Diageo Earnings Preview: Innovation Could Drive Growth, Although Headwinds Might Persist
Alcoholic beverage giant, Diageo (NYSE:DEO), is set to report fiscal 2015 preliminary results on July 30. The maker of iconic brands such as Johnny Walker, Smirnoff, Guinness, and Don Julio saw some headwinds in their half-yearly results announced earlier this year, with operating profits declining 11% on a year-on-year basis. This development occurred against a slowdown in the U.S. spirits market, economic stress in Russia, “anti-extravagance” measures in China, and economic turmoil in Venezuela, which resulted in a 2% decline in volumes, particularly among global brands that account for about 30% of sales. Here is an overview of the factors that could have worked in the company’s favor, and those that could have threatened prospects in the six months ending June 2015.
A Survey Of Key Markets That Could Hold Positive Prospects
Diageo’s operations range across many geographies. In this case, region-wise developments are crucial for the company’s overall performance. Here is a snapshot of Diageo’s expected performance across its key markets.
— Company strategies in North America could ensure growth: In spite of a recovering U.S. economy, Diageo lost out in its most important market, as witnessed in the company’s previous earnings report, where volumes underwent a 6% decline. A number of factors, including an uneven recovery in the economy, slower growth in the spirits market, higher price competition from new entrants, and changing tastes of consumers from vodka to whiskey and from scotch whisky to American whiskey, was to blame.
However, the past six months could have seen a turnaround in Diageo’s story in North America. The key driver for this could be innovations, where Diageo has launched a number of brands more akin to consumer tastes and preferences. Brands such as Crown Royal Regal Apple, Ciroc Pineapple, Buchanan, and Bulleit Frontier Whiskey could bring in positive results for the company going into Q4. In fact, the management expects the fast growing Bulleit brand to see sales of over 750,000 cases this year, which could bring in significant growth in the bourbon and rye category. This category could also benefit from the reintroduction of IW Harper and the launch of Blade and Bow. These brand launches, coupled with targeted marketing, could ensure success for Diageo in the region. Furthermore, the company has also stayed away from further price hikes, which could ensure some degree of competitiveness among other star brands such as Smirnoff, which were otherwise losing out to intense price competition.
— Emerging economies in Africa could be key drivers: While a number of developed markets seem to reach a point of saturation, emerging economies could be the key to growth for Diageo as a fast increase in the number of affluent consumers could ensure higher sales for premium spirits, such as that offered by Diageo. Diageo has adopted a number of strategies to drive sales in key emerging markets. For instance, in Africa, the alcoholic beverage manufacturer has resorted to innovations, where a number of brands, such as Kenya Kane and Uganda Waragi, will see flavor extensions. Apart from this, the company is also innovating in beer with brands such as Orijin, Balozi lager, and Ruut Extra. The management indicated that leveraging Diageo’s expertise in terms of the location and timing of driving brands across different categories and during different consumer occasions could help garner an additional £300 million (~ $470 million) in sales.
— China could show growth in spite of the “anti-extravagance”: China is also another important market for Diageo, where a fast growing middle class population has been driving sales in the region. However, in recent times, the market has been troubled in light of an “anti-extravagance” drive, which aims at curtailing lavish spending in the region. Although the management does not expect sales for hard-hit baijiu and scotch to rebound in the short-term, the company remains confident on a rebound in the medium to long run. Leveraging the idea that alcohol consumption complements meals in China, the company has resorted to targeted marketing to drive sales for the brand. For instance, Diageo organized meals for a number of VIP consumers in the region, which they used to encourage consumption of the company’s offerings. Apart from this, Diageo also indicated an attempt to increase sales by leveraging the synergies from their Baijiu and international spirits businesses. This entails the sale of brands such as Haig Club, Smirnoff, and Baileys, along with Baijiu, with an attempt to gain shares by offering a broader product portfolio in the region.
Headwinds Could Continue To Weigh On Prospects
In spite of these growth prospects, a number of headwinds could continue to weigh on results. This includes headwinds from currencies. Since Diageo functions in diverse geographical regions, they are constantly exposed to headwinds related to currencies. A devalued currency could inflate the price of imported spirits in the local currency to adversely impact demand. According to the company’s interim results, adverse foreign exchange movements were noticed, as the pound strengthened against a number of key currencies including the euro, Canadian dollar, Russian ruble, and Turkish Lira. Currency headwinds could persist as a number of oil-exporting economies in Latin America and Eastern Europe continue to remain troubled as the price of crude oil plummeted in recent times, leading them into a recession. Furthermore, this has also impacted demand adversely in these regions. More recently, the Euro zone has also seen economic trouble, with mounting debt resulting in economic turmoil for Greece. Against these headwinds, Diageo may not see significant growth in the six months on a year-on-year basis.
However, the company has a number of tools at its disposal, which could ensure growth in the medium to long term. First, Diageo functions across many markets, which could help it hedge against risks associated with any particular market. Second, the company sells a product which remains relatively less responsive to business cycle fluctuations. Third, they dabble across spirits and beer and across various price points, from value to super premium brands, which could safe-guard them from changing tastes and preferences. Lastly, Diageo is the owner of a number of top brands, whose competitive advantage is sure to remain for a while. In light of these factors, although we anticipate some trouble for the company in the short to medium term, we remain bullish on prospects in the longer term.
Trefis has a $116 price estimate for Diageo, which is slightly above the current market price. We will be updating our model post the earnings release.
See Our Complete Analysis For Diageo Here
Sources:
- Diageo’s (DEO) CEO Ivan Menezes on Q2 2015 Results – Earnings Call Transcript
- F-15 Interim Results
- Brunch Time Call with the Presidents – Asia Pacific
- Brunch Time Call with the Presidents – Africa
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