Diageo Results: Shares Up as Sales and Profits Rise

Diageo shares have jumped 2% as the drinks company revealed a large increase in sales and profits for the financial year ending June 30

Philip Gorham 28 July, 2017 | 9:51AM
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Diageo (DGE) shares have jumped 2% as the drinks company revealed a large increase in sales and profits for the financial year ending June 30.

The figures were in line with Morningstar analyst forecasts and showed that as pricing power, the source of the company’s competitive advantage, is returning to the portfolio.

The firm made good progress on reducing costs and announced a £1.5 billion share-buyback programme for the upcoming year.

It has been a long time coming, but Diageo finally is finally delivering pricing-led sales growth; full year organic growth was 4.3%, with a 3.2% contribution from pricing.

This is not spectacular; we think the firm can accelerate growth to the high end of the peer group at around 5% in the medium term, but the improvement is encouraging. In spite of the growing pressure from craft producers, we still believe premium spirits is an attractive category.

Diageo Returns to Historic Growth Levels

Diageo products are consumed in a social environment and often given as gifts, both purchase occasions in which the consumer is less price sensitive. Historically, Diageo could achieve 4% pricing fairly consistently, but it has been subdued in recent years, hovering around the 1% mark since 2014 as management managed price gaps to competitive products. This year's performance, however, shows that historical levels of pricing can be achieved again when inflationary pressures return to the global economy.

Diageo added 120 basis points to the earnings before tax margin this year, although a boost from weak sterling exaggerates the expansion. Management expects to add a further 75 basis points to its 2019 margin.

Another pleasing aspect of Diageo's results was the consistency of growth across the portfolio and across markets. No region saw organic sales growth of less than 3%, and most of the main portfolio categories except vodka and rum made positive contributions.

Reserve brands grew by 7% but are no longer the only contributor, and the "global giants" portfolio grew by 3%. Johnnie Walker posting organic growth of 6%, with 4% volume growth, was particularly pleasing. Vodka appeared to deteriorate sequentially in the second half of the year, however, as volumes remained down 2% despite an easing of pricing by 2%. With craft producers eating into the shares of the large vodka brands, we do not expect vodka sales to contribute to growth next year. 

While we are enthusiastic about this report, we are also cognisant of challenges on the horizon. The Brexit process will bring challenges, both in the short term through possible currency volatility, and in the long term through the potential for higher tariffs on scotch exports.

Weakness in Guinness sales may be a sign of things to come, as Anheuser-Busch InBev moves into Africa. We are also keeping a keen eye on the progress of craft producers in the spirits category, as this could be a structural headwind to long-term cash flow growth.

However, with a portfolio that still appears to carry pricing power at the high end of the global consumer sector, Diageo should be better positioned than most to deal with the challenges ahead.

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.

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Philip Gorham