Weakness Of The Pound Helps Diageo Beat Estimates

Diageo (NYSE:DEO) reported its earnings for the first half of its FY 2017 (six months ended December 2016) on January 26, 2016. The company saw its operating profit increase 4.4% on an organic basis, double of what the analysts had predicted. Diageo’s volumes also increased 2% on an organic basis over the same period last year, with an improvement in the organic sales growth in its biggest market of North America by 3%. The interim dividend has also been raised by 5%, to 23.7 pence per share. The spirits maker reiterated its medium-term guidance of mid-single digit top line growth, and 100 basis points of organic operating margin improvement in the three years ending 30 June 2019. The key highlights of the company’s earnings have been specified below:

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Attractiveness Of The North American Market

The company delivered growth in every region, with North America building on the momentum of the second half of FY 2016. US Spirits is the biggest and most profitable market for the company, and the changes implemented by Diageo in the region, including a new leadership team, a new marketing strategy, and a new approach to launching innovations, has paid off. The company has been closing the gap to industry growth, and in the latest quarterly data from Nielsen, Diageo’s growth is just 35 basis points lower than the market. North American whiskey, scotch, and tequila brands delivered the strongest performance in the half. Diageo is the market leader in North American whiskey, with Crown Royal the biggest brand by value. Another brand, Bulleit, is growing at four times the category. A positive mix in the region also led to gross margin expansion, which together with marketing efficiencies and lower overheads delivered a 6% organic profit growth. The company intends to continue spending on marketing, with the digital spend expected to be up fivefold in the year.

India’s Growth Potential

India is considered to be a big opportunity for the company and is a key focus area for FY 2017. Diageo has made good progress in accelerating growth as it focuses on the long-term opportunity, while mitigating short-term impacts of events and legislation. Demonetization in the country in November hit the performance; despite that, sales were up mid-single digits, with prestige and above up double-digits. The priority for the company in this region is to focus on and strengthen these prestige and above brands, improve the route-to-consumer to ensure that its brands have great visibility, and drive out costs to invest in growth and expand margin. In this regard, the company has relaunched a number of its core prestige brands in the half, with notable performance and market share improvement. For greater cost efficiency, the company’s tram-lining, which involves breaking down the individual costs involved in a product, and comparing them to other products in the market, as well as internal benchmarks, has helped to reduce glass costs, through light-weighting and a more effective sourcing strategy. Furthermore, Zero-based budgeting has reduced indirect costs.

Favorable Exchange In The First Half

With the weakening of the pound, the net sales of the company have benefited by about £850 million, and the operating profit by about £300 million. Moreover, the favorable exchange rate is expected to positively impact the net sales by £1.4 billion, and the operating profit by approximately £460 million, for the full year. Even in FY 2018, a favorable transaction exchange is set to continue due to the company’s hedging policy, which is focused mainly on the US Dollar.

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