Diageo: Could Africa Be The Motor For Growth?
Diageo (NYSE:DEO) is a leading alcoholic beverage manufacturer, producing world famous brands such as Johnnie Walker, Smirnoff, Baileys, and Guinness. Inherently, in terms of the business the company is in, Diageo stands to gain from two factors. First, demand for alcohol tends to be relatively acyclical. This means that demand is generally slower to respond to business-cycle downturns in comparison to other products. Second, alcohol sales happen across varied geographies, making it easier to hedge against risks associated with any particular market. By selling in over 180 countries, poor performance in one market is generally offset by good performance in another market. On the merit of these factors, Diageo saw revenues grow at about 4-5% and profits grow at 9% between 2009 and 2013, leading the stock value to almost double over the same period. More recently however, things have turned around for Diageo. With a slowdown in the U.S. spirits market, “anti-extravagance” in China, and unfavorable currency movements in other key markets, revenues registered a sharp 8% decline in 2014, in response to which the stock price fell almost 20%. In a situation when traditional markets are failing, we anticipate growth for the company to come from Africa. Here are the top reasons why Africa could be the star region for the alcoholic beverage giant.
- Diageo’s key markets in Africa include Nigeria, East Africa (Kenya, Tanzania, Uganda, Burundi, Rwanda, and South Sudan), Regional Markets (Ghana, Cameroon, Ethiopia, Angola, and Mozambique) and South Africa. [1] Over the past decade, African countries have experienced consistent economic growth at about 4-5%. [2] According to the International Monetary Fund (IMF), Nigeria, Angola, Rwanda, Ethiopia, and Mozambique, all made it to the list of the world’s fastest growing economies. Going forward, the IMF anticipates a growth rate of 4-5%, especially for Sub-Saharan Africa and Nigeria, against higher manufacturing activity and increasing foreign direct investment. [3] Furthermore, with fuel prices hitting record lows, many African countries have seen inflation rates dipping below 5%. [4] Against strong macroeconomic fundamentals, Africa could prove to be a very lucrative market for Diageo.
- A by-product of the tremendous growth in the region has been the emergence of the middle class, the size of which tripled over the last 30 years. As African economies continue to grow, the size of the middle class is expected to increase another 42% by 2060. [5] All of Diageo’s markets in the region currently have a prominent middle class population. These individuals, who cultivate more sophisticated tastes and preferences, can be expected to propel sales for Diageo’s products going forward.
- Africa also holds close to 15% of the world’s population currently, and according to McKinsey estimates, it will see an addition of 38 million households. Furthermore, Africa is home to the youngest population in the world with more than half of its inhabitants aged under 20 years presently. The working age population in Africa has steadily been growing and is projected to exceed that in China by 2040. The younger generation in Africa are better educated and have more refined tastes and preferences. Hence, higher disposable incomes among this group can be expected to drive sales of premium spirits in the region. An estimated 85 million are expected to reach the legal drinking age over the next decade, who can be targeted through appropriate branding strategies to propel sales. ((The Future Of Spirits In Africa))
- Apart from South Africa, African countries hardly have a prominent international spirits culture. In this situation, there exists a huge market at Diageo’s disposal to penetrate, especially as the purchasing power of people improve with higher economic growth. In fact, Diageo’s top product in the region had been Guinness, with little presence of spirits. In order to set a base for their spirits business, Diageo introduced a number of herbal and ready-to-drink (RTD) drinks, with close to 24 brand extensions in 2011. These acted as the basis to pave the road to mixing spirits and non-alcoholic counterparts. Giving customers the end drink might boost consumption of spirits, which bodes well for Diageo. ((The Future Of Spirits In Africa))
Now, almost all alcohol beverage manufacturers have acknowledged the potential in the market and have been taking necessary steps to capitalize on it. In the last five years, Diageo has invested close to $1 billion in the region and hopes to see sales from the region reaching 20% of the company’s revenues. [6] Furthermore, Diageo will be taking full control of United National Breweries, which will give them complete access to South Africa’s sorghum beer business. Diageo also enjoys a competitive edge over other players in the region since they have set a base in the continent for decades, while others such as Pernod Ricard and United Spirits entered the market more recently. However, in spite of the huge potential this market presents, it also poses a number of challenges prevalent in developing nations that could threaten prospects for Diageo. If Diageo manages to deal with these headwinds, Africa could leave Diageo’s cup half full.
Based on the upbeat prospects for Africa, we anticipate revenues from the division to undergo a 28% increase to go on to account for approximately 20% of the company’s total revenue by the end of our forecast period.
Trefis has a $116 price estimate for Diageo, which is slightly above the current market price.
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Notes:- Form 20-F, SEC [↩]
- Real GDP Growth Rates, 2005-2015, African Economic Outlook [↩]
- World Economic Outlook Update [↩]
- Drop in fuel costs lowers inflation rates among East African countries [↩]
- Deloitte on Africa The Rise and Rise of the African Middle Class [↩]
- Diageo’s CEO Menezes Sees Africa Rising to 20% of Sales [↩]