Will North America Again Drive Earnings For Diageo In Its First Half Of FY 2017 Earnings?

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Diageo

Diageo (NYSE:DEO) is scheduled to report its half yearly earnings, for the six months ended December 2016, on January 26. Impressive growth is anticipated in the first half, of over 16% in the revenue, and more than 20% in the EPS. This growth is expected to be driven by its North American segment, which returned to growth in the second half of FY 2016 (ended June 2016).

DEO H1 2017 Pre Earnings

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Turnaround Of North American Operations

North America is the largest premium drinks market in the world, and accounts for about one-third of Diageo’s net sales, and one-half of its operating profit. It comprises US Spirits, Diageo Guinness USA (DGUSA), and Diageo Canada. During the first half of its FY 2016 (six months ended December 2015), the company reported a decline in the net sales and volumes for the North American region. This was primarily a result of a fall in US spirits, due to late launches in the half and the implementation of the replenishment model for innovations, which reduced the shipment level, when compared to the first half of FY 2015. However, a recovery was already seen in the second quarter (three months ended December 2015) of the company’s performance in North America, with the quarterly growth rates improving from a negative 10.4% to a positive 4.7%. For the full financial year, North America delivered net sales growth of 3%, after a strong performance of a 10% increase in the second half of the year in US Spirits. This was driven by growth in North American whiskey, scotch, and tequila, which resulted in a positive mix. North American whiskey was the standout performer, accounting for half of the overall net sales growth, with net sales up 6%, due to share gains by Crown Royal and Bulleit.

The Distilled Spirits Council of the United States (DISCUS) divides all spirit categories into four segments: Value, Premium, High End, and Super Premium. Across all spirits, Value sales have dropped while that of High End and Super Premium has increased. This shows a growing interest in the top tier of the marketplace. Super premium whiskeys were particularly popular with American consumers, with luxury Bourbon, Scotch, Canadian, and Irish whiskeys all recording double-digit growth. Millennials of legal drinking age have been driving innovation and premiumization. The Council also noted that five states authorized spirits tastings in 2015, taking the total number of states supporting some form of spirits tastings to 46. This has been an important marketing tool, enabling consumers to sample numerous innovative and premium products available in the distilled spirits sector. Moreover, according to Technavio, the alcoholic beverage market in the U.S. is projected to reach over $250B by 2020, with the trend of premiumization across product categories continuing to drive growth in the market. This will ensure growth for Diageo in this market in the long run.

Whiskey Growth

Increased Market Volatility

Volatile markets sometimes fuel a return to defensive stocks. After the recent US elections, investors were warned for sharp moves in the financial markets, due to the uncertainty surrounding whether Trump’s campaign rhetoric will be translated into policies. The stock market as well as the polls had expected a victory for Hillary Clinton, and an unexpected win for Trump created uncertainty in the market.

Moreover, in the aftermath of the Brexit, the pound has also fallen considerably against the dollar. Analysts at Credit Suisse noted that the positive impact of a falling pound could “more than offset the potential underlying business risks” faced by Diageo. They further stated that such a scenario, of a weaker sterling, could result in a 9% to 17% rise to the  company’s earnings per share. Furthermore, since alcohol is a resilient business during economic crises, reflecting consumers’ inherent need to drink and also, greater loyalty among its customers, it may further result in an upside to Diageo’s stock. The company could see a significant currency benefit, as a result of a falling Sterling. Since a majority of Diageo’s revenues, almost 90%, come from regions outside of Britain, a weaker pound is bound to benefit its top line. This is because their goods will command more competitive prices overseas.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Diageo.

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