Diageo Earnings Review: Foreign Currency Headwinds Hit Upbeat Earnings
Diageo (NYSE:DEO) announced its interim results on Thursday, with good growth momentum across its business offset by foreign exchange rates and the impact of discarding of its assets. The liquor giant witnessed 1.8% organic net sales growth, with 1% organic volume growth. [1] However, the reported growth figures were underwhelming, minus 5% and minus 3%, respectively, with adverse exchange rate being the biggest driver for this decrease. Improved net sales growth in organic terms, despite the expected 2% decline in North American net sales, is a result of gaining share in key regions, such as Western Europe and emerging markets.
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Foreign Exchange Volatility Drags Down Sales
Despite an appreciation of the dollar against the pound in the last few months, the devaluation of nearly all emerging market currencies and of the euro continued to have a negative effect on the sales, estimated to be 5 percentage points of the growth. Foreign exchange also eroded the operating margin by 66 basis points. Disposals and acquisitions, in particular, the sale of Gleneagles and Bushmills, the jettisoning of non-core beer assets in Africa, Jamaica, and Malaysia, and the U.S. and U.K. wine operations, resulted in a $156 million (£109 million) drop in sales. [2]
Net sales trends improved in both developed and emerging markets; net sales in developed markets were flat, with growth in Europe and Australia neutralizing the decline in North America. In the latter region, organic net sales were pulled down by the massive 44% decline in Ciroc vodka. The company outperformed the declining North American rum category, with growth seen in both its big brands. Emerging markets reported a growth rate of 4%, despite volatile and difficult trading environment in countries like Russia, Brazil, Nigeria, and China. Strong double-digit growth was seen in Colombia, Mexico, and East Africa.
In terms of category, Scotch was up 1%, with 9% growth rates observed in Latin America and the Caribbean, and Johnnie Walker returning to growth in the North American region. The company faces challenges in this category from currency volatility, economic and political unrest in the Middle East, changing consumption trends in Korea, and a weaker economy in China. Ciroc, in the U.S., was the driver for the disappointing decline in the vodka sales. Chinese White Spirits continued its positive momentum with a 59% increase, albeit from a low base.
Positive Momentum To Continue In The Second Half
The company expects to see shipment growth in North America in the second half and top line performance in Europe to continue in line with the first half. However, a duty increase in Turkey may result in slower growth in that country. African trends are also likely to be maintained, with weakness in Nigeria and Angola to be offset by growth in other markets. Currency related weakness might dampen the Latin American and Caribbean earnings, while the performance in Asia Pacific is expected to improve, primarily due to stronger net sales growth of United Spirits in India. Given the above, an improved top line performance is anticipated; however, margins should remain flat. Productivity gains of $215 million (£150 million) per year, by year ending June 2019, announced in July 2015, will fund further investment in growth, with a guidance of 100 basis points improvement in the operating margin.
Key Financial Results:
- Organic net sales growth at 1.8%, with 1% organic volume growth, and 2.4% organic operating profit growth
- Adverse impact of exchange rate of 5 percentage points and disposal of non-core assets pushes net sales down by $156 million
- EPS increased by 5% and dividends up by 7%
- Organic operating margin improvement of 16 basis points
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