Diageo Falls as U.S. SEC Inquiry Compounds CEO’s Struggles

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Diageo Plc fell after it said the Securities and Exchange Commission is looking into its distribution practices in the U.S., compounding the distiller’s woes as frustrated investors question the performance of its chief executive officer.

Diageo said Thursday it’s working with the SEC to provide information on its distribution methods, after the Wall Street Journal said the regulator is checking whether the company shipped excess inventory to boost results. The shares fell as much as 2.6 percent in London trading.

Two years after taking the helm with a view that selling drinks is a simple business, CEO Ivan Menezes is grappling with stagnating sales, troubled acquisitions in China and India and a share price that has lagged the European Food & Beverage sector by more than 30 percentage points over his tenure.

“It’s not the best management team in class,” said Thorsten Winkelmann, a portfolio manager at Allianz Global Investors, which holds Diageo shares. He spoke prior to the announcement of the SEC inquiry. “You can see some investors have turned impatient.”

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Menezes has made some moves to improve operations, shifting his finance chief to oversee the U.S. business and selling a luxury hotel in Scotland. Yet investors are asking for more, including the sale of parts or all of the company. Analysts expect a second straight profit decline when Diageo reports full-year results on July 30.

Speculation by Brazilian magazine Veja that investment firm 3G Capital is considering a takeover pushed the stock up as much as 8.7 percent on June 8.

U.S. Quandary

“Diageo has not been firing on all cylinders,” said Kevin Dreyer, a portfolio manager at Gabelli Funds who holds the stock. “There are other ways to unlock value.”

Even before the SEC announcement -- deemed “a further source of distraction to an already embattled management” by Jefferies analyst Martin Deboo -- the U.S. had been a quandary. About a quarter of the bottles Diageo sells fall under the Smirnoff vodka brand, which has suffered from an overexpansion into flavored varieties. The region is Diageo’s biggest and one that Menezes ran before becoming CEO.

Another challenge is its beer business, which includes Guinness stout and Red Stripe lager and saw an 11 percent drop in volume last year.

A sale of beer could fetch as much as 11 billion pounds ($17 billion), bolstered by the potential for growth in Africa and the lower tax rate on Guinness in Ireland, said Simon Hales, an analyst at Barclays. Diageo declined to comment on potential divestments.

Main Obstacle

The main obstacle to a deal may be Menezes himself, who has said Diageo needs beer in Africa to help pave the way for consumption of spirits. The advantage of this strategy is limited. In Nigeria, the company uses separate sales teams and distribution channels for the two beverage categories.

“Beer and spirits are not necessarily an obvious fit,” said Richard Marwood of Axa Investment Managers, who oversees 10 billion pounds including Diageo stock.

Menezes has also paid about $3 billion for deals in countries such as India and China amid an emerging markets slowdown. The biggest acquisition was the buyout of United Spirits Ltd., India’s largest distiller. That business now faces an accounting probe as a report commissioned by the board found the company had diverted funds to companies controlled by USL Chairman Vijay Mallya.

While the push has exposed the company to issues of corporate governance, some investors still see promise in emerging markets and the CEO’s strategy. Others say the company’s failings risk opening a flank to an investor who might push for bigger changes.

“Diageo has underperformed its sector peers,” Societe Generale analyst Andrew Holland said. “It’s the kind of business that may be of interest to an activist investor who would seek to encourage a sale of parts of the company.”