Why the sugar tax is a sweet deal for Tate & Lyle, Pure Circle and Whitbread

In the recent UK budget, Chancellor George Osborne set out plans to introduce a tax on companies producing and importing sugar-sweetened drinks, in a concerted effort to reduce childhood obesity. It will be levied in two bands − one on drinks containing 5 grams of sugar per 100 millilitres, with a higher rate for those with more than 8 grams. At the higher tax level, this will amount to an extra 24p per one litre of soft drink.

The tax will take effect in 2018 and is targeted to raise £520 million ($733m, €656m), which will be used to fund a programme of after-school sports for the UK's children.

Something needed to be done

One fact is clear: obesity is already a fast-growing health epidemic in the UK. Obesity and related illnesses, such as type 2 diabetes and heart disease, today cost the National Health Service (NHS) over £5 billion per year.

What is worse, the UK has the highest rate of obesity of any major European country, at almost 25% of the adult population as of the last comparable figures back in 2013 (Chart 1).

The UK is not the first country to tax unhealthy food and drink

Other European countries have already imposed taxes on unhealthy food and drink. Finland put extra taxes on sweets, chocolate and ice cream back in 2011. France introduced a tax on all soft drinks with added sugar or artificial sweeteners in 2012, with an added tax on energy drinks added a year later.

In the US, the states of New York and California both introduced taxes on sugary drinks in 2014.

A sugar tax worked in Mexico

We can even examine whether the type of soda tax that Chancellor Osborne is going to impose in the UK has actually worked elsewhere. Mexico is the world's largest consumer per person of Coca-Cola, with the average Mexican drinking 728 small cans of Coke per year, far higher than in any other country (Chart 2).

The Mexican government had felt the need to act given the massive incidence of deaths from obesity-related diseases in Mexico, over three times greater than even in the US and 13 times greater than in the UK (Chart 3)

Mexico responded to this growing obesity epidemic by introducing a one peso (4p) tax per soft drink can in January 2014, increasing the price of these drinks by about 10%.

The result? By December of that year, soft drink purchases had already fallen by 12%. There seems to have been at least a partial switch to bottled water, with demand there growing by 4% over the same period.

Soft drink consumption is already in decline in the US

Believe it or not, according to market research firm IBISWorld, per-capita soft drink consumption in the US has fallen sharply since 2005, with coffee taking a bigger share of non-alcoholic drinks revenues over the past 10 years (Chart 4).

In fact, while US soft drink consumption has declined by 40% over the last 10 years, coffee consumption has risen by 50%.

Remember: the objective is not just to raise tax, more to make children healthier

In a way, the success of this soft drinks tax will not be judged by how much money the UK government receives in its coffers, but rather whether or not it achieves a reversal of the worrying rise in childhood obesity via a change in drinking habits combined with higher levels of exercise.

The fact that this tax is not to be applied until 2018 gives soft drinks companies plenty of time to change the formulation of their drinks. The likes of Coca-Cola, Pepsi and Britvic have time to introduce healthier variants of their most popular soft drinks, replacing sugar partially or fully with such naturally-derived sweeteners, such as Stevia.

Note how UK soft drinks maker Britvic, owner of such iconic soft drinks brands such as Robinsons, Tango, J2O and Fruit Shoot, saw only the smallest of share price reactions post-budget (Chart 5).

Firstly, they are already well-positioned to benefit from any move away from sugary soft drinks like Coca-Cola to lower-sugar, flavoured water alternatives with their Fruit Shoot and J2O brands.

Secondly, all soft drinks companies including Britvic are busily developing new, alternative formulations of their most popular soft drinks which will not be subject to this new sugary drinks tax.

And thirdly, soft drinks companies, like Britvic, Coca-Cola and Pepsi-Cola, may well launch a legal appeal against the application of this new tax, arguing that it unfairly discriminates against soft drinks, while not giving the same treatment to producers of fruit juices and milkshakes, which can also be very high in sugar content. So this tax may never even see the light of day.

What to do: Tate & Lyle might surprisingly be a winner

Which companies can benefit from the move away from sugar and soft drinks and foods towards no-calorie sweeteners like Splenda, which is based on the artificial sweetener sucralose, and Stevia, which is derived from the naturally-occurring stevia plant?

1. Tate & Lyle (UK code: TATE) are the exclusive producers of the Splenda artificial sweetener in the UK. Splenda is increasingly being adopted by soft drinks manufacturers in their low/no-calorie soft drinks as the sweetener of preference, instead of aspartame and saccharine.
2. Pure Circle (UK code: PURE) is a UK-listed company based in Malaysia that produces sweeteners based on Stevia.

But the real long-term winners could be those companies that are producing bottled water and flavoured waters, including the likes of soft drinks makers Britvic and Pepsi.

Another long-term winner from the shift away from sugary soft drinks towards coffee (as in the US) could also be Whitbread (code: WTB), owners of the ubiquitous coffee chain Costa Coffee.