Diageo Momentum Expected To Continue In FY 2018
Diageo (NYSE:DEO) is set to report its FY 2018 earnings on July 26, wherein it is expected to carry on its growth, albeit at a slower rate than that reported by the company recently. Whiskey sales are expected to continue to remain strong, along with strong growth in India and China. The U.S., its biggest market, is set to extend the momentum it has built recently, and Diageo is predicted to report another strong second half in the region. Moreover, the sales growth coupled with the productivity initiatives undertaken by the company are expected to result in operating margin expansion. Below, we’ll highlight the factors that are expected to have an impact on the company’s results.
We have a price estimate of $158 for Diageo, which is higher than the current market price. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on DEO’s FY 2018 results to modify the various drivers, to analyze their impact on Diageo’s revenues, earnings, and price estimate.
1. Productivity Initiatives: Diageo is in its second year of implementing Zero-Based Budgeting (ZBB), as part of its wider plan to be more ‘cost conscious.’ This means that the company’s finance managers will have to plan the budget of various departments from scratch, rather than them being based on the previous year’s spending, as is the case normally. This has helped in reducing the overheads, which has been a big driver in the margin improvement posted by the company. Diageo is on track to deliver margin expansion of 175 basis points for the three years ended June 2019. Based on the impressive productivity savings already realized, the company had, last July, increased its savings goal to £700 million from £500 million estimated earlier, two-thirds of which will be reinvested in the business. According to our projections as well, the EBITDA and EBITDA margin growth is set to continue in the medium term.
2. U.S. Spirits Growth: Sales of U.S. Spirits increased 3% in the first half, with the growth slowing as compared to the corresponding period in the prior year, as a result of a tough comparison. The company continued its focus on the recruiting of millennials and multi-cultural consumers, using a mix of traditional and digital channels for marketing. While all key brands were able to gain value share, vodka still remains a weakness. Excluding Cîroc and Ketel One vodka, net sales grew 5.5%. The company is undertaking a number of initiatives to return these brands to positive growth, such as focusing on the three core variants of Cîroc — Blue, Apple, and Peach — and the launch of the new flavor, French Vanilla, and highlighting the fact that Ketel One is 100% non-GMO.
3. Return To Strong Growth Expected In India: Net sales improved 2% in the first half in India, an improvement over the flat growth reported in the corresponding prior year period. However, the growth was negatively affected by a Supreme Court ruling that prohibited the sale of alcohol within 500 meters of a highway. This trend is expected to reverse, helped by more favorable comparisons. The company’s strategy in the country is to grow its Prestige and above brands, which grew 6% in the first half, and represent 65% of its business. Sales growth and accelerated productivity also helped to improve gross margins in the country by 200 basis points in the first half, notwithstanding the impact of inflation and the newly launched goods and service tax (GST).
4. Chinese Growth Trajectory To Continue: Despite the later timing of the Chinese New year, which was expected to have a negative impact on the sales in the first half, the stellar performance of Chinese White Spirits, which grew a scarcely believable 80%, helped in the 32% sales growth reported in the country. The company had taken a hit in China a few years back as a result of the anti-extravagance drive in the country. However, Diageo has managed to strengthen the business, with improvements noted in the route to market, and the sales and distribution system. While the company cannot be expected to maintain this massive growth in the future, strong double-digit growth can be anticipated, driven by whiskey and its white spirits brands, Shui Jing Fang in particular.
5. Attractive Opportunity In Africa: Despite macroeconomic pressure in the short term, the medium and long term opportunity in the region is massive given the fact that it has been forecast to be the fastest growing total beverage alcohol region over 2016-2021. This is expected to occur as a result of an increase in the LPA (Legal Purchase Age) population, higher incomes, current low per capita consumption, and consumers moving toward formal, safer drinks from the informal sector. Beer forms the largest portion of the total alcohol consumed, at almost 65%, and capturing this segment is essential as Africa is expected to be the fastest growing beer region in the world. Spirits, meanwhile, form 25% of the TBA (Total Beverage Alcohol) consumption, and present another key growth opportunity, as mainstream spirits growth is projected to outpace that of beer. Furthermore, given the low level of affordability, Diageo has ensured its brands are available at various price points, in both beer and spirits. This will enable Diageo to capture those consumers that are unable to afford its core products, as well as those wishing to trade up.
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