Drinks profits slow as economy recovers

3rd February, 2014 by Ron Emler

There is a dichotomy between the global economy moving out of recession and wine and spirits companies experiencing slowing profits growth.

Ivan MenezesThe pattern is evident in the latest results from Remy Cointreau, Treasury Wine Estates and Diageo, although LVMH appears to have bucked the trend in its drinks operations.

Commenting on his group’s profits growth slowing to 1.8% in the three months to Christmas, Diageo chief executive Ivan Menezes noted that consumer patterns around the globe were changing more rapidly than at any time during his 30 years in the drinks sector. While there were specific regional variations caused by local conditions such as the anti-extravagance measure in China and GDP growth in emerging markets as a group slowing to between 4% and 5%, the key to future profits growth was “acting like a small company” and adapting quickly to changing consumption patterns or external factors such as duty changes in Kenya and Turkey.

While Menezes expects the half year to the end of June to show some improvement, he no longer quantifies Diageo’s profitability target. In the three-years ending in June the target was annual average organic growth of about 6% and a 200-point improvement on margins. The latter will be achieved but Menezes now talks of a nebulous performance target of “being in the top quartile” of net sales value growth among leading consumer goods companies.

Reading between the lines suggests that an era of less dynamic profits growth is ahead. The US recovery is “uneven” and Menezes remains “cautious” about Europe, but still the biggest impetus will come from emerging markets, which now account for 42% of Diageo’s turnover.

Menezes is about to mount a cost-cutting drive that will generate savings of £200m a year by 2017 through improving logistics and “delayering” regional operations (he won’t say if jobs will be lost). This, he says, will mean that Diageo is well placed to reinforce its position as the world’s leading premium alcohol group. For instance, the premium core brands such as Johnnie Walker, Smirnoff, Guinness and Captain Morgan now account for 60% of the group’s turnover. And his first priority is to “strengthen and accelerate” those global giants. Reserve brands such as Ciroc and Don Julio must “win in every market”.

Diageo, he says, has a 75% share of the market for deluxe scotch in emerging markets. And he underlines that while growth in those regions may be slowing in aggregate, they are still developing more quickly than established markets in America and Europe.
And where change has hit Diageo negatively, Menezes is confident he will be best placed to come through the transition on top. For instance in the baijIu category Shuijingfang is said to have suffered a 66% slump in the past six-months as the Chinese anti-extravagance drive bit. But Diageo did not slash prices in pursuit of volume and he is confident that the category will be “back in growth in 2015….. the category is healthy”.

Similarly, following the loss of Jose Cuervo, Diageo is “committed to recovering profits” from the tequila sector and has “moved very quickly” to augment its portfolio by buying Peligroso and partnering Sean Coombs with De Leon. Don Julio, which grew by 26% in the half year, remains the prime offering, but Menezes says Diageo has “enough scale to regain its [market leading] position.” He also hints that there may be more developments in this sector.

NIche takeovers will be on Diageo’s menu as and when Menezes can find the right targets at a competitive price. And although he declines to comment on Suntory’s $16bn swoop on Beam, he says: “It was an asset that was going to go…it was not high on our priority list”, adding that “Suntory’s action shows what a fantastic business [global spirits] is and what fantastic brands we have.”
Sources in Diageo say that any takeover is governed by two factors – how much value can be added and how long you are prepared to wait for it to flow through. The need for Suntory to spread its global wings, they suggest, made Beam a very different proposition from a Tokyo perspective than from St James’s Square.

The same criteria apply to San Miguel’s beer and spirits businesses, which are reported to have attracted offers of $6.6bn. Menezes refuses to admit or deny interest as a matter of policy but any deal would be complicated by Kirin’s 48% stake. Nevertheless, someone in Diageo will be running the numbers… just in case.

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