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Diageo Can Withstand China Weakness

Although it is creating some near-term volatility, we like the long-run potential for growth in China and we expect Diageo to increase its exposure through acquisitions of local players

Philip Gorham 14 August, 2015 | 12:45PM

Diageo (DGE) remains one of our best ideas following the devaluation of the Chinese yuan. Despite its 2013 acquisition of ShuiJingFang, Diageo is relatively insulated from the Chinese market, and while the devaluation will certainly be a negative for reported results, we doubt it will have a meaningful impact on Diageo's sales growth. In fact, we continue to believe Diageo is an attractive idea for investors who can see through the near-term China risks. We think the firm has a wide economic moat due to its importance as a vendor to both on- and off-trade customers as a result of its portfolio in large categories, and we think it is on trend to benefit from long-term premiumisation in alcoholic beverages.

China is a small market for Diageo: The global leader in spirits boasts a broad geographic footprint, and we estimate that China accounted for around 3% of net sales in 2014. Granted, this proportion is lower after the decimation of Diageo's sales of baijiu in China, including a 78% drop in sales of the white spirit in fiscal 2013/14. Partly as a result of that decline, Diageo is today less exposed to China than most of its peers. For example, we estimate that China represents almost 13% of Pernod Ricard's (RI) sales and 15% of its EBIT, and is that firm's second-largest market. Remy Cointreau (RCO) is even more exposed, with as much as 30% of its revenue coming from China.

Although it is creating some near-term volatility, we like the long-run potential for growth in China, and we expect Diageo to increase its exposure through acquisitions of local players. The crackdown on conspicuous consumption has reset the base for consumption in the country, and absent any further government actions, we expect above-GDP levels of value growth in the high-end spirits market. International premium brands represent just 1% of total spirits consumption in China, and the runway for growth is generational, driven by millennials' growing disposable income.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Diageo PLC3,114.00 GBX-0.14
Pernod Ricard SA168.00 EUR-1.44
Rémy Cointreau122.40 EUR0.33

About Author

Philip Gorham  

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