Diageo Maintains Profit Growth With Move Away From Europe

Diageo Plc, the world’s largest distiller, maintained its pace of profit growth in the first half as it shifted away from the depressed economies of Europe and toward faster-growing emerging markets.

So-called organic operating profit rose 9 percent to 2.03 billion pounds ($3.2 billion) in the six months ended Dec. 31, the London-based company said today, the same pace of growth as in the previous financial year. Earnings exceeded the 2.02 billion-pound median estimate of 11 analysts.

The maker of Johnnie Walker whisky said it now gets 42 percent of sales from faster-growing markets that include Brazil and China. Europe, which in 2007 represented 38 percent of revenue, saw its slice of the total fall to 26 percent. First-half profit increased 23 percent in Latin America and 17 percent in Africa, while declining 3 percent in Europe, hurt by a 19 percent sales decline in the southern part of the region.

“This bipolarity and chronic weakness in Southern Europe is striking and endorses Diageo’s strategy of diversification into emerging markets,” said Martin Deboo, an analyst at Investec Securities in London.

Diageo rose as much as 2.5 percent in London trading, the steepest intraday gain since Sept. 18. The shares were up 2 percent at 1,889.5 pence as of 2:42 p.m., the third-biggest gain in the U.K. benchmark FTSE 100 Index.

Profit growth was led by a 23 percent increase in the Latin America and Caribbean region, where sales gained 18 percent. The distiller’s African earnings rose 17 percent.

North America

“Our expanding reach to emerging middle-class consumers in faster-growing markets was the key driver of our volume growth, while net sales growth was driven by our pricing strategy and premiumization, especially in the U.S.,” Diageo Chief Executive Officer Paul Walsh said in the statement.

The distiller gets the majority of profit from North America, where operating profit advanced 9 percent.

Europe was “a major disappointment,” according to Melissa Earlam, an analyst at UBS AG in London, who had expected earnings in the region to advance 2 percent. In addition to weakness in southern Europe, U.K. sales were little changed.

The region’s declining revenue was the main reason that total organic sales growth missed analysts’ predictions, gaining 5 percent, compared with the median estimate of 5.6 percent.

Sales Goal

Underlying consumer trends should remain the same in the second half, Chief Financial Officer Deirdre Mahlan said today on a conference call, adding that she doesn’t see “any real improvement” in difficult markets. Sales in France declined compared with a year earlier, when consumers and customers stocked up ahead of a tax increase in spirits on Jan. 1, 2012. French consumers still haven’t recovered, she said.

Diageo is seeking to increase profitability over the next three years and expand organic sales, which exclude the effect of currency fluctuations and acquisitions, by an average of 6 percent annually as it sells higher-priced products globally.

“The guidance was a compound annual growth rate, and not meant to be linear,” Mahlan said. “I still feel comfortable in the guidance we gave over the medium term.”

The target is “too challenging” for 2013, Earlam at UBS wrote. She cut her estimate for the year to 5.8 percent from 6.1 percent. “This still implies a second-half acceleration to 6.6 percent, which remains quite ambitious,” she said.

Jose Cuervo

Diageo said today that acquisitions made in the past two years added 300 million pounds to net sales in the first half. The company agreed to buy a majority stake in Indian tycoon Vijay Mallya’s United Spirits Ltd. in November. Local stock-market regulator, the Securities and Exchange Board of India, has raised objections to a clause in the deal, a person involved in the discussions said this month.

There is “nothing happening in terms of the transaction that would suggest to us there were any issues,” and Diageo expects a response from SEBI before the end of the first quarter, Mahlan said on the call.

CEO Walsh declined to comment on the United Spirits deal or whether the company would have to divest some of the Whyte and Mackay whisky brands because of antitrust concerns.

Diageo said in December that talks to buy the Jose Cuervo tequila brand had failed and that it won’t renew an agreement to distribute the spirit in 2013. Walsh said today in an interview on Bloomberg Television that the deal did not “fulfil objectives” for Diageo, and that it will focus on “organic” development of the tequila category.

The first priority in mergers & acquisitions “is always building what you own,” Walsh said at a press conference. “Once you’ve done that, you’re afforded the ability to broaden your credentials via acquisitions.”

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