Diageo: Moving Back To Basics?
Diageo (NYSE:DEO), the world leader in alcoholic beverages, recently hinted at pursuing the sale of its wine business, which includes key brands such as Blossom Hill, Piat d’Or, Rosenblum, and others. While the deal is still at its inchoate phases, with no sale price revealed, Australia’s Treasury Wine Estate is expected to be the potential candidate. Now, what could this possible sell-off mean for Diageo’s business?
Figure 1: Percentage change in revenues between CY 2010 and CY 2014, data taken from company filings
Diageo Under Stress
After many years of growth, Diageo’s sales have slowed over the past two years due to weakness across emerging markets and developed markets. While tough economic conditions and policy stances have dragged down demand in developing markets, little reprieve has come from developed markets where consumer demand has remained lull. Furthermore, currency headwinds have only contributed to making Diageo’s financial performance worse. All of these developments have put immense pressure on the company.
What Has the Company Done?
In response to waning consumer demand, Diageo has resorted to innovations. For instance, realizing that its woes in North America were a consequence of changing customer preferences from vodka to whiskey, and from Scotch whisky to American whiskey, Diageo quickly revamped its portfolio to include brands such as Crown Royal Regal Apple and Bulleit to capitalize on the opportunity. In fact, over the last fiscal year, the company generated over £500 million (~$782 million) in sales predominantly through innovations. However, apart from this, the company has also looked at offloading some of its non-core businesses. Recently, the company announced the sale of its hotel and golf resort business, Gleneagles, and now its wine business.
What Does This Mean?
This offloading of its non-core components imply a shift from diversification to specialization. Typically, the alcohol business can be a problematic one, right from changes in consumer demand, tastes and preferences, to regulatory issues. At such a time, big players in this domain have resorted to diversification — just like Diageo had with its wine business and hotel and golf resort. However, this offloading could mean a move towards doing what they do best, and achieve the optimum in those areas.
Will This Be A Win Or Loss For Diageo?
This move could have little negative impact on Diageo for a number of reasons. For starters, although Diageo has been involved in this business for about 15 years now, wine accounts for merely 4% of the company’s net sales. Furthermore, a number of key markets have actually been showing a declining trend in terms of wine consumption. For instance, traditional markets such as France and Italy have shown 3.7% and 18.1% declines, respectively, between 2010 and 2013. China, another high growth market, has been showing declines at the rate of 1.5% between 2012 and 2013, after growing at double digits in the previous years against the widespread “anti-extravagance” movement and economic slowdown.
According to a report by Vinexpo, consumption per head for top consumers — Italy, France, Switzerland, and Portugal — are all expected to show a decline between 2013 and 2018. While the report suggests some growth in China, this is expected to come from entry-level or medium-range wines rather than the premium options, which could drag down the lucrativeness Diageo could have reaped from the region.
The only potential loss for Diageo could come from the U.S., which has seen phenomenal wine consumption growth between 2010 and 2013 at 14.4%, to account for 13.5% of world consumption in 2013. Vinexpo and International Wine and Spirit Research suggest that U.S. consumption could undergo another 11% increase between 2014 and 2018 to steer demand in the global wine market. However, in spite of the phenomenal growth in the region, Diageo was hardly a beneficiary since the beverage house reported a 2% organic volume decline in wine in its North America region last fiscal year, in spite of innovations. Even then, channeling resources from wine to spirits, where Diageo is the champion, could offset any losses from the offloading.
Taking the aforementioned points, this renewed focus on Diageo’s core business could support the company’s growth. In spite of near-term headwinds, Diageo’s product portfolio and business fundamentals continue to remain strong. Given this, the company could show promise over the medium to long term.
Trefis has a $115 price estimate for Diageo, which is above the current market price.
See Our Complete Analysis For Diageo Here
Sources:
- World Wine Consumption, Trade Data and Analysis
- U.S. Demand Seen Driving World Wine Market Growth, Deglise Says
- Diageo Form 20-F, SEC
- Diageo Presses Ahead With Wine Sale
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