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Paul Walsh: Growth Accelerator

His track record at the world’s leading drinks business speaks for itself, and CEO Paul Walsh leaves Ron Emler in no doubt that his strategy of investing in existing brands and focusing on emerging markets will take Diageo to ever greater heights

“We could be entering a new golden age for spirit consumption,” believes Paul Walsh, chief executive of Diageo, the world’s leading premium drinks business.

“Just look at the number of consumers who can now afford or will afford our brands over the next 10 years. The industry, not just Diageo, has the brands with the prominence that these consumers want.

“It is like a raging torrent. The emerging middle class is not going to start shrinking, demographics don’t change. When you have strong demographics that are economically empowered we will do well.”

Although he is wary of present global economic conditions and predicts further crises, Walsh points to statistics on the shift of power to the “high-growth markets” and the burgeoning middle class consumers in them.

For instance, The World Bank estimates that by 2025, six economies – Brazil, China, India, Indonesia, Korea, and Russia – will collectively account for more than half of all global growth.

“I could dazzle you with statistics about the emerging middle class,” he says. “China will more than triple GDP per capita in the next 12 years. That took Victorian England 150 years. That’s staggering!”

What about Indonesia, sub-Saharan Africa, Latin America? “The numbers are incredible and what’s very clear is that when people have more money they don’t drink more, they drink better.

So we can trade them up the ladder [to premium products].

“When you’ve got categories like Scotch that are rich in heritage, rich in provenance, rich in stories, people want the feel-good that goes with that quality. It’s no different anywhere around the world.

“Four years ago our Reserve Brands [Johnnie Walker Blue Label, Gold Label Reserve, and Platinum Label whiskies, Ketel One vodka, Zacapa rum, Don Julio Tequila, Cîroc vodka and Tanqueray No. Ten gin] were worth more than £400 million in sales. In the last set of full-year numbers, they were worth £1.1 billion in sales. That will double in the next three to four years.”

Walsh speaks from a position of unquestioned experience. After 13 years at the helm of Diageo, he is one of the longest-serving chief executives among Britain’s biggest companies. Since he became chief executive, annual results to last June show Diageo’s operating profit rising by 59.5%, and the value of the company (market capitalisation) more than doubling. Today Diageo is valued at almost £50bn, making it Britain’s ninth biggest company. Significantly, even during the recession, Walsh increased both profitability and the dividend every year. The company also has a rock-solid balance sheet.

Walsh will step aside on 30 June 2014 and the company has already chosen his successor, Ivan Menezes, who became chief operating officer last year after running Diageo’s US arm.

“Diageo is a very fine racehorse but it can’t have two jockeys,” says Walsh. ”I will be around and do whatever I can to make Ivan and this company continually successful… But I must step aside and let Ivan ride this horse.”

As part of a three-year programme in anticipation of Walsh’s retirement, Diageo set a goal of earning 50% of its revenue from the newly developing markets by 2015. Walsh says he will meet that target earlier. And the recent deal to take control of India’s United Spirits (USL) can only accelerate the timetable. Indeed, he regrets that Diageo did not invest more in high- growth areas earlier this century, but admits it would have been difficult to convince shareholders of the wisdom at the time.

To give an example of the potential, he points to the takeover of Mey Içki in Turkey in 2011. Buying the dominant raki producer gave Diageo not only a brand with an 80% gross margin but also provided a stronger route to market for its held 20% of the Turkish market for Scotch; today it has more than half of it.

The takeover of Ypioca in Brazil offers similar prospects, as does the expansion of Diageo’s brewery interests in East Africa. And it is a pattern he sees continuing.

“Smaller companies will find their way into larger companies but I am not near term. There will be more deals comparable with Mey Içki. Overall there will be more power in the hands of the global players. It’s an exciting time for the industry.”

So where will Diageo look for further geographic consolidation and enhanced routes to market? Walsh is non-committal. But based on his criteria, an outsider might speculate that countries such as Mexico and Colombia are under consideration.

“When we buy a local company we are buying a strong local brand and a strong route to market… There are not that many of the quality and scale that would be appealing to us. There are some, but our first objective is always, always, always to grow what we already own. Then if you see things you can add value to and you can acquire at sensible prices – not cheaply, I want to pay a fair price for a good asset – then we will do so. But the way that we will drive value for our shareholders is
by growing what we already own.”

So the main engine of growth will remain pemiumisation to the middle-class consumer backed by what Walsh calls Diageo’s “innovation machine”.

Scotch, which accounts for 30% of Diageo’s turnover, “has a lot of legs. I keep coming back to this emerging middle class. The future is very, very bright”, he says. That underlines the importance of USL because India has a tradition of drinking whisky and a strong local industry, factors not applicable in China, for instance.

But other categories also are ready for the Diageo treatment. Here Walsh points to vodka as an example of how to expand and premiumise the market.

“If you go back to 2004/2005 people would have appropriately been critical that we really only had Smirnoff,” he says. “We have grown Smirnoff, which is already the world’s largest volume spirit, and we grow it every year. There is clear water from the number two. But we acquired [a 50% stake] in Ketel One and have done a very good job with it; and we innovated with Cîroc. So collectively we have transformed our role and our position in vodka.

“That’s what we intend to do with Tequila. We’ll look to acquire where we can, but it will be modest. We’ll also look to innovate and we’ll look to forge partnerships. We will have a very robust category position.”

Walsh was not content merely to be the distributor of the leading volume Tequila brand Jose Cuervo and declined a new contract. “After the end of June we can do what we want,” he says. “We own 50% of Don Julio but don’t just assume it’s Don Julio. We’ll have a much broader play. By late summer, you’ll start to see what we have to offer in Tequila.”

And as far as the Ketel One vodka joint venture with the Nolet family is concerned, Walsh says the agreement, which is soon due for renewal “can just roll on and roll on. If the family wanted us to have a bigger stake in the business, we would happily contemplate that. Equally, if they want things to remain as they are, that’s also fine. It has been very successful for both parties”.

In the six months to the end of December, Ketel One grew its organic net sales by 13.4% on a 10% volume increase. It is now a 2.4m case brand.

Walsh concedes that Diageo might be considered too big by the regulators to go for a “major, major takeover” in the vein of Seagram. On the rumours of a break-up of Beam he says, “There would be brands in Beam that we couldn’t own: there would be brands in Beam we wouldn’t want to own.”

Beyond that he is silent, but it is widely assumed that all he would consider would be Jim Beam Bourbon itself.

That said, should a major break up of a competitor be considered, then Diageo, as the biggest fish in the pond, would have an influence on the outcome in the same way that it picked up Bushmills as part of the 2005 dismemberment of Allied-Domecq.

Walsh is realistic about the prospects of buying the 66% of Moët Hennessy he does not own. “There are no regulatory hurdles there, but the owner is very content with his stake. Each time I see M. Arnault [the head of LVMH] I ask him if he would like to sell me Moët Hennessy. He says no and we move on to the next time. So long as that continues to be the case we are where we are.”

He is also clear that Diageo is not about to make an acquisition in wine, which comprises about 6% of its turnover.

“Wine is a volatile category from a profitability point of view. Because it (the wine arm) is the size that it is, we can handle that volatility. But if it was bigger, it would have an impact on the total group, therefore we are fine where we are. I don’t see the need to exit, but I certainly don’t see the need to get bigger.

“I’m sure as hell glad that when certain assets (he doesn’t identify them but read Southcorp and BRL Hardy) became available a number of years ago that we stuck to our guns on our evaluation criteria, even when many in the market were urging us to spend our cashflow.

“There are not enough volumes of quality wine to turn into a global brand, on that I agree with the late Patrick Ricard for whom I had enormous admiration. But there are other dynamics at play.

“There’s the supply component, there is nature – it’s not like Scotch or vodka; sometimes you get a good vintage, other times you get a bad vintage and your prices move accordingly. And the third thing is that the wine industry has not done a good job in getting consumers to pay for the quality they offer.

“It became fashionable to say, ‘Let’s try this, I bought it for £5’. That’s a rough market. I would hate them talking about a bottle of Scotch like that. I want you to tell me how it is worth a much higher price point rather than talk about a little brand that‘s ‘not bad for the price’.

“There are too many minute brands and the industry is incredibly fragmented. A lot of the margin in wine has been given to the major retailers. And a lot of that margin is passed on to the consumer. Look at some of the deals there were around last Christmas on Aussie wine. Three bottles for £10. Horrible! After duty there is not a lot left to pay the capital on the acquisition! That’s why we’re not interested.”

Walsh doesn’t like speaking about his “achievements” – he prefers to talk of “changes over which he has presided”.

“We have put our brands on the pedestals around the world that they deserve to be placed on. Our brands have never been in better shape. We have created an innovation machine, we have improved the image of the industry around our marketing, around responsibility and we now have a seat at the table with the regulators… We have really created a luxury mantle for our brands.

“We have created with Diageo a British company that is global and a champion. And the great news is that there is more to do. It’s an exciting market and Ivan will continue to move it to higher levels.”

Not a bad legacy.

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