Strong Earnings Growth Reaffirms Diageo’s Growth Story
Diageo (NYSE: DEO) reported its results for the first half of FY 2019 (six months ended December 30, 2018) on January 31, 2019, and held a conference call with analysts on the same day. Beating analysts’ expectations, Diageo reported organic net sales growth of 7.5% in 1H 2019, driven by good volume performance and good price mix with growth being broad based across categories and regions, including the three focus areas of scotch, US spirits, and India. After accounting for foreign exchange impact, organic net sales grew by 5.8%, partially offset by unfavorable foreign exchange and impact of disposing of a portfolio of 19 brands to Sazerac. Pre-exceptional EPS for the same period increased by 13.6% over the corresponding six-month period in the previous year on the back of higher operating profit and lower finance charges, which more than offset higher tax expenses, largely as a result of a one-time benefit from US tax reform in the prior year period.
(Source: Diageo’s Latest Earnings Presentation)
We have summarized the key takeaways from Diageo’s earnings in our interactive dashboard – Diageo’s Financial Performance In First Six Months Of FY2019.
Key Factors Affecting Diageo’s Results
Growth across geographies: Diageo witnessed healthy sales growth in all its geographical segments. North America delivered net sales growth of 6%, with the disposal of 19 brands to Sazerac in December 2018 positively impacting net sales growth by 78bps. DBC USA and Canada net sales increased 13% and 5%, respectively, with good performance in both ready to drink and beer and prior year innovation launches. The European segment delivered net sales growth of 5%, with Western Europe gaining 6% share in gin; and 28% growth in the ‘ready to drink’ segment driven by strong growth across Gordon’s premix range. Net sales in Turkey went up by 10% driven by inflation and excise led price increases. Benefiting from prior year weakness following the presidential election in Kenya, East Africa net sales grew by 13%. Latin America and Caribbean delivered 9% growth in net sales with strong performance in Mexico, Colombia, and CCA, which benefited from lapping the impact of last year’s hurricanes.
Impressive growth in APAC, led by India: Asia Pacific net sales grew 13% with strong growth in Greater China, India, South East Asia and Travel Retail Asia, and Middle East. This was partially offset by the continued contraction of the scotch category in Korea. Greater China grew 20% driven by strong performance in both scotch and Chinese white spirits. Net sales in India grew 12%, largely driven by both IMFL whisky and scotch in the prestige and above segment. India accounted for nearly 60% of the total volume growth of the company, benefiting from clarity on the law related to sale of alcohol in proximity to highways as well as completion of over one year of the implementation of GST.
Broad-based growth across categories: 1H 2019 net sales growth was broad-based across all categories of the company, with the exception of rum. Scotch – Diageo’s largest category – grew by 7%, driven by a 9% increase in sales of Johnnie Walker on the back of the successful launch of “White Walker by Johnnie Walker” inspired by the TV series Game of Thrones, which resonated with the huge fan base. In the Vodka category, where net sales grew by 3%, growth from the Ketel One Botanical innovation roughly offset declines in Smirnoff and Cîroc vodka. Outside the US, vodka net sales increased 6%, with growth in every region. Net sales in IMFL whisky were up 11% driven by prestige and above brands. Diageo India delivered a solid performance, as a result of good execution and lower results last year. Strong double-digit sales growth and continued share gain in Europe helped net sales in the gin category accelerate by 28%. In tequila, net sales increased 29% with both Don Julio and Casamigos delivering strong growth and share gains in the US. However, net sales of rum declined 3%, largely driven by a 9% decline in Captain Morgan net sales in US Spirits, as a result of category weakness and a strong performance in the previous year. Outside US Spirits, net sales in Captain Morgan were up 4%.
(Source: Diageo’s Latest Earnings Presentation)
Higher margins: Reported operating margin increased 164bps driven by organic operating margin improvement and the positive impact on operating margin due to exchange rate, as a result of the higher negative impact of exchange rates on net sales relative to operating profit. Organic operating margin improved 152bps driven by improved price/mix and efficiencies from Diageo’s productivity program partially offset by a higher marketing spend. The company also benefited from phasing of productivity related costs. However, it has spent less than expected on its marketing programs in the first half of the fiscal by pushing a larger portion of expenses into the second half. Thus, we believe that margin growth will likely be subdued over the next half, compared to the six months ended December 2018.
(Source: Diageo’s Latest Earnings Presentation)
What is in store for FY 2019?
For FY 2019, we expect net sales to be approximately $17.5 billion, which marks a 3.8% rise over net sales in the previous fiscal. Revenue growth will mainly be driven by revival in the APAC segment, mainly India and China, and strong growth across all product offerings. North America will continue to be the largest contributor to net sales. The recently implemented productivity program which focuses on everyday efficiency and driving out cost across its business, along with increased sales, would drive margins higher and lead to growth in earnings per share for the year.
We have a price estimate of $155 for Diageo, which is higher than the current market price. In 2018, management approved a new share buyback program to return approximately £1.3 billion to shareholders in FY 2019. In January 2019, Diageo enhanced the program by an additional £660 million, which takes the total repurchase program to over £3 billion. Additionally, the company has also increased the interim dividend by 5% in January 2019. We believe that increased revenue and productivity, higher margins, and enhancement in shareholder return programs will support Diageo’s stock price in 2019.
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