Diageo toasts European gin drinkers as North Americans eschew vodka

Reported net sales of £6.5bn in the six months ended 31 December were 1.7% higher than the same period the year before and in line with the average analyst forecast, while profit before tax was up 6.2% to £2.2bn. Organic profit growth rose 6.7%, versus a City analyst consensus forecast of 4.3%.

First-half organic volumes growth of 1.8% was only just short of City expectations of 1.9%, while net sales growth of 4.2% compared well with consensus forecasts of 3.7%.

Ramping up marketing investment in brands such as Guinness, Tanqueray gin and various Johnnie Walker whisky variants, the FTSE 100 group expanded organic operating profit margin 138 basis points to 33.5% thanks to efficiencies from the productivity programme.

By region, North American organic volumes grew 1% as they had in the last full year but net sales growth was just 2% as growth from most brands was partially offset as vodka net sales declined 8% primarily driven by Cîroc and Ketel One vodka, with Smirnoff down 2%. An 8% increase in marketing in North America held back operating margin growth to 6bps.

In Europe, volumes and net sales grew 4% and 5% respectively, primarily driven by the growing category of gin, where Tanqueray gained market share and Gordon's benefitted from the launch of its pink variant. Operating margin improved 239bps.

Asia Pacific volumes shrank 12% at the reported level and 1% organic, though organic net sales increased 7% with strong growth in China and solid performance in India, South East Asia, and travel retail and the Middle East offsetting a decline in net sales in Australia and scotch in Korea, while Indian sales were hit by a curbs on sales near state highways. Operating margin increased 204bps.

Chief executive Ivan de Menezes, who a year and a half ago set a target of expanding organic operating margin by 175 basis points, said the board's financial expectations for the full year remained unchanged.

Basic earnings per share for the half-year increased 36% to 82.2p, though allowing for exceptional items EPS was up a lesser 9.4% to 67.8p, driven by higher organic operating profit and lower finance charges. The interim dividend has been increased 5% to 24.9p per share.

Heading into 2018 Menezes was bullish: "By consistently delivering on our six strategic priorities, Diageo continues to get stronger: we have better consumer insight through superior analytics, improved execution on brand and commercial plans and have embedded everyday efficiency across the business through our productivity initiatives. This has enabled continued growth, improved agility, and consistent cash flow generation."

MARKET AND ANALYST REACTION

Diageo shares, which had fallen since Christmas after a strong run, climbed more than 1% to 2,569p on Thursday morning.

Analyst Phil Carroll at Shore Capital said it was a strong performance overall, with sales and operating profit growth both coming in ahead of market expectations.

"The productivity work is seemingly becoming very effective and is driving strong bottom line leverage. We would suggest however the outperformance probably helps underpin FY expectations rather than suggest underlying upgrades although the analyst presentation may reveal more where management have guided to more H2 weighting in terms of performance."

He noted that FX guidance has turned to an adverse impact of £60m on operating profit so a 1.5% headwind but the guidance on tax is one percentage point lower so an offsetting tailwind to the FX.

Neil Wilson at ETX Capital was also impressed. “It’s customary to raise a glass or three to the bard around this time of year so it certainly seems apt timing for Diageo interims," he said. "And while scotch continues to be the biggest contributor to Diageo sales, the resurgent gin market is now proving to an important driver of growth."

He noted that Scotch represents 27% of sales and was up 3% with broad based growth across all regions, with a good performance in beer, which represents 15% of sales and grew 4%, while only Smirnoff of Diageo's ‘global giants’ brands to see a decline in sales.

"Elsewhere, we saw a good Gin (see Fevertree) was a strong performer, no doubt boosted in large part by the UK’s burgeoning ‘gin craze’. Sales in this category were 16% ahead of last year, with Gordon’s and Tanqueray both enjoying double digit growth. However this remains a relatively small source of earnings, contributing 4% of net sales."

Wilson pointed out that Casamigos, the super-premium tequila brand that Diageo shelled out $1bn to acquire from George Clooney and friends, contributed a fairly meagre £20m to net sales and £2m to profits. Tequila sales actually jumped 43%, but this was driven by double digit growth of Don Julio in the US and Mexico.