North American Growth To Push Diageo’s Earnings Higher

Diageo (NYSE:DEO) is scheduled to report its second half and full year (ended June 2017) earnings on July 27. Impressive growth is anticipated in the half, of more than 13% in the revenue, and over 15% 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).

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North American Growth Momentum To Continue

North America is the largest premium drinks market in the world, and accounts for about one-third of the Diageo’s net sales and a half of its operating profit. Its North American segment comprises of US Spirits, Diageo Guinness USA (DGUSA), and Diageo Canada. Recovery in this segment started in the three months ended December 2015, when the quarterly growth rates improved from a negative 10.4% in the prior quarter, to a positive 4.7%.

In the first half of its FY 2017 (six months ended December 2016), 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, 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 first 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 in the first half of FY 2017; despite that, sales were up mid-single digits, with prestige and above categories 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 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 helped to reduce glass costs, through light-weighting and a more effective sourcing strategy. Furthermore, Zero-based budgeting has reduced indirect costs. These improvements are set to continue in the second half, which will result in reduced costs and improved margins.

Favorable Exchange Rate To Boost Earnings

With the weakening of the pound, the net sales of the company benefited by about £850 million, and the operating profit by about £300 million in the first half of FY 2017. 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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