When Ivan Menezes became CE of Diageo in July 2013 he inherited the world’s largest spirits company, spanning 180 countries. Menezes also inherited the task of reversing flagging earnings performance from a group with a liquor cabinet filled with iconic brands such as Johnnie Walker scotch, Captain Morgan rum, Smirnoff vodka and Guinness stout.
After growing earnings at over 7% annually for a decade the liquor group, which is domiciled and listed in the UK, began to take strain in its year to June 2014. Earnings came in 8% down, with a further fall of 7% recorded in 2015. Sales over the two years declined 5.4%.
The biggest damage was caused by stalling economic growth and sharp currency falls in emerging markets (EM) . Diageo derives almost 45% of its annual £10.5bn sales from EMs in Africa, Eastern Europe, Asia and Latin America.
A major force in Africa, Diageo has big spirit market shares in Kenya (42%), Algeria (41%), SA (35%) and Nigeria (28%). Through Guinness it has a 27% share of Nigeria’s beer market.
Also playing a big role in Diageo’s EM ambitions is India, where the big attraction is the whisky market. With annual sales of about US$10bn it is the world’s largest whisky market by volume, well over three times bigger than its nearest rival market, the US.
Diageo made its initial move on India in 2012, acquiring an initial 10% stake in the country’s largest spirits group, United Spirits Ltd (USL) from the then controlling shareholder, Vijay Mallya. By June 2014 Diageo had lifted its stake to 54.8% at a total cost of £1.85bn.
"Overall, Diageo paid a hefty 38 p:e for USL," says Euromonitor senior alcoholic drinks analyst Jeremy Cunnington.
It was a high price for a company far from being in prime condition. Though USL is the world’s second-largest spirits company in its own right by volume, and effectively doubled Diageo’s total spirits volume, it had been grossly mismanaged by Mallya. "He used USL as a cash cow to fund his other ventures [through a $225m loan] including now defunct Kingfisher Airlines," says Cunnington. "There was no re-investment in USL’s brands."
Even after gaining control of USL, Diageo was stuck with Mallya, who had secured for himself the position of USL chairman. Bringing the bizarre situation to an end, Diageo agreed in February to pay Mallya $75m to vacate the position.
With a 39% share of India’s spirits market, USL offers "huge growth potential", says Cunnington. "It is the only player with a national distribution reach across India."
Diageo’s challenge, and its biggest opportunity, is to up USL’s profitability. USL contributes around 40% of the group’s volume, but, as a result of a past focus on low-price brands, only 9% of its revenue and 1.7% of operating profit.
In part, Diageo is tackling the challenge by introducing higher-margin brands such as Johnnie Walker in the fast-growing premium whisky sector, where rival Pernod Ricard holds sway.
Group-wide, Diageo is pulling out the stops to reverse its earnings slide. Its strategy includes the goal of achieving £500m in productivity savings and upping operating margins by 100 basis points in the three years to June 2019. Two-thirds of cost savings will be reinvested to accelerate growth.
An upturn in Diageo’s fortunes was evident in its latest financial year. First-half sales lifted 1.8%, accelerating in the second half to a 3.8% rise. EPS growth also resumed, with a full-year rise of 1% after a first-half 3.7% fall.
"Momentum will continue," said Menezes at a presentation.
EPS will receive a boost in the current year from the fall in the value of the pound. A consensus forecast by analysts polled by Thomson Reuters is that there will be a 15.4% EPS rise, with a further 7.9% increase the following year.
For SA investors who will have to use their offshore allowance to buy Diageo, the share represents an interesting diversification into a group with huge potential still to unlock.