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Diageo sets its sights on value growth

The drinks giant is not short on ambition in a mature, well-established market
November 17, 2021

It may seem like a case of overreach, but Diageo (DGE) has hatched plans to capture a greater share of the global booze market. Indeed, you would instinctively think that it already controls a fulsome slice of the market given the ubiquity of brands such as Guinness, Johnny Walker and Smirnoff. Given that the first solid proof of beer brewing comes from the period of the Sumerians, this is unquestionably a mature, well-served market.

The drinks giant currently accounts for around 4 per cent of the value of the global market but plans to increase that to 6 per cent by 2030. That’s probably more realistic than some of the decarbonisation pledges doing the rounds, but it’s certainly not short on ambition, either.

The new target was set at the group’s biennial Capital Markets Day, a chance for management to convince investors about the viability of the group’s business model in the face of secular trends, chiefly more moderate alcohol consumption. This represents a stumbling block for any companies that are looking to boost volume sales in the coming years, especially as this form of puritanism is most prevalent within the Millennial and Gen Z demographics. More than a quarter of 16- to 24-year-olds don’t drink, compared with just over a fifth of the general adult population.

Of course, the absolute value of the drinks market declined during the lockdowns even though off-licence sales increased dramatically. That’s because the on-trade generates greater sales and unit profitability, so the closure of pubs and restaurants reduced the value of sales volumes on a proportional basis. UK value sales of alcoholic beverages contracted by an annual rate of 20.6 per cent to £39.4bn in 2020, a function of the shift from on-trade to lower-priced off-trade channels.

And it’s becoming a structural trend. Research published prior to the pandemic by the British Beer and Pub Association (BBPA) and the Office for National Statistics shows that pub numbers have been decreasing steadily for several decades. From 2000 to 2019, UK pub numbers declined by 13,600, or 22 per cent. Anecdotal evidence also suggests that some consumers are opting for home entertaining even after the reopening of hospitality venues, possibly out of fear of infection, but also possibly because of a squeeze on discretionary household income is from rising inflation.

None of this has cast a pall over Diageo’s near-term prospects. The group anticipates organic sales growth of at least 16 per cent in the first half of FY 2022, with profits expanding at an even higher rate. Lavanya Chandrashekar, chief financial officer, points to organic net sale growth across all the group’s locales, with a boost to the organic operating margin, “despite rising inflationary pressures, which are partly due to supply chain constraints”. Looking further out, management forecasts growth rates of between 5 and 7 per cent in the years between 2023/25, against a 4 to 6 per cent range from 2017 to 2019.

Investors love clarity, to say nothing of the promised near-term growth, although Chandrashekar did warn on tough second-half comparators. Nevertheless, the shares rose to an all-time high in reaction to the news, although the indicative value of the new target equates to approximately £10bn at current prices, which represents a lot of extra hooch.

Naturally, M&A will figure prominently in Diageo’s plans, it always has done, but there are other ways to boost the overall value of its sales beyond hawking ever more units. Take premiumisation. This is a clunky term, no doubt coined by marketing folk, yet nonetheless an effective means to that end. By narrow definition, it is the practice of making a brand appeal to consumers by emphasising its superior quality and exclusivity. And you can appreciate why brewers and distillers have gone down this road, particularly in view of the growth of an aspirational middle-class in China.

Consider whisky – I regularly do. Just prior to the pandemic, exports of Scottish single malt whiskies had increased by around 19 per cent in the first six months of 2019. They now account for roughly a third of Scotch shipped abroad, a leap from less than 10 per cent in the early 1990s – that's impressive growth. Diageo owns some of the largest exporters of blended whiskies, but it has also brought brands such as Lagavulin within the fold to exploit the premiumisation trend.

Of course, there is always a chance that consumers may simply choose to down-trade due to the impact of Covid-19 on their finances, so the path towards an effective 50 per cent increase in market sales value, like the way home from the pub, might be a little more tortuous than originally envisaged.