Diageo Preliminary Earnings Review: Net Sales Maintained Against Innovations Even As Headwinds Persisted

+20.45%
Upside
149
Market
179
Trefis
DEO: Diageo logo
DEO
Diageo

Global spirits maker, Diageo (NYSE:DEO), reported preliminary earnings on July 30. In general, the past year has remained challenging for the maker of Johnnie Walker, with headwinds in both developed and emerging markets. Even against this, the company managed to maintain sales, with operating margins registering a 0.2 percent point increase on an organic basis. Here are the key take aways from Diageo’s preliminary earnings report and what we expect going forward.

A survey of major markets

Let’s start by looking at the company’s performance across various operational areas. Diageo’s biggest advantage lies in the basic fact that the company operates across a number of geographical areas, which allows the spirits maker to hedge against risks associated with any particular market. However, since 2014, the company has been facing troubling circumstances in both developed and developing markets, with the U.S. experiencing an uneven economic recovery, Western Europe grappling with the Euro crisis, Russia facing political and economic stress, and China dealing with slower demand against the “anti-extravagance” drive. Against these factors, sales and volumes underwent a 1% and 2% decline in the six months ending December 2014. [1] These effects exerted an impact even in the last six months  resulting in a 1% decline in volumes, even as net sales remained flat on an organic basis, and grew 5% otherwise. Here’s what worked and what didn’t in key markets for Diageo in the past six months.

Relevant Articles
  1. Does Diageo Stock Have More Room For Growth?
  2. Up 16% In A Month, Will Diageo Stock See Higher Levels?
  3. Should You Buy Diageo Stock At $175?
  4. What’s Happening With Diageo Stock?
  5. Should You Buy, Sell, Or Hold Diageo Stock Around $175?
  6. What’s Next For Diageo Stock After A 10% Fall In A Month?

North America: Positive performance in the U.S. was driven predominantly by innovation. Last year, Diageo had lost out to changes in consumer preferences, with Americans choosing American whiskey over Scotch. This led the spirits maker to launch a number of products to capitalize on the opportunity in this realm. These innovations were well received as witnessed by the 13% increase in net sales for the category. This was predominantly guided by brands such as Crown Royal Regal Apple and Bulleit. The last six months also held good news for scotch in the U.S., with Diageo’s Buchanan brand experiencing a 20% increase in net sales. Even in tequila, new launches, particularly under DeLeón and Don Julio, contributed to a 10% increase in category net sales. However, in spite of solid performance among the newer brands, older brands continued to suffer. In particular, sales for Johnnie Walker and Smirnoff continued to remain slack. However, the management has indicated some strategic changes in the U.S. to secure volumes going into 2016. For one, they have acknowledged that much of the volume loss has occurred at the lower end of the market, where intense price competition has resulted in lower demand. In this case, some subtlety in pricing could be in the cards going into 2016 to avoid further volume losses to competition. Furthermore, the company has also indicated further launches in the U.S. to capitalize on various consumer occasions. Tactful pricing, along with further innovation, could ensure volume growth for Diageo going into FY 2016.

Europe: Although a number of countries in Western Europe, such as Britain and France, gained traction in the six months, weakness in other countries, such as Greece, that were adversely impacted by the Eurozone crisis, dragged down performance. Furthermore, another key market, Russia, continued to deal with economic and political turmoil, as dwindling crude oil prices sent the oil-exporting country into a depression. However, even as customers continued to downtrade to cheaper alternatives, Diageo managed to gain share points in categories such as rum and scotch whisky. Overall, Europe experienced sustained performance, with net sales increasing 2%, even as macroeconomic headwinds persisted. This performance was driven by innovations in Great Britain, the use of campaigns to drive sales of brands such as Guinness, and double-digit growth rates in reserve brands. Going into FY 2016, Diageo could continue benefiting, particularly from Western Europe, if the economic situation in Greece stabilizes. Even in Russia, the company expects some moderation in volume declines going into next year as the price of crude eases.

Asia Pacific: The region saw a 7% increase in net sales in the fourth quarter, predominantly guided by innovations. This includes launches such as Haig Club, W-Ice by Windsor in Korea, Guinness Zero in Indonesia, and new ready to drink offerings. The six months also saw better performance from China, which was otherwise dealing with lower volumes on account of the “anti-extravagance” drive. Net sales in the region experienced double digit growth, which was predominantly aided by the Shui Jing Fang brand. Diageo also benefited in Asia with the completion of the integration with United Spirits Limited in India. This allows the company to sell Diageo’s brands in the growing Indian market. Even going forward, synergies from this deal could be realized to benefit the company, in terms of volumes.

Diageo Could Hold Growth Potential Going Forward

Although Diageo’s results in the last year cannot be described as phenomenal, the company most definitely holds growth potential in the medium to long run. For one, statistics suggest that there will be an addition of a billion new consumers over the next ten years, who would be able to afford international spirits, and about 800 million who would be able to afford luxury spirits, predominantly coming in from growing economies in Africa, Asia, and Latin America. Diageo’s extensive footprint could help them leverage this opportunity. Furthermore, the company has been further expanding their footprint across many emerging markets to drive availability, considering alcohol consumption tends to be an impulse buy. In the last year, the company increased their outlet count by 30%, which brought an additional £90 million (~ $140 million) in sales. We could expect further outlet expansion to drive sales going forward. Secondly, as highlighted before, innovations have driven a large majority of net sales in the last year even as tougher economic situations continued to threaten prospects. According to Diageo, the company generated over £500 million (~ $782 million) in sales predominantly through innovations. While launches from this year are bound to continue exerting a positive impact on sales even going forward, the company has indicated further innovations in the pipeline that could hit the market in the next year. Against this, Diageo could witness further sales growth. Last, but not  least, Diageo is a the owner of a number of top brands, whose competitive advantage is sure to remain for a while. This itself could give the company an edge, not only in terms of ensuring sales of existing products, but also in terms of adding credibility to their new launches.

Trefis has a $116 price estimate for Diageo, which is slightly above the current market price. We will be updating our model in light of the earnings release.

Sources:

See Our Complete Analysis For Diageo Here

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap

More Trefis Research

Notes:
  1. Interim Results 2015 []