Diageo grows its premium brands

Drinkers are continuing to shell out for high-end products at Diageo (DGE) despite consumer spending headwinds, judging by the 7 percentage points more of net sales that premium-plus brands took against pre-pandemic 2019 levels in the latest year. Company-wide, the 6.5 per cent organic net sales uplift was driven by price increases, which “more than offset the absolute cost inflation impact on gross margin” the company said. Gross margin was up by 150 basis points to 43.7 per cent, and cost control helped organic operating margin expand by 15 basis points. 

Pricing power challenges are evident across the beverage sector. Earlier this week, Heineken (NL:HEIA) said it expected lower full-year profits after “the cumulative effect of pricing actions” led to a 7.6 per cent volume fall in its second quarter. Diageo didn’t cut its guidance despite reporting a 7 per cent annual fall in volumes, with unit selling numbers contracting in seven out of 12 of its key categories. But the outlook statement for 2024 trading was rather vague, pointing to hopes that operating profit will “accelerate gradually” next year.

Diageo posted double-digit sales growth across all its geographic trading posts apart from Africa in the year, with price rises as well as changes in product mix behind the uplift, but the post-Covid comedown in home drinking hurt performance in the key US market. Net sales of tequila, a driver of Stateside spirits growth for Diageo in recent times, may have risen by 15 per cent over the year but growth is slowing. And whisky, vodka, and rum sales fell across the Atlantic.

The centrality of the US market, Diageo’s biggest revenue driver which took almost a third of total sales, to the business was seen in the confirmation of the decision to present the financial statements in dollars moving forwards. This has implications when it comes to currency fluctuations, although ordinary shareholders will continue to receive their dividends in sterling.

Elsewhere, free cash flow of £1.8bn was down by £1bn due to working capital movements, tax and interest payments, and capital investment. The leverage ratio sat at 2.6 times at the balance sheet date, which is at the low end of the board’s target range.

New chief executive Debra Crew, who took up the role in June after the death of longstanding boss Sir Ivan Menezes, warned that she expects “operating environment challenges to persist, with continued cost pressure and ongoing geopolitical and macroeconomic uncertainty”. A valuation of 20 times forward earnings, according to the consensus position on FactSet, keeps us where are. Hold.

Last IC view: Hold, 3,476p, 26 Jan 2023