Diageo needs to ‘show direction’

When Diageo’s chief executive, Ivan Menezes, unveils the group’s annual results at the end of this month, investors and analysts will be more interested in what he has to say about the direction and prospects of the world’s biggest premium alcohol group than what it has achieved in the past 12 months.

It is common ground that Diageo has had a mediocre couple of years and the shares have fallen by about 5% since Paul Walsh stepped down. But the problems caused by the slowing of some emerging markets, notably China and the continuing sluggishness of the key North American market, where the difficulties in the vodka market are well rehearsed, came at an inopportune time for Menezes when he stepped into the top job at Diageo.

He has reacted to these challenges by slashing annual costs by about £200 million in a programme which is largely complete and by asking finance director Deirdre Mahlan to move back to her native US to shake up Diageo’s largest market and profit centre.

All well and good, and analysts are expecting modest improvements in revenues and profitability to show through in next week’s figures; most rate the shares as either “hold” or “buy”. But what they will be hoping for is guidance on how Diageo will shape itself for the longer term and resolve a number of ongoing questions.

These have been thrown into focus by a rumour begun in Brazil a couple of months ago that some of the world’s biggest investors might be hatching a bid for Diageo. This story has never been confirmed but it has underlined that Diageo has several interests that may be worth more outside the group than within it. In addition, there are several instances of “unfinished business” where resolution would bolster sentiment towards the group.

Menezes has recently sold the Gleneagles hotel and golf complex (for an estimated £200m) because it was peripheral to Diageo’s core liquour business; is it part of his strategy to refocus the group even more closely?

For instance, would shareholders benefit more by Diageo accepting that is unlikely ever to convince LVMH to sell its majority holding in Moet Hennessy?

Diageo holds 34% of the Cognac and Champagne and Glenmorangie Scotch company, a throwback to the mid 1990s merger and acquisition spree, part of which involved the two groups taking cross shareholdings in each other.

LVMH has long since divested itself of a stake in Diageo and the two groups have moved away from joint marketing and distribution chains. Would selling the Moet Hennessy stake back to LVMH release considerable cash that could be put to better use on the balance sheet or via alternative acquisitions?

Equally, although Guinness is a great global brand, does it sit easily in a spirits empire? Are beer brands such as Red Stripe or Kilkenny peripheral interests? Undoubtedly the Kenyan and Ethiopian beer divisions are opening doors in converting African drinkers to spirits consumption, but longer-term would they be worth a premium price to a global brewer?

A pointer here may be that United Spirits (controlled by Diageo) has recently sold its stake in India’s United Breweries to Heineken.

The same questions can be raised about the US wine interests. Diageo has made no secret over the years that wine does not feature in its acquisition tactics. The margins are low compared with spirits, the supply is variable and the scope for truly global marketing initiatives and brand building is limited to the commodity end of the market. Does Diageo therefore see a long-term future in its portfolio for Sterling Vineyards, Rosenblum Cellars and Beaulieu Vineyard?

At the other end of the spectrum is how Menezes proposes to deal with outstanding difficulties in China and India.

In China the austerity crackdown has resulted in Diageo shelving construction of a mega-production facility for Baijiu. The market will take some years to recover and so the returns will be slower to achieve than Diageo had hoped. How will the group maximise revenues in the meanwhile? Will it need to delay the premiumisation programme?

In India, Diageo has imposed its own management and operating style on United Spirits, the market leader which has been under attack from competitors, disgruntled investors and an army of lawyers trying to unravel the machinations of former owner VJ Mallya. While trading is said to be improving as a result, there are still doubts, not least about margins in the face of strong competition, especially from Pernod Ricard.

Mallya remains chairman of United Spirits, but shorn of executive power. As the Indian courts continue to unravel his byzantine financial affairs, he cuts a controversial figure and casts a shadow over Diageo’s efforts on the sub-continent. Ousting him is not proving easy and is a further distraction Menezes could do without.