After years of consistent growth, Diageo saw a downturn in 2014, with revenues undergoing an 8% decline amid a slowdown in the U.S. spirits market, “anti-extravagance” in China, unfavorable currency movements in key markets, and lower revenues from acquisitions. However, this slowdown in revenues could very well be a temporary phenomenon leading to the stock touching new heights, going forward. Here are the top reasons why
- Acyclicality in alcohol consumption: Diageo has much to gain solely based on the kind of business that it is in. For one, alcohol as a product is generally acyclical, or slower to respond to business cycle downturns, in light of its addictive properties. Some studies suggest that people continue to drink even during recessions, but might alter venues (home instead of bars) or opt for cheaper alternatives. Data collected during the 2008 recession finds that alcohol sales increased almost 9% when unemployment rates hit 5.8% and maintained this growth even in 2010 when unemployment rates reached as high as 9.3%. A relative resistance to crisis situations could put Diageo in a better position than other companies, especially as the spirits giant is well-equipped to face such circumstances with a product portfolio ranging from ultra premium offerings such as Cîroc and Blue Label, to value offerings such as VAT 69 and Rowson’s Reserve.
- Strong brand portfolio ensure competitive advantage: Diageo is the owner of some iconic brands such as Smirnoff, Johnnie Walker, Baileys, Don Julio, and Guinness, all of which are the market leaders in their respective categories. In spite of volume declines for key brands such as Smirnoff, Johnnie Walker, and Guinness over the last year, these brands have a certain competitive advantage and market dominance that is sure to remain, going forward. Furthermore, the fact that Diageo dabbles across spirits, beer, and wine, safeguards them against changes in tastes and preferences, to a large extent. For instance, in FY 2014, a slump in volume sales of a number of key brands, such as Johnnie Walker and Smirnoff, was offset to a large extent by double-digit growth in brands such as Don Julio.
- Exposure to emerging markets could be an advantage: While developed markets can prove to be great sources of revenues, most multinationals expect emerging markets to be the key drivers of growth in consumer goods. Given this, Diageo has directed significant resources to form a solid presence in key emerging markets in Asia, Africa, and Latin America. Emerging markets currently account for approximately 42-45% of the total sales, and this figure is expected to increase further against higher disposable incomes, which are expected to grow by approximately 5.6%, as opposed to 2.3% in more advanced countries. Diageo has taken a number of steps to leverage the growing potential in emerging markets. This includes the recent acquisition of a stake in
United Spirits Limited, India’s largest spirits company, to reach out to the budding middle class population in the country. Furthermore, Diageo also took over Don Julio last year, which is expected to give them a strong hold over Mexico.
- Operational changes indicative of growth: Lastly, certain changes within the organization are also suggestive of higher potential for the business in the long term. Recently, Diageo has taken a number of steps to improve cash flows, which more than doubled in the first half of fiscal 2015 (ending December) in spite of flat sales and lower net incomes. Diageo has set forth plans to cut costs and improve efficiency to be able to save approximately £200 million (or $304 million) per year by June 2017. Furthermore, the company has indicated a higher focus on high-margin brands, as evidenced by the end of a distribution deal with Jose Cuervo, a lower end tequila brand, in fiscal 2014. Instead, Diageo has chosen to channel resources towards the fast-growing premium tequila brand, Don Julio. Diageo’s altered focus toward returns rather than volumes may just prove to be beneficial, to ensure profitability going forward.
Although the aforementioned points indicate better performance going forward, a number of headwinds persist that could prove to be obstacles. Top among this is adverse currency movements. Since Diageo functions in a number of international markets, they are often exposed to risks associated with fluctuations in exchange rates. In the first half of fiscal 2015 (ending December), the company reported an EPS of 53.7 pence (or $0.87), which was almost 17% lower than what was reported the previous year. Furthermore, a constantly climbing U.S. dollar, and the consequent increase in the price of Diageo’s offerings in local currencies, has managed to stifle demand to reduce volume sales. However, currency related losses may just be temporary and could turn around for the better, going forward. Many economists expect the U.S. dollar to ease especially as the Federal Reserve acknowledges how a strong dollar has been curtailing growth for the U.S. economy.
In general, 2014 may just have been a bad year for Diageo. The simple fact that the company operates across so many geographical locations allows them to hedge against risks associated with any particular market. However, 2014 just happened to be one of those years where every market was troubled — right from the Chinese anti-extravagance, crisis situations in many oil-exporting countries, to changing tastes and preferences in key markets, like the U.S. Given that last year was more or less an exception to an otherwise strong business, Diageo might be headed for stronger performance in the longer term, after facing some headwinds in the short term.
Trefis has a $116 price estimate for Diageo, which is almost in line with the current market price.
See Our Complete Analysis For Diageo Here
View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
Like our charts? Embed them in your own posts using the Trefis WordPress Plugin.
