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Diageo marches to more upbeat tune

The bagpiper striding across the bottle label wears flowing green tartan, a luxuriant black moustache — and a red turban. Bagpiper whisky, distilled by Diageo through its United Spirits subsidiary in India, is one of India’s most popular brands, available even in a tetra pak.

But at Rs300 ($4.50) for a 750ml bottle, it is not a brand that will power a rapid return on Diageo’s £1.9bn investment on its majority stake in United Spirits.

Bagpiper is one of a growing list of mass-market Indian brands that Diageo has started franchising in some states, enabling it to focus on selling more expensive liquor in India, such as its Royal Challenge and Signature whiskies.

Ivan Menezes, chief executive, says the management team, put in place after Diageo took control from United Spirits’ mercurial founder, Vijay Mallya, in 2014, will unbottle India’s potential.

“We’ve really got our mojo back in the prestige Indian spirits market, which is where [United Spirits] had underperformed for many years. It’s been a lot of hard work but I’m pleased with where the business is today,” says Mr Menezes.

Diageo, whose brands include Johnnie Walker whisky, Tanqueray gin and Guinness beer, is the biggest distiller in India. The country is its second-largest market by value and volume, but analysts estimate it contributed just 1.5 per cent to group operating profits of £2.8bn last year.

North America, Diageo’s biggest region, accounts for 49 per cent of profits.

In India, Diageo is playing catch-up with Pernod Ricard. Its French rival has “a portfolio of mainly premium drinks with retail prices that are on average 45 per cent higher than those of Diageo”, according to Ed Mundy, analyst at Jefferies. Pernod’s operating profit margins of 25 per cent in India, are more than double those of Diageo.

But Mr Menezes says United Spirits’ operating margin will rise to “the high teens” within five years from 10 per cent today.

“We’re doing that through moving the centre of gravity of the business up to the higher price points. We are franchising some of the lower price points because we really want to keep the focus on the higher end,” he says.

Diageo has only recently had a free hand with United Spirits after Mr Mallya resigned as chairman last year. He left as part of an agreement under which Diageo paid the self-styled King of Good Times a controversial $75m.

The payment has attracted the attention of India’s markets regulator, Sebi. Asked whether the problems with Mr Mallya are in the past, Mr Menezes says: “Yes. We’re very clear on our position and are working our way through the process with Sebi.”

Sat in Diageo’s Soho offices — its central London outpost -— the 57-year-old looks more relaxed than in a long time.

Ivan Menezes, Diageo chief executive, says putting consumers ‘at the heart of the business’ has helped the company steer its turnround © FT montage / Bloomberg

Diageo’s interim results in January showed a 15 per cent jump in pre-tax profits and were hailed by analysts as finally marking the group’s turnround.

The uplift comes after three years of slowing annual organic sales growth that started when Mr Menezes took the helm and emerging markets’ economies began stalling.

James Edwardes Jones, analyst at RBC Capital Markets, says the results were: “the most impressive that we can remember — and certainly the best performance since Ivan Menezes took over”.

Johnnie Walker, the group’s biggest money-spinner, is back in growth, though Smirnoff, squeezed in a crowded vodka market, is “still work in progress”, acknowledges Mr Menezes.

In the US, Diageo’s sales are below the industry average but Javier Gonzalez Lastra, analyst at Berenberg, says that “although Diageo continues to underperform its peers” in the country, “the gap between the company’s and the market’s growth has closed considerably”.

Mr Menezes expects to close that gap by the summer.

In China, the group’s baijiu white spirits business has recovered strongly after a pummelling and the performance in Africa and Latin America was better than analysts’ expectations.

“We had all our regions in growth. We had the US, scotch and India — which were our three very important priorities — perform well,” says Mr Menezes. “Where the business is trending right now, is very much a function of the hard work around putting the consumer at the heart of the business and de-layering the organisation by removing big regional structures.”

The shift to focusing on selling to consumers — rather than retailers and distributors — was painfully slow and contributed to Diageo’s underperformance, especially in the US.

But the world’s largest distiller is now able to respond more quickly to often fickle consumer tastes, helped also by automated systems. By way of example, Mr Menezes seizes a bottle from a trolley of Diageo drinks.

“Here it is. Baileys with almond milk. There’s a huge trend of dairy-free, so we developed this. Rather than research it forever, we took it quickly into a couple of southern states in the US. We learnt, in action, who was buying it and how they were drinking it. That data suggested this [variant] was very good for the Baileys franchise. So we’ve gone national with it.”

In the US, President Donald Trump’s threats to change the Nafta regional free-trade agreement could pose a problem for Crown Royal, Diageo’s popular Canadian whiskey.

“You could bottle it in the US; a bit like German cars made in the US,” muses Mr Menezes, but adds that “it’s too early to have a definitive view” about Mr Trump’s policies.

The UK’s trade agreements are even more uncertain. As head of the world’s largest producer of scotch — which can only be produced in Scotland — Mr Menezes came out against Brexit, citing the threat to free-trade agreements.

One positive now, he says, is the potential for the UK eventually to strike a free-trade agreement with India more quickly than the EU.

Another positive, analysts say, is that the UK-based company’s high dollar earnings make it a big beneficiary of the 20 per cent fall in the value of sterling since last year’s vote to leave the EU.

Diageo estimates that the weak pound will boost operating profits this year by £460m — £303m of which came in the first half. This has cheered the shares which are 23 per cent higher than a year ago.

Diageo last year launched a £500m cost-cutting and efficiency drive, helped by zero-based budgeting. This annual scrutiny of costs from scratch, wielded vigorously by the Brazilian founders of Anheuser-Busch InBev and 3G Capital, has set a new, higher norm for profitability among consumer companies.

Mr Menezes says two-thirds of the savings will be reinvested but some analysts expect Javier Ferran, Diageo’s new chairman, to use his private equity experience to drive further savings and, possibly, mergers and acquisitions.

Diageo already has “aggressive goals”, says Mr Menezes. Now it needs to deliver them.

“In the emerging markets, [spirits’] penetration is still low; in Europe and in the US, consumers are moving away from beer and wine, towards spirits — premium spirits,” he says. “So the perfect blend for Diageo is to drive efficiencies very hard but then reinvest. This is a growth company.”

Via FT