What Does North America Have In Store For Diageo?

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After years of consistent growth, revenues and profits for Diageo (NYSE:DEO) saw a downturn in 2014. Although slower growth in Europe and emerging markets dragged down the sales, the biggest blow for Diageo came from its North America division. North America is an important region for Diageo, accounting for over 20% of the net sales and 45% of profits. [1] With sales declining around 7% in North America, the company saw an 8% fall in overall revenues in 2014. A question worth asking at this point is what contributed to this development, and whether North America will get back to being the lucrative market that it had been till recently.

Why Did The U.S. Fail Diageo In Spite Of A Strong Economy?

Unlike many, Diageo was hardly a beneficiary of an upbeat U.S. economy. Although GDP grew at 3%, and unemployment rates reached record lows at 6% in 2014, economic growth proved to be largely unequal leading to weaker demand growth among the middle income groups. [2] Hence, although the U.S. spirits market expanded by a meager 1.5% in the year, the top five brands lost ground to register a 1% decline. [3] To make matters worse, the U.S. spirits market has also been witnessing a high influx of new distillers, who offer more competitive prices in comparison to Diageo. For instance, Captain Morgan Spiced costs 25% more than the leading white rum, Crown Royal costs 10% more than the leading Tennessee whiskey, and Ketel One costs 24% more than its biggest competitor. This hurt sales for Diageo in the premium and super premium categories.

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Along with a slowing spirits market and intense price competition, Diageo also failed to capitalize on the changing tastes and preferences of Americans. For one, Americans have been increasingly moving away from vodka towards whiskey, which is set to grow at 10%, with approximately 70% of the growth coming from flavored whisky, and unflavored bourbon, and rye. ((2014 brunch-time calls with Larry Schwartz, President Diageo North America))  Although Diageo has a prominent presence in scotch whisky with iconic brands like Johnnie Walker, American whiskey was not a major focus area for the company. These factors triggered a 6% fall in volumes and a 1.5% fall in revenue per unit in the region in 2014.

What Has Diageo Been Doing In Response To These Trends?

Key to Diageo’s success in North America could be innovation, as the millennial generation, that accounts for almost a third of the U.S. population now, looks for new consumer experiences. Keeping this in mind, Diageo has unveiled the launch of a number of products and also targeted marketing strategies to tap various consumer occasions.

In vodka, apart from adopting tact in pricing to effectively compete with burgeoning entrants, Diageo initiated new marketing campaigns to drive sales. These include, the ‘Exclusivity for Everybody’ campaign for Smirnoff and the ‘Step Into the Circle’ campaign for Ciroc. [4] Diageo plans to roll-out these campaigns across various mediums to increase its customer base. Beer is also seeing innovation, with the introduction of Guinness Blonde American Lager as a part of the Discovery Series. This aims at complementing Guinness 1759, which will primarily aim at targeting dining and gifting opportunities.

In order to leverage the growing whisky market, Diageo introduced seven flavors between the $14.99 and $24.99 price points last year. According to Nielsen, Crown Royal Regal Apple, introduced in October last year, has taken the number one spot for innovations followed by Ciroc Pineapple at the number three spot. Buchanan, the second largest scotch after Johnnie Walker, also shows immense promise, especially among the Hispanic community that account for close to 20% of those consuming scotch. This brand aims at targeting those who are familiar with a particular taste from their home country, and look to experience it in the U.S. This year, Diageo sponsored the Latin Grammy’s with the aim of tapping an increasing number of Dominicans, Colombians, and Venezuelans settled on the East Coast. ((Diageo’s (DEO) CEO Ivan Menezes on Q2 2015 Results – Earnings Call Transcript))

Another brand that holds tremendous potential is Bulleit Frontier Whiskey, which has carved its place as America’s number one rye whiskey, and is poised to see sales of over 750,000 cases this year. [4] In order to preserve the brand’s craft status, Diageo plans to keep off large-scale advertising and aims at building appeal through bartenders and hearsay. Although Bulleit currently accounts for only 20% of the bourbon and rye growth in the U.S., it can be seen growing at a 57% rate and could go on to become a real winner for Diageo. Apart from these, the bourbon segment will also see the reintroduction of IW Harper and the launch of Blade and Bow, all of which hold promising prospects. [5]

Diageo still dominates the alcohol beverage industry with iconic brands such as Johnnie Walker, Smirnoff, and Baileys, whose competitive advantage is sure to stay. Although Diageo is expected to see a lag in terms of positive results from the region in the near term, we believe that the company has sown the seeds to see a rebound going forward.

Trefis has a $116 price estimate for Diageo, which is slightly above the current market price.

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Notes:
  1. Diageo Annual Report 2014 []
  2. Alcoholic drinks in the US []
  3. Special Report: U.S. Spirits Market Up By 1.5% In 2014, As Fireball Rises High []
  4. Diageo’s (DEO) CEO Ivan Menezes on Q2 2015 Results – Earnings Call Transcript [] []
  5. DIAGEO RELAUNCHES I.W. HARPER BOURBON IN US []