Chief delivers ‘turnaround’ year and pledges to keep up momentum
There were cocktails, dance music and a party mood in London’s Soho yesterday. This was no club, but the central London offices of Diageo, the world’s largest distiller.
The maker of Johnnie Walker scotch and Guinness stout was celebrating its annual results, reporting a long-sought return to growth in North America – where it makes almost half of its operating profits.
Ivan Menezes, chief executive, has delivered the “turnaround” year promised to investors, who had been made tetchy by three years of slowing organic sales growth.
Organic operating profits of £2.9billion rose 3.5 per cent in the year to the end of June – a sharp improvement on the 0.7 per cent recorded in 2015 – after a strong second half in North America and higher demand in Europe.
Profit margins were 0.3 percentage points higher at 28.7 per cent, thanks in part to a £200 million cost-cutting plan.
“Diageo is stronger,” says Menezes, adding he is confident of higher growth next year. “We’re feeling good.”
Diageo’s lengthy hangover is dissipating – but has it fully lifted?
Since taking the helm almost exactly three years ago, Menezes has faced two big problems: a slowdown in emerging markets and dispiriting demand in North America, which reached its nadir last year when both sales and operating profits fell.
Diageo’s most important emerging market is India, the second-biggest region by sales after the US. Sales and profitability on its £1.8bn investment in United Spirits India have been held back by a tense relationship with Vijay Mallya, the mercurial entrepreneur.
But after a three-year battle, Diageo gained control of USL and in February reached a $75m settlement with Mallya, who stepped down from the chairmanship of USL.
The headache was “well worth it” says Menezes, citing the potential for growth in India’s market.
Jeremy Cunnington, alcoholic drinks analyst at Euromonitor, says: “Having finally integrated United Spirits into its operations and stabilised its volume share in India, now is the time to see if it can [emulate] the success of its rival, Pernod Ricard.”
Emerging markets’ sales growth of 3 per cent in 2016 was weaker than analysts’ expectations. It was dragged down by two of Diageo’s biggest markets – Nigeria, where sales fell 15 per cent, and Brazil, which posted a 9 per cent drop.
Menezes points to growth elsewhere – a 10 per cent rise in sales in Mexico and revenue growth of 28 per cent in Colombia. Certainly there is recovery for Johnnie Walker, for which emerging markets account for 70 per cent of revenues. Sales of the whisky rose 1 per cent in 2016, driven by demand for its premium-priced Blue, Gold and Green labels – after falling for two consecutive years.
One big change is a positive swing in exchange rates after several years of weaking emerging market currencies.
The steep fall in the pound after the UK vote to leave the EU has given Diageo a Brexit boost. Its shares have risen 19.5 per cent since the referendum, as sterling’s fall benefits UK-based companies with high dollar earnings.
The company says it expects the weak pound to benefit net sales by £1.1billon and operating profits by £370million in 2017.
In North America, Diageo has faced an uphill battle in appealing to millennial consumers, whose tastes have become frustratingly eclectic instead of brand-loyal. They have been well-served by a proliferation of craft gin and vodka labels that have helped erode Diageo’s market share.
And although whisky sales have been booming in North America, Diageo’s portfolio is under-represented in the most popular categories of Irish whiskey, bourbon and single malt scotch.
Sales of the group’s premium-priced Reserve brands rose 7 per cent – twice the rate of its biggest spirits, but Reserve only makes up 15 per cent of net sales.
Menezes’ strategy has been to try to react more quickly to consumer trends by making more frequent and smaller shipments of the latest flavoured vodka or spirit. Senior management in North America was also changed and sales staff given greater incentives. These initiatives appear to be working: Smirnoff and Captain Morgan swung back into growth in 2016.
James Edwardes Jones, analyst at RBC Capital Markets, says: “We can’t remember when we last saw this – organic sales grew in every category. Scotch was flat, but not down at least, suggesting that Diageo’s new marketing approach might be starting to pay off.”
Despite the improvement, sales in North America, which rose 3 per cent in 2016, are still not growing as fast as the market average, suggesting Diageo continues to lose market share.
Trevor Stirling, analyst at Bernstein says: “The state of the global economy that has put pressure on scotch sales has been outside Menezes’ control. But investors could hold him responsible for having a US portfolio that has not kept up with consumer tastes. Diageo has some stars, such as Bulleit [bourbon] – but not enough of them.”
Menezes disagrees. “We’ve got a broad portfolio which is well-positioned to perform in that market,” he says. “I do think we’ll do better than 3 per cent next year.”
Diageo’s challenge now is to keep up the momentum in the first half of 2017.
“This is a supertanker,” says Menezes. “It’s all about steady improvement.”
Source:FT
