Diageo plc (DGE) Earnings Call Transcript & Summary

Good morning and afternoon. Welcome to the Diageo Greater China President's Call hosted by Sam Fischer, President of Diageo, Greater China and Asia Pacific. This is a live Q&A session for 30 minutes following the prerecorded presentation that was made available on diageo.com earlier today. This call is being recorded. [Operator Instructions] We are now ready to start the Q&A.

Our first question from -- our first question comes from Mitch Collett with Deutsche Bank -- with Credit Suisse. I apologize, we'll take our first question from Sanjeet Aujla with Credit Suisse.

Just a couple of questions from me, please. Firstly, you highlighted the exceptional growth of the Greater China business, around 15% CAGR in recent years. I guess with scotch now starting to accelerate, do you think there could be upside to that over the next few years? And my second question is just around e-commerce. For scotch, how significant is that now as a part of your scotch business? I think a couple of years ago, it was around mid-teens. I'd just like to get a feel for how that's progressed since then.

Hi, Sanjeet, and hi, everybody else on the call. Welcome to our Greater China Q&A. Just in relation to our performance in scotch, generally, I think through the presentation, we talked into our confidence around the progression of scotch. It's still relatively small, with only 3% penetration rate. But with the work we've done in the last -- over the last 3 years, really trying to build the credit category from a credentials perspective. And I do think we've got confidence in the green shoots that we've seen. We have been working on whiskey summits, whiskey boutiques, whiskey -- Diageo Whiskey Academy, which is all about educating people around this category, the credentials of the category, the craftsmanship, the heritage that goes into it. So we talked about sort of enhanced penetration in some provinces that had given us confidence. We've seen interest in whiskey in -- sorry, online options. So I think the runway is really long, and we've got lots of confidence in our future. In relation to e-commerce, we have been investing in e-commerce also for a long period of time. We're #1 with scotch on the e-commerce platform, and we've got about 20 people now working specifically on e-commerce. I think it represents just over 15% of our business today, no reason to think that, that won't continue to increase as e-commerce as a channel continues to be more prevalent in China. [ Casey ], can you hear me? I seem to have lost connection. [ Harriet ], can you hear me? Can anybody hear me?

Yes, we can hear you [ fine ].

We'll take our next question from Richard Withagen with Kepler.

I have two questions. First of all, are you using tools like Catalyst and EDGE in China? And how useful or effective are these in the country? And then secondly, do you see an opportunity for other whiskeys like Bulleit or Crown Royal, given also strong growth rates for other whiskeys and scotch?

Thanks for the question, Richard. Yes, look, I think we do use Catalyst and EDGE and many more of the Diageo tools to drive effectiveness and also efficiency in our business in China. We talked a little bit about our sales force automation. Where we've got through the sales force an ability to see into some of our core stores real time what's going on with our execution and sales performance, et cetera. So again, these are all technologies that we've lent from Diageo we'd implemented in China and making are making a big difference our execution. When it comes to whiskey generally, I mean, scotch is the bulk of the whiskey category, and at only 3% penetration, we've got a lot of work to do to continue to drive that penetration in our core provinces, but also more broadly across the country. So #1 for us is to continue to build the power brands we have in scotch, particularly behind Johnnie Walker Blue Label, Singleton, Talisker and Mortlach. And the runway we've got with scotch is huge. We are feeding other brands in the form of an -- and I talked a little bit about Baileys and Guinness and our Reserve portfolio. I mean Reserve and Bulleit would sit within that. But the core focus for us remains developing our scotch business and our scotch power brands, and of course, our baijiu business.

We'll take our next question from Simon Hales with Citi.

A couple for me as well, please. Can I just sort of ask you about sort of perhaps the need for investments over the next sort of few years to sort of really -- sort of realize the opportunity you talked about, both from a marketing, and perhaps from an SG&A and the route to market some points. You talked about how you're building sort of penetration beyond the South and the Southeast sort of markets. And maybe linked into, can you just remind us, outside of the Shuijingfang sort of business, how your route to market operates given your JV with Moët Hennessy, which brands are still going through that? And which brands and which parts of the portfolio now do you have full control in that? And then secondly, can I just to go back to your comments around e-commerce? Can you talk a little bit about the opportunity perhaps to go more directly to the consumer with your e-commerce business? Do you have much of a presence in that sort of [ D2C ] opportunity at the moment? And I'm wondering whether there is really particularly an opportunity around things like single malts, where you clearly got a good story to tell [ about brand ] portfolio that you could perhaps take directly yourself to the consumer without going through a third-party platform?

Terrific. Thanks, Simon. So let me just start with the route-to-market piece and investment. I do think that we're investing ahead in China to support the growth ambition that we have for the market. That will include brand investment, that will include investment in technology and platforms, and of course, investment in our route to market. We are looking at expanding the route to market, we talked into that a little bit. We're strong in the south, and the bulk of the business remains in the south in Guangzhou and Fujian. But we are seeing pockets of growth in Shanghai, in Jiangsu, in Beijing and [ surrounds -- ] and also in the West in Chengdu and Chongqing. So we're building out our route to market there as well, a relatively small penetration at the moment but we are seeing those green shoots we talked into around some of the whiskey bars, the super deluxe end of the market where we're getting specific consumers continuing to ask about our scotch portfolio. So we do see big opportunities to continue to build out that route to market to give us more of a national coverage. We've got a great relationship with MH, as you know, in many parts of Asia and France. We've got a strong relationship and partnership in China. They've done a good job for us on Red and Black Label, and we're pleased with that performance and that relationship. In relation to e-commerce, the bulk of our e-commerce is still focused on this O2O using some of the key platforms of Jindong and Tmall through Alibaba. We're a bit nascent in the direct-to-consumer space at the moment, but we do see opportunities, particularly with the prestige part of the business where we can build up with some high net worth individuals in China, the potential of a direct-to-consumer. But right now, there's still a massive opportunity to drive performance of our business across some of those core platforms. And that's what where the bulk of our invest is at the moment.

We'll take our next question from Edward Mundy with Jefferies.

Two questions, please. The first is I think you mentioned in your opening remarks that China is now 5% of the business from -- I mean, at 2% 5 years ago, but you think it can get to 10% of group sales. I was wondering whether you're able to show time frame on when you think that might take place. And then second of all, I think in your presentation, you talked about there are 5 cities where the penetration rate of scotch is higher than cognac. Can you talk about what's perhaps different in these cities? And how is the route to market? How is the consumption through the consumers? What is giving scotch a higher penetration rate for [indiscernible] cities?

Yes. Okay. Let me just start with the ambition of 10%. I think we've seen the progression from 2% to 5%. And that's really on the back of all that work we've done on the category developments of scotch, overlaying all the investment around establishment of our brands, and I've talked into Blue Label. Singleton, the fastest growing malt business in China. And also, [ however ], supporting malt in Talisker and Mortlach. So that 3% penetration and the momentum that we're seeing at a category level that gives us some [ real ] confidence that there's an enormous runway here for Scotch whiskey in China and our brands are perfectly placed to capitalize on that. So when you project that out into what could happen if penetration continues to improve and frequency continues to improve, which is what we would expect, then again that gives us confidence that 10% is attainable. When we look at baijiu, this massive category that exists in China, we're in a very exciting part of it in the super and ultra-premium segment, a segment that is going to benefit from this premiumization trend that we've been seeing for a long period of time. And we look at the massive volume that sits underneath that super and ultra-premium segment and the premiumization trend. Again, we think there's a massive runway for our baijiu business. And again, Shuijingfang is really one of the very few baijiu brands in China that is national. So when you start to look at the potential of both of those core pillars, then you look at that in the context of what 10% represents to Diageo, I think we've got great confidence. Of course, we can't predict what's going to go on, and we've seen all sorts of volatility in the world at the moment. But all that I can say in relation to the time frame is that we will continue to make appropriate investments that build the brand, build out our footprint and sets us up for the longer term. And when that 10% arrives, I'm not going to give the date because I don't know.

Got it. Just on that point for me, the second question. I mean if you -- I mean, just some crude math. I mean if you grow at 15% per annum, you get there in 10 years. If you grow at 20% per annum, you got there in 5 years. It's not like the budget category is going to grow at least 10% and you're going to grow ahead of that. And equally, you're quite excited about scotch. Is it fair to think it's somewhere in between the 2? Or -- very crude math, I'd like to get your view on that.

I think that our goal, again, Edward, is to continue to grow share in the marketplace on the back of very considered careful investment that we've proven over the last 3 years. So I think when you take those into consideration and some of the assumptions [ you've used ], the amounts can be correct. But again, I'm not going to put a time frame on it.

Got it. And on scotch [ on niche ] markets that where scotch has got greater penetration than cognac?

Well, I think when you look at Hong Kong and Taiwan right next door, I mean, you've got some very influential markets that sit right next to the bulk of the international spirits business in China in the form of Taiwan, which is right next to Fujian and, of course, Hong Kong. And in both of those markets, scotch is significantly bigger than cognac. And that wasn't always the case. So we saw cognac many years ago in those markets, it was really large, but as people got involved with scotch and started to explore and understand that craft and heritage and provenance, that interest grew and scotch became the largest category by a long shot. So again, it's those leading indicators that give us confidence around what we're doing in China.

We'll take our next question from Chris Pitcher with Redburn.

A quick one on Shuijingfang. You mentioned that you are making it into a national brand. But can you give us -- update us on the percentage of sales that's still in [ Chengdu ]? And then also the challenges to taking it national. Is it route to market? Is it brand awareness? Just to kind of get a sense of that distribution upside? And secondly, have you considered using the Shuijingfang distribution network perhaps recruit people earlier into scotch? I mean I'm trying to think how you might get cheaper scotches into the market to capture people. Or are you really just focused on the premium opportunity?

Yes, yes. I mean, thanks, Chris. Let me just start with the Shuijingfang piece. I mean we are based in Sichuan in Chengdu and our factory in Chong Li. But actually, we've got quite an even split of businesses across basically our top 15 provinces. A little bit stronger in our top 8 and we're present in 28 provinces. So there's no real one province that makes up a significantly larger portion of our business than anyone else. So the national coverage, I think, is there. We're in 30,000 outlets, as I mentioned in the presentation. I think what drives that share further, and we're very precise in relation to how we do this. We target provinces. We look at our media investment. We support that with investment in our route to market, in our execution, in our core store programs. We build out those banqueting relationships, those corporate gifting relationships. So there's a whole suite, if you like, of codified growth drivers that we deploy when we look to drive share disproportionately in target provinces. So I think, again, that's been working. In some instances, we've seen strong share growth on the back of that investment. And that's been quite successful for us. The second part of your question, could you just remind me?

Yes. Sure. In many other markets globally, you're actively trying to recruit scotch consumers early with primary scotch. Do you have the route to market to do that in China? And can I just add [ another ] to that? What lessons did you learn with the 12-year old scotch category when you tried to see that in the earlier 2000s? What did you learn from that?

Yes, yes. Thanks, Chris. Yes. Look, I think we are looking at recruitment into scotch. I mean we're very -- we're been very targeted in relation to focusing on super deluxe scotch, really building the category from the top. Blue Label has done exceptionally well over the last 3 years growing at a CAGR of 51%. So this is really helping us position our brands and the category in that very aspirational super deluxe segment. And then we worked on from there as we've looked at our 15-year old Johnnie Walker sherry, which, again, is more accessible in its price points to super premium and super deluxe, but that's, again, helping us to recruit a slightly different consumer into Johnnie Walker and into the category. So we've got very targeted investment to ensure that we position the brands and the category where we want, and that's super premium, and then how we add to that through innovation and the rest of the portfolio to recruit drinkers into it. And that the same goes what we're doing on single malt. I've just given you an example with Johnnie Walker. In relation to kind of the synergies and what we've learned from Shuijingfang, I mean, you might remember, some years ago, we did look at province testing whether we could put the routes-to-markets together, unlock [ Shuijingfang's ] synergies and learn from each other. I think what we found was that they were quite distinctive partners and customers that we had in each one of the chains and different jobs that we needed for them to do to in relation to the development of the various businesses. So it's been quite successful for us to be very focused in relation to our route to market and our customers and really trying to educate them and help us to develop he categories that we operate in. In the future, maybe there's an opportunity to unlock more synergies. But right now, that focus is what's key to the success that we've had so far.

We'll take our next question from Olivier Nicolai with Goldman Sachs.

I've got two questions, please. First of all, regarding the Hainan province. Could you tell us how big it is today [ as the state of your sales ] for China? And since you said it was likely to become much bigger going forward, can you give us an idea of the profitability? Is it more profitable than the rest of your business for instance? And then the second question, I was wondering if you could give us a bit of an update on the Zhong Shi Ji, which is a -- and if you are thinking about launching new local collaboration?

Okay. So Hainan is a duty-free island today. So it's not really part of our domestic business. It's part of our GT business. And again, very excited about what that's going to provide in relation to a runway for luxury spirits growth. It is benefiting from the Chinese government policies, which is increasing the quotas for the purchase of liquor. And liquor has been included now very recently. It's still very small in relation to the overall, if you like, volume that Hainan is generating. But we're very excited about its future. We've got boutiques going up in Sanya and [indiscernible]. So we're investing through the GT business to make sure we access what we see as a huge opportunity for duty-free. And also a huge opportunity for brand building because there's lots of customers who are going to Hainan who are engaging online before. They're learning about products, they're absorbing content. In some instances, they're pre-ordering. So again, it's a matter of the domestic business working with the GT business, the Global Travel business, to ensure we've got the content online. We're working with the customers in Hainan, so that we've got that online and off-line opportunity. And there's even an opportunity for the customers who have gone to Hainan to purchase when -- I think it's within 180 days and they return. So this repatriation of the travel dollar that's going on in Hainan, I think is huge, and I think it's going to be terrific for luxury spirits, and we're right in the middle of it. In this -- I've spent too long answering that question, and I've forgotten the second question. I think it's Zhong Shi Ji. Zhong Shi Ji was an experiment to sort of marry a liquid with Scotch and baijiu to try and bridge, if you like, that taste barrier to try to tap into international and local culture, and take kind of master distillers from the baijiu business and the Scotch whiskey business. So I think if the performance has been only okay so far, I think we've had trouble inserting that into the meal occasion, which is a big opportunity in China. So we'll continue to experiment and to learn and to see if that opens up any more innovation opportunities. But I would say the performance of that business was always very small. It's only okay at the moment.

And just a follow-up on that perhaps. On the -- so first on Hainan, if I understand correctly, it's very similar to a normal duty-free business in terms of margin structure. And then just the second part of the other question, are you thinking about launching more local whiskeys, for instance, not necessarily mixed with baijiu, but more local collaboration and local whiskey? Or is it just going to be essentially scotch?

Okay. Now in relation to the Hainan margins, yes, I think they remain attractive. We will continue to invest because there's so much infrastructure being built there. That content online is being built. So this will be an investment market for us as well. But certainly, our margins are attractive. We'll continue to look at insights from markets, feed those into our innovation machines, and we'll see whether or not there's opportunities for us to localize liquids or to infuse culture into our innovation, which is what we've been doing for many, many years and what we continue to do. So right now, we really are focused on Scotch whiskey, but if there are opportunities to localize whiskey, we will consider them. But they're not on the table at the moment.

We'll take our next question from Mitch Collett with Deutsche Bank.

Thanks for the presentation, Sam. A couple of questions, please. You gave a slide where you talk about territory expansion, channel expansion, some custom network development, I mean, is there any way to quantify how much each of those 3 components contributed to your growth over the last 5 years? And how much of a contribution you'd expect each of them to make going forward? And then just a very general question on e-commerce. You said that most of your business, the majority of your business in e-commerce is not direct-to-consumer. Can you perhaps give us a comment on the economics of selling through e-commerce through third-parties and whether it's comparable to the rest of your business in China or perhaps more or less profitable?

Yes. Yes so, Mitch, thanks for the question. In relation to the contribution of that route-to-market expansion, I think very difficult for me to quantify that. We are seeing momentum building as we extend our route to market into new territories as we drive distribution. And as we sort of bring the whole suite of assets to play when we start to invest in brand building, in A&P, in our commercial drivers, we start to educate those customers because the customers play a very important role in helping us to educate their customers and their consumers. So there's, again, this whole suite of boutiques, the Diageo Whiskey Academy. We do bring summits now out to some of these regions, again, and those summits, we bring in some of the influencers, we bring in media, customers and consumers to provide, if you like, a very intensive education of Diageo's Scotch whiskey business and Scotch whiskey as a category. So what we've seen so far, particularly in the East, has been extremely positive. We're seeing interest. Again, I mentioned the North and the surrounding provinces in the North and that Sichuan province in the West, all of those are showing very positive signs off a relatively small base. And I think we'll continue to invest and learn and educate like we've been doing for the last 3 years. And my expectation is that, that business will continue to grow on the back of the momentum that we've already seen. In relation to e-commerce and the economics in e-commerce, I mean, we're very careful actually to ensure that the e-commerce channel is an investment channel, but one that is invested in brand building, in content creation, in recruitment. We put innovation down there, and those channels are about the same margins as we have in the rest of our business. So they're not eroding our margins at all. They're about the same.

Understood. And maybe just one related follow-up. I think you said that Shuijingfang reaches 30,000 outlets. Are you able to comment on the number of outlets reached by Diageo, Moët Hennessy and also Diageo [ in China ]?

Well, two things. While I can't -- I won't comment on the MH number because I don't have it at hand. But certainly, the number of outlets that we reached within the international spirits business is smaller than 30,000 by virtue of the fact that the bulk of that businesses at the moment is still concentrated in kind of Guangzhou, Fujian, Shenzhen, that Southern area. We have -- we continue to expand into provinces, bringing in more wholesalers, sub-wholesalers, direct coverage by our consumers. I don't have the number at hand, Mitch. But I mean, from a coverage perspective, I think we're well covered in most Southern provinces. And we're expanding our coverages in the provinces that I mentioned previously.

We'll take our next question from Laurence Whyatt with Barclays.

A couple for me. Firstly, with China having emerged from COVID now for a number of months. I was wondering if there are any learnings that we perhaps weren't expecting or not seeing anywhere else in the world that is happening in China with regard to change in consumer behavior? And secondly, a number of years ago, counterfeiting of these sorts of luxury drinks products was fairly widespread in China. How much of an issue is that now? And is it something you need to keep a handle on?

Yes, yes. Thanks. So in relation to COVID, I think like everywhere, there has been some shifts in consumer behavior, and China is no exception. But we should remember that in China, they really did get hold of COVID very quickly. And whilst there was 2, 3, 4, 5, 6 months of impact, the rebound was very strong, particularly in the on-trade, where we've seen almost total recovery. What we haven't seen recover quite so quickly has been kind of the banquet in large gatherings. They seem to have gone into a slightly smaller gatherings those gifting occasions through key periods of the year. So -- but again, even banqueting, we're starting to see come back now, which is very encouraging. The at-home occasion became more prevalent through COVID, so we could see online and convenience support that at-home occasion. And we saw indulgence actually pop up where people stuck at home were looking for a treat to have, whether that be us [ selling ] scotch or kind of using Baileys, for example, to cook up nice treats for themselves. So we very quickly responded to that when we saw it and started to put recipes out with Baileys in it and [ serves out ] for Baileys. And again, had wonderful online discussions with consumers around how they were using that. So I think -- the intelligence that we got allowed us to move quickly into some of the opportunities, particularly the off-trade, particularly convenience channels, the national key accounts, and of course, e-commerce. And then when you look at the consumer behavior, some of those trends with people at home, smaller groups and how we were able to tweak what we were doing with our product portfolio and activation to tap into it, I think, helped us as we navigated through it. But I would say the thing to remember is that it recovered faster than anywhere else in the world, and we've seen a strong rebound, which has been very, very encouraging.

And just a follow-up on that specifically, where you saw premiumization among Chinese consumers and then the return to the on-trade happened, did the premiumization in the off-trade be retained or did people trade down as they return to the on-trade?

I think the dynamic of premiumization has been prevalent all the way through, whether people were at home, looking for a discerning moment with a single malt or still trying to ensure that they were able to gift or enjoy something a little bit more special than what they would normally have. I mean this is something that we've seen in the market for a long period of time. So this premiumization trend, I think, has been very encouraging and continued all the way through. And my expectation is that, that will only accelerate now as markets go back to normal. In the on-trade premiumization, there's particularly the modern on-trade, which is really being driven by urbanization, where people want to go into the on-trade and celebrate [ and show ] what they can buy their friends, I think, has been something that's been in the market for a long period of time. That has returned, and we're seeing that in the on-trade. An interesting dynamic between the 2 is the fact that many people go to the off-trade to buy products for the on-trade, it could be restaurants and so forth. So it's difficult to separate those trends because they're kind of interlinked. The modern on-trade, we're seeing, my expectation is that as traditional on-trade opens up, the off-trade will support that and the continuation of the trends that we saw at home. I didn't answer the counterfeit question. I think counterfeit is something that we need to be aware of China. We've been working with the authorities across many provinces for a longer period of time. We've been helping educate them in relation to understanding where they see a counterfeit problem. And right now, I would say that in all of the sampling that we do, the prevalence of counterfeit on our products is relatively low.

We'll take our final question from Trevor Stirling with Bernstein.

A couple of questions from my side, please. Sam, in the press, you highlighted that Shuijingfang is a disruptor in baijiu. Can you maybe just give us a little more color about how you think the brand is disrupting the baijiu category and perhaps also comment on the relative weight of baijiu and western spirits inside the portfolio at the moment?

I mean, I think, Trevor, in relation to how we're disrupting, when we started to think about the core store program, for example, which was all about execution and how we identified core stores with specific trading terms and incentives around execution and engagement with consumers and we had QR codes that allowed us to track their sales gives us -- gave us real time information that we were then able to respond to, whether that be with innovation or tweaked execution standards or activation. I mean, I think a lot of other baijiu players looked at that and said, oh, wow, that's interesting. It was extremely successful for us. I think we're up to now core store version 4.0. So again, in relation to how we thought about the 5 plus 5 plus 5 focused expansion strategy on route to market and the core store program, I think, was quite different for the rest of the baijiu category. Many of them have [ fostered us ] into that space now and have really started to lift their execution standards. If you look at our packaging as well, Trevor, I mean we've got some wonderful packaging on Shuijingfang. We've got beautiful designs on the bottle, carvings on the bottle, the outer package is quite stunning. So again, when I think about what we're doing on a packaging front, even with our museum series, compared to the rest of the category, I think it's quite disruptive and much different from everyone else. So is there more that we can do to disrupt? Yes. But that's just 2 examples of how we've gone in there with some of the things we do elsewhere in relation to innovation and execution that have been quite different to what has been in baijiu for some period of time.

And could you comment, Sam, just on relative weight of baijiu and Western spirits inside the portfolio at the moment?

I mean it's not a number we would disclose, Trevor. I guess the way I would comment about that is I'm equally excited about both. I think that the runway we've got on Shuijingfang is truly exciting. We've seen some wonderful growth, industry-leading growth over the last 4 years. And we've still got so much more to do in relation to the opportunity that exist in baijiu with Shuijingfang and that premiumization trend, which we think is going to drive growth over many, many years. And the same with scotch, we've worked hard over 3 years to build a scotch category that's genuinely aspirational for Chinese consumers. And I talked about the summits and the boutiques and super deluxe and auctions and 600 whiskey bars. I mean last time I spoke to you all, it was 300, it's doubled and they're spread all over the country. So just those 2 pillars, I think, give us massive confidence and opportunity. So I won't talk about the relative weighting. I'll just talk to you about how excited I am about both.

That will conclude our question-and-answer session. I'd like to turn the call back over to Mr. Fischer for any additional or closing remarks.

Well, thank you very much. As usual, very probing questions. Nice to speak to names that I recognized from the past. And I hope we've given you an insight into how excited and confident we are about our position in China and the runway we've got for growth long into the future. I look forward to coming back with a progress update at some point in the future. Thank you very much for attending. Bye.

That concludes today's call. We appreciate your participation.