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Diageo's (DEO) FY14 Earnings Decline on Macroeconomic Woes

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Diageo plc’s (DEO) earnings in fiscal 2014 (ended Jun 30, 2014) went down 7.6% year over year in local currency to 95.5 pence ($1.60* per share) from 103.1 pence ($1.61** per share) in the year-ago period.

Weak sales results due to macroeconomic headwinds and tough retail condition in emerging markets lowered profit during fiscal 2014.

On a reported basis, net revenue (i.e. total revenue excluding excise duties) declined 9% in local currency in fiscal 2014. On an organic basis, revenues fell 0.4%, while volume declined 2% from the prior-year level. Volume growth in reserve brands was largely offset by decline in beer and scotch in the emerging markets.

Diageo reduced its marketing spending by 1% organically in fiscal 2014. Operating profit before exceptional items (excluding acquisitions and disposals) went up 3% year over year on an organic basis.

Segment Details

All the regions, except Western Europe and Asia Pacific, delivered positive organic sales growth.

In North America, Diageo’s organic sales increased 3% in fiscal 2014, backed by 5% and 6% year-over-year growth in U.S. Spirits and Wine, respectively. Marketing spending increased 10% in the region, primarily backed by a 3-percentage-point benefit from procurement efficiencies. Operating profit declined 4% organically in the fiscal year. In Canada, net sales grew 1% as strong growth in reserve brands backed by the Ciroc and scotch malt brands were offset by the general slowdown in the economy.

Sales of Beer and Ready-to-Drink declined mainly due to increased competition and supply disruptions 

In Western Europe, organic sales and volume remained flat as modest growth in Great Britain, Benelux, France and the Nordics offset the slowing decline in Southern Europe and Ireland. Operating profit also remained flat as higher production efficiencies were offset by an increase in marketing spend on premium core, innovation and reserve brands. Efficiencies in procurement and promotional activities were used to fund a 15% increase in media spend.

Diageo has started reporting Africa, Eastern Europe and Turkey as a new geographical segment from fiscal 2014. This segment's organic sales increased 11%, with 4% volume decline due to specific market challenges in the region. Marketing spending increased 1% in the region, particularly on commercial activations and new brand building initiatives. Operating profit declined 18%.

The Latin America and Caribbean region delivered modest performance in the fiscal year, with organic sales growth of 2% and volume decline of 1% backed by strong growth in Venezuela and Paraguay, Uruguay and Brazil (:PUB), partially offset by slowdown in Mexico. The company also increased its marketing spending by 1% to enhance the brand equities in its reserve brands. It also benefited from advertising during FIFA World Cup and foraying into new outlets.

In the Asia Pacific region, sales slipped 7% due to weaker trading environment in China and South East Asia. However, the company gained share in scotch in both Thailand and China. Marketing spending slipped 7% mainly due to lower spend in international spirits in China and South East Asia.

The company is increasing marketing investment in all the geographical segments and is focusing more on its premium brands. The strategy of converting to high-margin high-priced products is helping the company improve its margins.

Diageo is expanding fast into the emerging markets. The company holds 27.4% ownership in United Spirits Limited, a leading spirit company of India.

Currently, Diageo carries a Zacks Rank #3 (Hold). Other companies in the same sector worth considering include Boston Beer Inc. (SAM), Castle Brands Inc. (ROX) and Molson Coors Brewing Company (TAP). While Boston Beer and Castle Brands sport a Zacks Rank #1 (Strong Buy), Molson Coors carries a Zacks Rank #2 (Buy).

*£1=$1.62647 (average price of the year ended Jun 30, 2014).

**£1=$1.56910 (average price of the year ended Jun 30, 2013).

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