In the Spotlight – Diageo dangles M&A as results disappoint

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Diageo is openly seeking more acquisitions in emerging markets and might even have a pop at Jim Beam, but the bullish talk was not enough to crush investors’ disappointment at the drinks giant’s half-year results. Here, just-drinks examines the market reaction.
It is a curious feature of the speculative financial world that, sometimes, a double-digit rise in profits is simply not good enough. So it was for Diageo yesterday (10 February), when it served up a 17% increase in net profits for its half-year, while net sales rose by 2%.
Not bad, you might think, considering the dazed state of the world’s economy. “Not good enough,” cried investors, however. Diageo’s share price sank by 4% after it missed analysts’ profits estimates.
Group CEO Paul Walsh declared himself “perplexed” by the share drop at yesterday’s press conference. He suggested that some observers should have added two and two (or should that be ‘minus two’) together on the flimsy nature of the economic recovery. Diageo itself has not particularly talked up its prospects over the last six months, saying only that operating profits growth for the full-year would be stronger than last year.
That said, there is cause for concern about the group’s operations in key European countries and, perhaps more surprisingly, in China. Sales in Europe fell by 7% on a reported basis, with operating profits for the region down 10%. Double-digit gains in Russia were not enough to offset problems in Spain, Ireland and Greece, which account for half of Diageo’s European sales.
Sanford Bernstein subsequently reduced its full-year earnings estimate on Diageo by 2.5%. “Europe was much worse than our expectations on the bottom-line,” said the analyst group in a note. Bernstein also expressed concern about China. “Disappointingly, organic net sales declined 3% in China, likely much weaker than their global competitors, and in our view only partially explained by the absence of Cognac in the portfolio.”
Investec analyst Martin Deboo joined in the gloom. “A poor result with further hangovers to come,” he said.
“Others, however, were willing to give Diageo the benefit of the doubt. Morningstar analyst Philip Gorham said: “First half results were broadly very positive, and we expect our thesis that the firm’s strength in premium categories should position it for solid long-term growth to play out over the next few months.”
“Gorham was sanguine about tough conditions in mature European markets. “We think it may now take slightly longer for these markets to stabilise than we had initially thought,” he said, adding: “However, Diageo remains an emerging markets story, and its solid growth in developing markets is likely to continue unabated through 2011.”
Mergers and acquisitions chatter has dominated a lot of the results coverage of late, with Paul Walsh unusually forthcoming on Diageo’s plans. Was this a tactic to steer the news agenda away from Europe, or genuine transparency? Probably a bit of both.
Walsh told journalists that Diageo is seeking more acquisitions in developing markets and he said that, in respect to the possibility of Beam Global Spirits & Wine becoming available, the group “would look at everything” that comes up. Could 2011 be the year that the group’s warchest is unlocked?
Several press articles went this way. The Scotsman, as an example, spoke of Diageo’s plan to unleash “many billions of pounds” on takeovers. Some deals may, however, remain beyond the Guinness brewer’s grasp. The Australian newspaper reported Walsh as saying that a move for Moet Hennessy looks unlikely any time soon. “I think he is keen to keep it,” Walsh reportedly said of LVMH head Bernard Arnault.
Over the next six months, then, Diageo is clearly going to try to take more costs out of its businesses in weak markets like Spain, Ireland and Greece. At the same time, though, the group’s Johnnie Walker-shaped star in Asia shows little sign of dimming and Africans continue to thirst after its beer. North America could be a key region to watch in the second half, with early signs of improvement in the US spirits market.
Diageo may have got a bloodied nose, then, but it is far from on the ropes. Prepare for calendar 2011 to be an interesting year as the group seeks to expand its footprint in emerging markets and, just possibly, new product categories. Jim Beam on the rocks, anyone?