures) spirits. Its primary profit driver is as a wholesale provider of American whiskey barrels. It distills the whiskey, puts them in barrels, and then sells those barrels, effectively on a white-label basis, to other companies that bottle, brand, and sell the whiskey. The market for white-label/wholesale whiskey barrels is reasonably opaque, largely conducted directly or through brokers. In our view, the primary driver of MGPI’s value is the price of wholesale American whiskey barrels. We believe we have been coming off the top of a historic super-cycle for American whiskey barrels (which MGPI rode on the upswing) and are in the initial innings of the crash. Given the limited number of variables in assessing where we are in the cycle, we have a high degree of conviction in the ultimate outcome, and see very few “outs” for the company, or the industry, to escape what is to come. 

1. American whiskey has all the hallmarks of a hyper-cyclical commodity, arguably to a greater degree than any other commodity we can think of. Namely:

   1. Supply/demand bullwhip effect. A lengthy lag between: a) decisions to bring on incremental supply and b) when that supply is available for consumption. As a result, supply decisions react to dated demand signals, and supply overshoots dramatically to the upside and downside. In the case of whiskey, the time lag is due to both:

      1. The aging required in barrels.

         1. Straight bourbon whiskey must be aged a minimum of two years, and require an age statement if less than four years. 

      2. The capital investment in new distilleries, which take time to construct, and are also reticent to come offline (more on this below).

   2. Diversified supplier base.

   3. Easy, but time-consuming, to bring on new supply; friction taking supply offline.

   4. Opaque pricing.

   5. Lack of in-depth and/or readily available analysis by market participants. 

2. American whiskey is coming off an epic supercycle. Specifically, the pandemic caused an incremental supply supercycle to be superimposed on top of an existing supply supercycle. 

   1. Backdrop: We believe normalized whiskey inventories should be ~5 years of demand. This estimate is based on:

      1. The consistent level of inventories prior to the 2010s supercycle (it was actually 4 - 5 years of demand prior to 2013).

      2. What intuition, and our research, would suggest given how long American whiskeys have to be aged. 

   2. Supercycle 1:

      1. During the 2010s, American whiskey demand accelerated. Prices for whiskey barrels increased throughout the 2010s. 

      2. The supply response was resounding. Craft distilleries proliferated. More importantly, the larger players expanded existing distilleries and built new distilleries. 

      3. As in many upcycles, the “investor/speculator” class emerged. Funds emerged, largely predicated on previous price increases, and stimulating artificial (i.e. not for consumption) demand for whiskey barrels. 

      4. As a result, as of 2019, supply additions (i.e. production) and inventories both hit all-time highs. For 2019, we estimate:

         1. The U.S. produced (i.e. put in barrels) over 2x as much whiskey as it bottled (i.e. a proxy for current demand). On a normalized basis, this metric should be ~1x (for obvious reasons). 

         2. As of year-end 2019, inventories were at 8.71x demand. This is as high as we can find on record (by a margin). 

      5. Checks at the time suggest that pricing for whiskey barrels had begun to crack in 2019….

   3. Supercycle 2 (Supercyle on top of the Supercycle): COVID

      1. COVID led to pantry-stocking and accelerated whiskey demand at retail. This drove an artificial and unsustainable demand shock. 

      2. As might be expected (and as occurred in countless other industries), suppliers interpreted this as a sustainable demand response. As a result, they brought on more distillation capacity!

3. The dye has been cast, and the floor is coming out from under the industry. We are grossly oversupplied already, and supply continues to grossly outstrip demand. The numbers are mind-boggling.

   1. As of October 2023, we estimate the U.S. had inventory in barrels equal to 11.4 years of demand. 

   2. Our checks suggest that prices, which had been supported by a “greater-fool” bid, began to crack in the second half of last year. 

   3. However, critically, as a result of previous additions of distillation capacity, inventories continue to grow - at an accelerating rate!

   4. In October 2023, the ratio of supply additions to demand hit an all-time high of 2.63x. This number has been increasing. As a reminder:

      1. This number needs to be 1x for inventories just to stabilize. 

      2. Inventories are already ~6.5 years too high.

4. Replacement cost is a fraction of MGPI’s current enterprise value. 

   1. MGPI’s current EV is ~$2 billion (market cap of $1.7B + net debt of $270mm). 

   2. Its primary asset is a distillery in Indiana, which was acquired for $15mm in 2011. 

      1. This acquisition price alone points to the hypercyclicalty of the industry. 

      2. MGPI’s stock price appreciation from the low single-digits to the current high-$70s was a function of this upcycle. 

   3. The above is a simplistic picture: MGPI has put in incremental capital investments, has inventory value, and also has some other assets (namely the, in our view ill-timed acquisition of Luxco during the pandemic); however, it is directionally illustrative. 

   4. Triangulated differently, Tangible Book Value is ~$250mm (or ~11.50/share). 

   5. Given the dramatic state of oversupply, replacement cost may be a generous assessment of value.

5. The street and investors are missing the forest for the trees.

   1. Generally, investors seem focused on:

      1. How much excess inventories are at distributors and/or retailers. These are inventories of bottled spirits (i.e. finished goods). 

      2. What is post-COVID normalized demand.

   2. The above analyses miss the tsunami of whiskey that is aging is barrels. We believe a bourbon bath is likely to ensue. 

Some key charts below tell the story better than words. The two primary sources are based on government data: federal data from the TTB (Alcohol and Tobacco Tax and Trade Bureau) and Kentucky data from the KDA (Kentucky Distiller’s Association, only through year end 2022).  

Notably, the TTB stopped populating the data on their website several years ago. However, last year, they updated and backfilled the data - needless to say, we were blown away by what it revealed.

Note: all above references to years of inventory, production and bottling are our estimates based on analysis of the TTB data 

TTB Data: https://www.ttb.gov/distilled-spirits/statistics

Note: Graphs below are our estimates based on the TTB data.

KDA (Kentucky) Data (only through year-end 2022):

 https://kybourbon.com/wp-content/uploads/2024/02/Economic-and-Fiscal-Impacts-FINAL-2-6-24.pdf

Catalyst

Earnings misses & whiskey price declines.