Diageo plc (DGE) Earnings Call Transcript & Summary

And now saving the best for last. Please join me in welcoming Diageo back to CAGNY, and thanking them for generously sponsoring tonight's dinner. Diageo is a leader in the structurally attractive total beverage alcohol industry and has an advantaged portfolio and geographic footprint. Diageo's strong culture fosters agility, creativity and experiences, which also drive opportunities for premiumization and stronger margins. With us on stage are Ivan Menezes, who has been CEO of Diageo for almost 10 years and has been instrumental in pivoting this company towards a higher growth, higher-margin company. And Lavanya Chandrashekar, who was appointed CFO about 18 months ago. [Presentation]

Thank you, Janet, and it's great to be here. We're coming to CAGNY after a long time. Thank you for joining the session. It's my first at CAGNY. Here's a forward-looking statement. Now for those of you who don't know Diageo, we're a global leader in beverage alcohol. We have over 200 brands, operate in 180 countries. Our purpose is celebrating life every day, everywhere. And it goes hand-in-hand with our performance ambition, which you see on the screen, to be one of the best-performing, most trusted and respected consumer products companies in the world. Now I believe 3 things at the Diageo apart. First, we are consumer and brand obsessed. We put our consumers at the heart of what we do. Of -- we just completed, net sales was up 9% with growth across all regions. Volume grew 2%, even though we took price. Operating profit was up 10%, and we expanded organic margins by 9 basis points. We had GBP 800 million of free cash flow, and we've continued our track record of increasing dividend every year for the past 2 decades. But we're not complacent. We are restless and determined to go after more opportunities. Now here's why we're confident in our ability to deliver quality sustainable growth. Our industry, total beverage alcohol, TBA is very attractive. And within TBA, we have the best assets plus an advantaged portfolio and geographic footprint. Our obsession with being close to consumers and customers while doing business the right way is the key competitive advantage. We're investing in our brands while driving efficiencies to fuel the investment. And we've delivered strong performance consistently in every period. Diageo has a long runway for exciting growth ahead. TBA represents our overall consumer opportunity, and we're focused on increasing our share. We're the leading international spirits player by retail sales value. 2 years ago, we set out our 2030 TBA share ambition when we held about a 4% share. Now I'm thrilled. We are already almost 1/3 of the way to achieving it. But we're only at about 4.6% value share of global TBA. As I say to our people in the company, we're still -- we're only a startup. We have tons of headroom to go after. Now I think Diageo operates in the best consumer goods segment. TBA is incredibly attractive. Over the past decade, TBA, the market, worldwide, grew at a 4% compound annual growth rate. Spirits grew materially faster at a 7% compound annual growth rate. Spirits is premiumizing as consumers around the world drink better. This is the Diageo's sweet spot. We've shaped our portfolio and positioned ourselves to go after this growth. Let's turn to the U.S., which I call our most exciting developing market. Here's why. First, the number of LDA-plus drinkers in America continues to grow consistently at 1% a year. Second, spirits continues to gain share of TBA. Since 2019, spirits has taken almost 5 points of TBA share. And this is driven by long-standing secular trends, taste preferences, demographics and cultural relevance. The cocktail culture continues to thrive. Third, premiumization continues, and it is resilient because of the affordability of our category and the infrequent purchase cycles. I love the stat; in 2021, about 1/4 of Americans bought a bottle of spirits over $50 a bottle. 1 year later, in 2022, it's 33%, 1/3 of Americans are buying spirits over $50 a bottle. Now if you look at the last 2 decades, the U.S. spirits industry has shown remarkable resilience. Volume and value growth have both have grown every year, including during the great financial crisis. I was here with our business in North America then. And we only have a 7% value share of U.S. TBA, a lot of headroom for growth. We've shaped our portfolio to participate in faster growing categories, and we continue to invest strongly in this key market. We are confident in continuing the sustained growth of our North American business. Our strong performance in the first half of fiscal '23 demonstrates our advantaged portfolio and broad geographic footprint in action. We grew organic net sales in all 5 regions in the first half of fiscal '23 despite lapping strong double-digit growth. Over the past 4 years, Diageo has delivered a net sales CAGR of 8%, with a 3% volume CAGR, with strong growth in every region. You see it here on the map. North America, a CAGR of 8%; Europe, 7%; APAC, 7%; Africa, 8%; and wonderful Latin America, 15%. Now the strength of our business is not just in our footprint. We're also in the fastest-growing categories and price tiers. The top end of our portfolio, Premium Plus is 57% of our business. It's been growing, and it contributed to 65% of our growth. And we've been steadily premiumizing our business across every region in the world. [indiscernible] categories. And I'm delighted with the growth of our brands. Again, in the last 4 years, our scotch business is nearly 40% bigger. Our tequila business is more than 4x as large, and Guinness is almost 20% bigger. We all [indiscernible] scotch is hot. It's highly aspirational, it's cool, it's recruiting the next generation of consumers around the world, and we are shaping the vibrancy and driving the growth of the category. 8 years ago, we could see consumer interest building in the high end of the tequila market. So we went about and acquired Don Julio in 2015 and Casamigos in 2017. We applied brand-building expertise, commercial excellence and supply chain advantage to accelerate the performance of these brands. As a result today, we are the market leader in tequila in the U.S. and globally. Now in spite of this exciting growth in the U.S., tequila is only in half the households or has half the household penetration of vodka and North American whiskey. And the category continues to show strong consumer momentum. So it still has a long runway for strong growth in the U.S. But we're also very excited about the global opportunities for tequila, and we will invest in growing Don Julio and Casamigos globally starting this fiscal -- starting fiscal 2024. Our brands. Could we play the video. [Presentation]

As Ivan mentioned, we play in an extremely attractive category, and we have an advantaged footprint. And we use this along with our operational excellence to be able to deliver exceptional results. As you will see on this chart, Diageo has, over the 5-year period fiscal '17 to '22, exceeded every other CPG peer group company in top line growth. I'm extremely proud of the work that we have done to achieve this. And it is our capabilities in digital, in supply chain, in brand building, in innovation and our people that enables us to make this happen. It is this performance history that gives us the confidence in our ability to continue to grow this business in a profitable manner for the long term and drive shareholder return. So there's 2 things that underpin this. The first is our growth algorithm and the second is our consistent approach to capital allocation. So let's move on to our growth algorithm. It's actually really simple. We drive top line growth because we have a fantastic portfolio of brands, and we have an advantaged footprint. We drive revenue growth through price and mix improvement. Our culture of everyday efficiency helps us deliver productivity. And we take all of this and we reinvest it back into our brands through sustained investment, and that enables us to be able to further accelerate the growth of our top line and our share results. Since this is at the heart of the thesis of investing in Diageo, let's walk through this one step further. So let's start with top line growth. One of the key enablers of our superior ability to deliver the top line growth that you saw 2 slides ago, is our deep consumer understanding, our brand building and our innovation. It is this deep consumer understanding that enables our innovation team to create magic, magic that allows us to bring more consumers into our brand portfolio. But rather than listen to innovation from the CFO. Why don't we go and listen to it from the people who actually make this happen. Mark Sandys, our Global Head of Innovation. [Presentation]

Diageo has over the years built out a really strong capability in revenue growth management. We are extremely strategic and surgical in how we take pricing action. And we do this in a very data-based manner using the investments that we have made in digital and technology and data analytics over the years to be able to take the right pricing decision by market at a brand level. In a category where price -- pack sizes are mostly regulated, another big lever for us to grow price/mix is premiumization. And we do this, as you saw in the video before, through innovation and through how we allocate our A&P spend. I've talked a lot about the great progress we have made in premiumization. But to give you a very tangible example. In the period fiscal '17 to '22, our portfolio grew net sales at a 14% compounded annual growth rate. At the same time, Johnnie Walker Red Label grew at 4%. So the growth of Johnnie Walker Blue Label was more than 4x faster than Johnnie Walker Red Label. As you can see from the chart on the left, we have driven price mix growth ahead of our peer group on a consistent basis. And as you can see from the chart on the right, our delivery of price mix has accelerated over the recent past. And this has been driven by the strong growth that we have delivered on our super-premium brands and by the increased pricing that we've been able to gain in the recent years versus what we have historically done. This is a strong capability that is present across Diageo, across all of our markets in the developed and in the emerging markets. Let's move from price to productivity. At Diageo, we do not think about productivity as a program. Everyday efficiency is a mindset, and that's built into the culture of the company. And it is this culture that has enabled us to deliver GBP 400 million of average -- GBP 400 million of productivity a year for the last several years. In November 2021 in our last Capital Markets Day, I set out a goal for us to deliver GBP 1.2 billion of productivity in the 3 fiscals '22, '23 and '24. We're at the halfway mark, and we have delivered GBP 600 million of productivity. And we're off to a really strong start in fiscal '23. In the first half of the year, we've delivered about GBP 220 million of productivity. The most significant part of our productivity savings comes from COGS. And this is where our supply chain colleagues used the scale of Diageo and the breadth of our business to build strategic relationships with suppliers that enable us to deliver regular cost savings. In the -- we also deliver cost savings from the work that we do on sustainability. When we improve energy efficiency of our operations, when we reduce the water usage of our operations, when we remove carton boxes from our products, we're also delivering COGS savings. In the area of marketing, we go after waste in every spend type from agency spend to being more choiceful in how we use point-of-sale material, reusing it, as well as in gaining efficiencies on media. We also deliver cost savings on overheads. We completed our productivity program from fiscal '17 to '19. But even after that, we have been extremely careful about how we have managed our head count. From fiscal '19 to fiscal '23, we have actually gone down headcount by 1.5%, while we have grown our business by 36%. The thing that really distinguishes us from our peer group is the fact that we consistently upweight investment in marketing behind our brands. In the last 5 years, we have increased marketing investment in our brands by nearly GBP 1 billion. Our reinvestment rate has gone up from 14.9% to 17.6%. That's an increase of 270 basis points during this time period. We do not have a target reinvestment rate, but we are extremely disciplined and data-based in making decisions around marketing investment. Going back to fiscal '17, we started to invest in a suite of tools and capabilities to enable us to improve our marketing efficiency, tools such as catalyst and sensor, which we have talked about in the past. And these tools enable us to use the data and technology at our disposal to ensure we make the best investment choices by brand, by market. This ensures that we are continuously investing in the highest growth opportunities that deliver the highest returns. And it works. Our marketing investment help us to gain market share. As we shared in our interim results, we are holding or gaining market share in 75% of our net sales value. And this is not a capability that we only have in our developed markets like in the U.S. or in -- Great Britain. This is equally a capability that we put into use across all of our emerging markets as well. So let's now move -- let me introduce you to Patty, who is from our Latin America team, and she will bring to life the magic of our brand building and our digital capabilities. [Presentation]

We have a consistent track record of delivering operating profit ahead of net sales growth. At Diageo, promises made are promises kept. In the 3 fiscal years prior to the pandemic, fiscal '17, '18 and '19, we increased operating profit ahead of our net sales growth. And we have continued to do so as we have emerged from COVID. The 2 periods in between the second half of fiscal '20 and the first half of fiscal '21, our business was significantly impacted by a once in 100-year pandemic with the on-trade being closed, with travel restrictions and a slowdown of global travel, that really impacted our business in those 2 periods. But coming out of that, despite supply chain disruptions and significantly stepped up inflation. We have continued to increase our operating profit ahead of net sales growth. And we have done this by using all of those strategic levers that you see on the page over there. In the last 2.5 years, price and productivity from supply operations has more than offset COGS inflation. We have grown our business at a volume CAGR of 3%, and that has enabled us to get operating leverage through the P&L. And we have driven premiumization and premiumization drives margin improvement because premium products tend to have better margins. And this is what is at the heart of our medium-term guidance as well. Having gone through the growth algorithm, let's now turn to our capital allocation, where we use a very consistent and disciplined approach. Our first priority on capital allocation is investing in the organic growth of our business. Second, we invest in acquiring strategic brands that strengthen our exposure to fast-growing categories. Third, we have a progressive dividend policy. As Ivan said, we have increased dividend every year for over the last 20 years, including in fiscal '20 when the business was significantly impacted by COVID. And fourth, where we have excess cash, we return it to shareholders. We have stayed invested in this business in marketing, in CapEx and in maturing stock as well as making regular bolt-on acquisitions despite the challenges of the last several years. Let me walk you through some of these. We run this company for the long term, like true owners. A true testament of this is the steady increase in investment that we have made in maturing stock, which currently sits at 5 -- a little over GBP 5 billion. This is our liquid gold. This is what provides Diageo its strongest moat, and this has increased by over 1 billion in the last 5 years. In fiscal '22, our production volumes were up 9% over fiscal '19. That is the equivalent of us producing approximately 400 million more bottles in filling it and shipping it with our most delicious liquids. We did this because we have consistently invested in this business in CapEx. This is what -- our confidence in our business and the potential that it has, along with our share ambition has led us to decide to increase our CapEx investment to be between GBP 1 billion and GBP 1.2 billion from fiscal '23 to '25. This will help us to be able to invest in adding capacity in strategic categories, such as scotch, tequila, baijiu, U.S. whiskey, Canadian whiskey and beer. In addition to adding capacity, our CapEx investments also enable us to invest in delivering against our sustainability objectives. We use CapEx to build our digital capabilities, which will ensure that we retain the competitive advantage that we have in this space. We invest capital in consumer experience centers such as Johnnie Walker Princes Street, which enable us to build a deep and lasting relationship with consumers. And most recently, we announced a Supply Agility program, which is designed to ensure that our supply chain remains a competitive advantage for us in the long term. The Supply Agility program will enable us to increase the resilience of our supply operations while reducing our carbon footprint and increasing the efficiency and costs -- and reducing costs as well as increasing cash flow. Let's take a look at a short video that brings to light. [Presentation]

Beyond investing in organic growth, we are also active and disciplined in managing our portfolio. We use our deep consumer insights to identify opportunities to expand our portfolio into attractive new segments. Since fiscal '17, we have invested GBP 2.2 billion in acquisitions, 10 of which are in fast-growing super-premium price segments. During the same period, proceeds from divestitures, which are mostly brands that either did not really fit within our portfolio and mostly played in slower growing segments have netted us GBP 1.2 billion. Recent divestitures include our move of our Guinness business in Cameroon to an asset-light model, the divestiture of Archers and the disposal and franchising of a portfolio of popular brands in India. We not only make smart acquisitions, but we also have a strong track record of turning these acquisitions into blockbuster brands, an example of which is Casamigos. So what does this all do, the growth algorithm and our capital allocation strategy? It creates value to you, our shareholders. In the last 5 years, we have increased our return on invested capital by 300 basis points to 16.8%. Now let me hand it back to Ivan, to take you through how this translates into a steady increase in shareholder returns.

Thank you, Lavanya. Okay. As you can see here, we've delivered significant value for our shareholders, increased dividend every year for 20 years, consistently returned excess cash to shareholders. We just completed our GBP 4.5 billion return of capital program earlier this month. And we've just started a GBP 0.5 billion buyback last week and expect to complete it by June, the end of this fiscal year. Now here's Diageo's competitive edge. It's our people and culture. All 28,000 colleagues are driven by our purpose and our performance ambition. They have an ownership passion to build brands the right way for the long term. And they are restless to execute better every day. We enjoy 82% employee engagement and 90% of our employees are proud to work for Diageo, a very high benchmark. Our culture and performance track record enables us to recruit, develop and retain talent in a fiercely competitive market. I am very proud of and grateful to my 28,000 colleagues across Diageo. Now we aim to create a more inclusive and sustainable world. This is not new to Diageo. We're very proud of what we've achieved from 2010 to 2020. And we've now set ambitious industry-leading targets as part of our Society 2030 ESG action plan. We champion responsible drinking, including our commitment to reach 1 billion people with dedicated responsible drinking messaging by 2030. We are well on our way to our ambition to achieve 50% representation of women in leadership and 45% of leaders from ethnically diverse backgrounds. Diageo's attractiveness as an employer enables us to hire, grow and retain the best and most diverse talent. We aim to become net carbon zero in our direct operations by 2030. And we aim for a 50% absolute reduction in our Scope 3 carbon emissions also by 2030. We aim to use -- in every drink we make, to use 30% less water. We intend to replenish more water than we use in water-stressed areas. Diageo is well recognized externally for our leadership on inclusion and sustainability. Now given what Lavanya and I have covered, I hope you see why we are confident that we're well positioned to deliver our medium-term guidance, which is consistent organic net sales growth in the range of 5% to 7% and sustainable organic operating profit growth in the range of 6% to 9% for fiscal '23 to '25. So in closing, here are the key takeaways. I'm excited about Diageo's future because TBA is an attractive industry. And within that, spirits is super attractive. We have an advantaged portfolio of fantastic brands. We have an unrivaled geographic footprint. With only a 4.6% share of TBA, we have a long runway for growth. We are investing behind the growth opportunities, our focus on driving quality sustainable growth, delivering everyday efficiency and reinvesting smartly is working. We have a strong track record in ESG delivery, and we've delivered consistent, high-quality, strong performance. And finally, we are excited about our strategy and confident in our ability to deliver sustainable long-term growth and shareholder value. I believe the best is yet to come. So now before we go to Q&A, I have to show you at least one of my favorite ads. This is on Guinness, which was -- which broke recently after the pandemic and lockdowns. By the way, if you haven't tried this, Guinness 0.0 absolutely delicious. You can't tell the difference. So I hope those of you who come to our party tonight, you're going to have fabulous cocktails and dinner tonight, but try this as well. Could we show the ad, please? [Presentation]

Thank you, and let's open it up for Q&A.

Wait for the microphone, Robert.

Thank you, Ivan. I am sorry, Sir Ivan. And congratulations on the knighthood.

Thank you.

So when I -- think I first saw Diageo at CAGNY, it was Paul Walsh, probably around 2010, and he made very clear an objective to grow in emerging markets, and lo and behold, that happened a number of deals, transactions. More recently, I think 5, 6, 7 years ago, you set out a very clear objective to grow market share in the U.S., which you clearly have delivered on and done extremely well. So looking out longer term now, next 5 years or so, what are the key challenges that you see? What are you kind of tasking the front to do to accomplish so that you can continue the long history of growth?

Thank you. Yes, I would say at its heart, the success and value creation of this company comes from staying extremely close to the consumer, spotting trends faster than anyone else and moving and executing against them faster. So as I think I indicated, Robert, there's plenty of attractive profitable growth right across our geographic footprint. I mean, if you look at Latin America, which has had stunning growth, but it's also improved its margins significantly in the last 4 years. So as a management team and with our general managers, we just had them all together, we always talk about double down on your external focus, really be the best at understanding consumers. We've got the wherewithal to invest, and our magic of brand building and innovation, the digital capabilities we built. So I say Diageo's success and lack of success will depend very much on that factor in my mind. It's -- and this, to me, is what we've been building in the company over the last 6, 7 years, the talent, the capabilities, the tools, the analytics to really make us at the leading edge of this. Now beyond that, of course, we have to ensure we deliver on our Society 2030 commitments. We have to ensure we're a great player in the communities we operate right across the world. But we see -- I mean, we did, as you said, in 2010, the emerging markets was the big move. Right now, we're seeing really exciting growth in the developed world. In the last 6 months, everyone talks about the doom and gloom in Europe. We grew our business 10% in Europe in the first half of this fiscal year. And we see this trend to spirits gaining share of TBA and premium brands doing well as very sustained. So the main differentiator is going to be the consumer centricity and execution against opportunities and threats that we see with the consumer. And I think Diageo is well positioned to navigate the world we're in to keep outperforming and growing market share.

Next, Simon.

Can I just drill down a little bit more into the whole confidence in pricing on a go forward basis. I mean I think as growth rates begin to normalize around the world after a period of outsized growth. If you look at somewhere like the U.S., I think historically, a lot of your, certainly, above-average growth was coming through volume and mix. Going forward, how do we think about the build of growth in a market like the U.S. or maybe other developed markets? How is it going to split volume mix and price? It seems you're much more confident perhaps than you were? And maybe as an industry than you were, in your ability to take headline price.

So on pricing, we are extremely surgical in the pricing action that we take. I mean pricing is not the only lever that we have to either grow brand equity or to offset inflation. It's one of multiple levers that we have. And our objective is to drive balanced growth, balanced growth between volume growth, between taking price, but also driving premiumization. And it is the combination of all of these that really enable us to be able to build brands that are sustainably strong for the long term, while also achieving on our medium-term guidance objectives. So strong brands can take more price. And as we invest more A&P behind our business, we enable our brands to be able to take more price and still provide the right value equation to our consumers.

I think just to add, I mean, volume growth is critical. It means more consumers enjoying your brands. And we take a very firm view that the health of our business is in expanding the consumer franchise. So getting volume, price and mix and balance is really important. And if it gets out of kilter, we very much focus on getting it back into balance. Now it doesn't work everywhere in the world, but that is our intent. And that's by and large, in most places around the world across our categories, we're able to deliver it.

And with that, we're going to move next door for the rest of the breakout. I'm really excited to try this liquid gold. So thank you again, Diageo, for sponsoring tonight's dinner.