What To Expect From Diageo’s Results For The First Half Of FY 2019?

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Diageo (NYSE: DEO) is set to report its first half of FY 2019 earnings on January 31, 2019, 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 drive overall growth. Additionally, revival is expected to be seen in the company’s APAC business with rising sales in China and India, after receiving clarity on the legality of liquor sales in the vicinity of highways in India. Revenue growth coupled with the productivity initiatives undertaken by Diageo are expected to result in operating margin expansion. Consolidated net sales for the first half of FY 2019 is expected to be around $8.73 billion, which is 5.3% higher than net sales in 2H 2018, and marks a 1.2% y-o-y growth. Cost-reduction and productivity enhancement measures would help increase margins, which, in turn, would lead to higher sequential EPS.  However, EPS is expected to be a bit lower on a year-on-year basis, mainly due to a strong report a year ago.

You can view our interactive dashboard – Diageo’s 1H 2019 Results Preview – and modify our assumptions to arrive at your own estimates for revenue, EPS, and share price.

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Key Factors affecting First Half 2019 Results

  • Legal Clarity in India: India, the second largest market in terms of revenue for Diageo, where it operates with a 54.78% stake in United Spirits, saw a slowdown in 1H 2018 after the country’s Supreme Court banned liquor sales within 500 meters of a highway. However, subsequently it was clarified that only liquor shops would be banned, whereas all the pubs and hotels can continue to function normally. This has led to a strong second half of FY 2018 and we expect the momentum to continue in 1H 2019.
  • Timing of Chinese New Year: Like last year, the Chinese New Year falls in February this year as well (it was in January in 2017). This occasion, which is a time for increased liquor sales, will drive higher sales in the second half of the current fiscal instead of the first. However, increased advertising would likely lead to an increase in revenues in the first half of FY 2019.
  • Growth In North America: Net sales of US Spirits in the North American segment grew by 3% in FY 2018 in spite of vodka sales declining during the year. Margins for the segment were slightly down due to increased marketing spending. We expect the benefits of the new marketing campaigns to continue to drive higher sales for Bulleit, Johnnie Walker, Crown Royal, Baileys, and Captain Morgan. As the company incurred a major marketing outlay in the previous year, margins are expected to inch higher in the first half of 2019 as the company has taken a number of steps in that direction – improving the digital content, leveraging partnerships with Drizly, Uber, and Tasty, launching new variants of its brands, and driving efficiencies to cut down costs.
  • Scotch to continue to drive growth: Scotch, which accounts for 25% of Diageo’s net sales, grew by 2% in the previous year, in North America, Latin America, and Asia-Pacific. We expect it to continue driving higher sales and margins, largely benefiting from new marketing campaigns. Also, focus on gifting as an option would likely increase sales of the company’s expensive scotch variants, especially with Christmas and New Year falling in the first half of the year. Korea is expected to be a drag on net sales as the geography is seeing a contraction in the scotch category with consumers switching to lower alcohol content categories.

Full Year Outlook

For FY 2019, we expect net sales to be approximately $17.2 billion, which marks a 2.0% rise over net sales in the previous fiscal. Revenue growth will mainly be driven by revival in the APAC segment and strong growth in Latin America. North America will continue to contribute the largest share to net sales.The recently implemented productivity program which focuses on everyday efficiency and driving out cost across its business, is expected to deliver 175 bps operating margin improvement over three years ending June 30, 2019. The cost-reduction measures, along with increased sales, would drive margins higher and lead to a healthy growth in earnings per share for the year.

We have a price estimate of $157 for Diageo, which is higher than the current market price. In July 2018, management approved a new share buyback program to return approximately $2.6 billion to shareholders in FY 2019. Along with better financial performance, the share repurchase program, and a rising dividend pay-out per year is expected to support the stock price and increase returns for the shareholders.

 

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