New Coverage On Diageo: Price Estimate At $119

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Diageo

Diageo (NYSE:DEO) is a multinational alcoholic beverages company comprising the world’s leading premium drinks business, with a wide range of well-known spirit, wine and beer  brands. Every year, the company produces more than 6.5 billion liters of its brands from more than 100 locations in 30 countries. The company is headquartered in London and is listed on the London Stock Exchange (LSE: DGE), as well as on the New York Stock Exchange. Diageo is recognized for its scotch, vodka and rum brands, and is the largest producer of spirits in the world. Some of its best selling brands include Johnnie Walker (the world’s #1 blended scotch whiskey), Smirnoff (the world’s best-selling vodka), Baileys (the world’s best-selling liqueur), and Guinness (the world’s #1 stout). Diageo is the world’s largest whiskey producer with 28 malt distilleries.

Diageo offers a wide variety of brands at different price tiers for each category. On the basis of quality and price, Diageo’s beverage offerings can be differentiated into:

  1. Ultra Premium Brands
  2. Super Premium Brands
  3. Premium Brands
  4. Standard Brands
  5. Value Brands

Diageo was formed as a result of a merger between the Grand Metropolitan Public Limited Company (GrandMet) and Guinness PLC (Guinness Group) in December 1997. Since then, the company has been consistently involved in various acquisition activities.  In 2011, Diageo acquired the Turkish liquor company, Mey Icki, for $2.1 billion and in 2012, it acquired Ypioca, Brazil’s largest selling brand of premium cachaca, for $300 million. In November 2012, the company acquired a 53.4% stake in the Indian company United Spirits for $1.28 billion. The company owns the Gleneagles Hotel and has a 34% stake in the Moet Hennesy drinks division of the French company LVMH.

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Diageo derives the majority of its value from its North America segment, which accounted for nearly one-third of the net revenues and 45% of the operating profit in 2013, primarily driven by a 5% growth in the U.S. spirits sub-segment and growing demand of beer in Canada, partially offset by weaker volumes, especially in the price sensitive vodka segment. In terms of volumes, North America is the largest geographical segment for Diageo, constituting 32.5% of the net volumes in 2013, followed by Africa and Eastern Europe constituting 23%. With a majority 55% stake in UB Group’s United Spirits, Diageo accounts for 9% of the global spirits volumes and nearly 2 billion liters in volume. Johnnie Walker produces six versions of its scotch  at various price points. It is also a very global brand being available in almost 200 countries, with six bottles being sold every second. [1]

We have a $119 price estimate for Diageo, which is roughly 1% above the current market price. We have broken down our analysis of Diageo’s operations region-wise. The breakdown is as follows:

  1. North America
  2. Western Europe
  3. Africa and Eastern Europe
  4. Latin America
  5. Asia-Pacific

See Our Complete Analysis For Diageo

Following are some of the trends that might impact Diageo’s top-line performance in the near term:

Increased Marketing Of Ultra-Premium Brands To Drive Margins

Diageo is a strong popular brand name across the world, with the U.S. as the company’s largest market. Some of its premium brands, such as Johnnie Walker, Smirnoff, Crown Royal and Captain Morgan are the largest selling brands in their respective categories in some of the biggest markets across the world. However, with increasing competition from other multinational companies, such as Pernod Ricard, Beam Suntory, Bacardi, and Brown Forman, as well as from other local and regional companies, Diageo’s volume growth has been comparatively slow over the past couple of years. As a result, the company has been focusing more on strengthening its market share, through strong advertising and marketing campaigns.

Diageo leads the U.S. spirits market, accounting for roughly 19% of the volume share. The company’s strong brand positioning is mainly due to its dominance in the vodka and whiskey category, as well as a growing market share in rum. Spirits in the U.S. are anticipated to grow 2% in volume and nearly 3% in value. Diageo expects its premium scotch and vodka brands to show improvement in volumes. The popularity of Johnnie Walker, Captain Morgan, and Smirnoff is increasing gradually and this might lead to slow but gradual growth in the volumes.

In Europe, Diageo leads the spirits market in the U.K. and Greece with a 26% and 27% value share respectively. In Ireland, Diageo is the second leading spirits brand with a 30% market share closely following Ireland distillers. In Ireland, Smirnoff Red and Captain Morgan are the company’s top performing brands. Moreover, Diageo’s spirits account for nearly 80% of the total sales in Latin America and the Caribbean. In Uruguay, Diageo is among the top alcohol companies, with approximately 27% of the market share. The increasing popularity and demand of Cachaca liqueur in Brazil will help boost the overall volumes of the company in that country. In India, Diageo acquired a 54.78% stake in United Spirits Limited, the largest spirits company, with a 36% market share of the Indian spirits market in 2013. Moreover, in Vietnam, Hanoi Liqour Joint Stock Company led the spirits market with a 51% market share in 2013. Diageo holds a 45% stake in Hanoi Liqour JSC.

This shows the company’s strong hold in some of the top markets worldwide. With the increase in popularity and sales of its higher-end premium brands, Diageo’s revenue growth, as well as its margins might get a huge boost.

Gradual Consumer Shift In North America From Beer To Spirits & Wines

According To Euromonitor’s statistics, the Canadian wine segment grew 3% in volume and 5% in value in 2013, in the lucrative $9.75 billion market. [2] In the U.S., wine grew by 5% in sales to reach $40.3 bn, and grew 3% in volumes. This is in comparison to the slow overall growth of the alcohol industry. Premium wines remain a strong segment in restaurants, as wine has become more of a social beverage in the country. As the health conscious population in the North American region shifts from beer to spirits and wines, the latter is expected to outperform the former. As a result, Diageo’s sales in the country increased 8% in 2012 and 1% in 2013, despite the flat volumes.  This was partly due to the consumer shift to ultra-premium brands as well.  In Canada, Crown Royal is growing in market share as it outperforms in the Canadian whiskey category. Wine is forecasted to grow by 2% in volume and 5% in volume year-over-year for the next 4 years. A slowly recovering economy in Canada will further boost the demand for higher-end spirits. As a result, it will drive the volume growth for the company in Canada.

On the other hand, the beer market in the region is very competitive and as a result, Diageo’s Guinness market share might decrease in the next couple of years. The U.S. beer market volumes declined by 6% from 2009-2013, with the exception of a slight rise in 2012. Volumes declined by 2% in 2013, fueled by shifts in demographics and consumer preferences. As a result, the per capita beer consumption also decreased in the region. The beer market is losing volumes to spirits and wine, with sales of liquor rising from 13% to 28%, and sales of wine increasing from 14% to 24% in the last twenty years. Per capita beer consumption among drinking-aged adults in the country fell from 28.3 gallons in 2012 to 27.6 gallons in 2013. The decrease in volume of beer might slow down the overall volume for the company in the country.

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Notes:
  1. Company website []
  2. Wine in Canada []