Strong Organic Growth Drives Diageo’s Impressive Performance In FY 2018
Despite missing the consensus expectation on sales, Diageo (NYSE:DEO) reported an impressive FY 2018 (year ended June 2018), driven by strong organic sales growth and margin improvement, offset by negative currency translations. The company’s ambitious share repurchase program is another factor which resulted in the 9.3% growth in the adjusted EPS. DEO returned £1.5 billion to shareholders in FY 2018 through a share buyback, with its strong cash flow delivery enabling it to announce another share buyback program of up to £2 billion for FY 2019. The measures undertaken by Diageo, as well as the strong momentum it has built up, should ensure steady growth in FY 2019 as well.
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.
Factors That May Impact Future Performance
1. Productivity Initiatives: Diageo completed 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 as a percent of sales, which fell 110 basis points in the year, and this has been a big driver in the margin improvement posted by the company. During FY 2018, the company delivered an organic and reported operating margin expansion of 78 basis points and 151 basis points respectively, and is on track to deliver 175 basis points of margin expansion 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 3.3% during the year, 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 4.5%. 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. DEO is targeting the super-premium vodka segment to drive the U.S. spirits performance.
3. Return To Strong Growth In India: Net sales improved 9% in India, reflecting an acceleration in the second half of the year. The company’s strategy in the country is to grow its Prestige and above brands, which now represent two-thirds of the company’s portfolio in the country, and grew 12% in the year. Sales growth and accelerated productivity also helped to improve gross margins in the country by 300 basis points, notwithstanding the impact of inflation and the recently launched goods and service tax (GST).
4. Chinese Growth Trajectory Continues: The stellar performance of Chinese White Spirits, which grew a scarcely believable 63%, helped in the 25% sales growth reported in the Greater China region. 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.
6. Increasing Marketing Expenditure: Diageo has raised the advertising and promotion expenditure as a percent of sales by 27 basis points this year, resulting in marketing expenditure increasing 7%, and expects this trend to continue. The company increased investment behind U.S. Spirits and scotch, as well as in India and in attractive growing categories such as gin in Europe and Chinese white spirits. Consequently, gin sales increased 13.5% in Europe, and double-digit growth reported in markets such as Brazil, Mexico, South Africa, and Australia, with Tanqueray being a significant driving force behind this growth.
7. Acquisitions In Key Areas To Drive Growth: Diageo has undertaken a number of acquisitions this year, in fast-growing segments such as Tequila. DEO completed the acquisition of Casamigos, the fastest growing super-premium tequila brand in the U.S. The company also acquired ultra premium mezcal Pierde Almas and premium aperitif Belsazar. Furthermore, DEO recently launched a partial tender offer to potentially increase its stake in Shui Jing Fang from just under 40% up to a maximum of 60%.
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