Diageo plc (DGE) Earnings Call Transcript & Summary

Good morning. At our year-end results for fiscal '23, I guided that we expected to see sequential improvement in our business results in the current fiscal year. At the group level, we are seeing slower-than-expected growth and we no longer are expecting fiscal '24 half 1 to be stronger than fiscal '23 half 2. This is due to a materially weaker performance outlook in Latin America, which makes up nearly 11% of Diageo's net sales value. Importantly, we have momentum continuing in 4 out of our 5 regions, including seeing sequential improvement in our largest regions of North America. So what are we seeing in Latin America? Well, LAC is now expected to decline organic net sales by more than 20% year-over-year in the first half of fiscal '24. If you remember, we disclosed back in August that we ended fiscal '23 with higher-than-expected inventory levels as economic activity has slowed post our shipments for World Cup. But we are now seeing 2 additional headwinds in the region. First, consumer conditions have worsened. Macroeconomic pressure in the region is resulting in lower consumption for the category and consumer downtrading. Second, due to higher interest rates and inflation, we are seeing customers destocking. Both of these impacts are slowing down progress and reducing channel inventory to appropriate levels for the current environment. It's important to note that despite the slowing category growth, our business in LAC continues to win share in most markets within the categories we participate in. If you remember, this business grew 20% in the first half of last year, and so we are lapping extremely high comps. For the impact at the group level, what this means is we now expect organic operating profit growth for the first half of fiscal '24 to decline compared to the first half of fiscal '23, primarily due to LAC's declining net sales, increased trade investment, lower operating leverage and adverse mix resulting from downtrading. Across other regions, we expect to continue to invest additional A&P ahead of net sales. We expect that there will be continued, albeit moderating, cost inflation which will be partially offset by pricing actions. Looking ahead to the second half of fiscal '24 at the group level, we expect to see a gradual improvement in organic net sales and organic operating profit growth from the first half of fiscal '24, while we continue to invest in marketing and in the business to drive long-term sustainable growth. I recognize the magnitude of this issue, and we are putting together the right actions to manage it. We will come back to you at our interim results in January 2024 to give details on actions being taken. Most importantly, the rest of the regions, which is 90% of our portfolio, are on the right trajectory. As for the other regions, we are seeing strong momentum in APAC despite the slower recovery in China. While our Baijiu business is proving to be more resilient, we're seeing less momentum than we expected on the international spirits business, which is true also for the industry in general. In Europe, we will see momentum, albeit slower than in the second half of fiscal '23. With geopolitical tensions escalating in the region, trading has unfortunately stopped in key geographies in the Middle East where we hold leading positions in spirits, and this has reduced some of the momentum of the region. As we said at the end of the year, globally, we still expect to see growth and gradual improvement through fiscal '24. While we see green shoots, we also continue to experience volatility, and the operating environment is likely to remain challenging. These are, however, short-term challenges, and we run the business for the long term. We will continue to invest in the business as I'm confident in the long-term sustainable growth for our portfolio. All of us at Diageo have huge confidence in the medium- to long-term attractiveness of the industry and category. We believe in the solid business we have built over the years, the consistent investment we have made in it, and we have the talent, tools and capabilities to drive sustainable growth. So now on to our medium-term guidance. Moving forward, we expect to deliver organic net sales growth between 5% and 7%. This is ahead of what we were growing pre-COVID. Our confidence in this guidance is underpinned by 3 things: first, our participation in the attractive segment of international spirits, which is growing ahead of total beverage alcohol sourcing from beer and wine occasions; second, our advantaged portfolio and footprint, which enables us to grow ahead of spirits; and third, the investments we will continue to make to grow share. Given our share ambition, we will continue to invest behind our brands. As for operating profit, we expect to grow broadly in line with organic net sales growth in the medium term, driven by the investments we will make to further strengthen the business as the industry normalizes from the growth super cycle and driven by continued higher inflation. Over time, as inflation moderates and productivity from our supply agility program flows through, we expect operating profit to grow ahead of organic sales growth. So that's what I have in my prepared remarks this morning. I think we can open it up for Q&A.

[Operator Instructions] The first question comes from Laurence Whyatt from Barclays.

Three from me if that's okay. Just in terms of the medium-term guide coming out of -- you've got the 5%, 7% top line and then the organic profit in line in the medium term. But you also mentioned over the longer term, you do expect that to improve. Could you give any sort of time frame on that? Are we looking sort of 1 or 2 years of limited margin expansion and maybe expansion in a couple of years? Or is that simply due to inflation levels and as we expect inflation to drop to a more normal, say, 2%, 3% globally, that's when we'd start to expect the margin expansion to take place. Secondly, I was wondering if you could just talk us through really exactly what happened in October. Of course, you made your AGM statement back in September where presumably, things were performing a bit better. But clearly, something happened in October. And I was wondering if you could just sort of run us through precisely what that was. And then finally, on Lat Am. Within that region, are there any specific countries you'd call out that are performing better or worse than some of the others?

Thanks. I'll take your second question about October, and then I'll let Lavanya talk about the medium-term guidance a little bit further. So look, so what happened since the AGM? I mean really 3 things have happened. One, of course, we knew about and disclosed and knew would be challenging, which is we did end the year with higher inventory levels. And -- but the team really did expect -- within the region, the team really expected to be able to move through that within the first quarter of our fiscal. So really did expect October to be a key month for coming back to regular ordering. Two additional things have happened that really have worsened the consumer environment. We talked a little bit about that in the call in August about what had led originally to that inventory build, particularly in Brazil. But conditions have really worsened. Things like U.S. interest rates do impact Latin America quite immediately as well as elections in several key markets. All of this really has created a very tough consumer environment. Seeing more downtrading caused us to have to spend a fair amount of trade spend on pricing in order to move that inventory. In addition, while we have good visibility in inventory levels through our distributors, we have less visibility to inventory at wholesaler and retailers that they sell to. Latin America is one where our point-of-sale information is just much more limited. So if you remember, we've had to take multiple rounds of pricing throughout fiscal -- really the last 2 fiscals. And in an environment of benign interest rates, these channels purchased ahead clearly of anticipated consumption. You also have to recognize that in many of these markets, our products are often viewed as a hedge against devaluation. We do have a very experienced team in Latin America. And in a more stable environment, you can see where these customers do these prebuys. Unfortunately, in the environment of this extreme volatility and coming through that COVID super cycle, it was just difficult to see what part of what was going on was true consumption growth versus inventory increases. And it became very clear to the team as they were working through October orders that clearly there was more inventory below that kind of in those more opaque layers underneath our direct distributors that we did not anticipate. As far as for what -- for where this is -- where we are performing kind of better and/or worse. I mentioned that we were gaining share in most of our markets in Latin America. The one exception to that is Mexico. And certainly, Mexico is a place that we have seen some of the most challenges right now in our business. But we are seeing really pressure kind of throughout the region, I would say, but we are gaining share in those other markets. And then Lavanya, I'll let you take the medium-term guidance. And of course, for those of us -- for those of you that are joining us for Capital Markets Day next week, we'll go much deeper into this. But Lavanya?

Thank you, Debra. Laurence, so I'd say 3 things. The first one is I do want to reiterate that we do feel good about the strength of this business and the resilience of the business and the long-term outlook of the business. So in terms of how we -- our frame, we will want to continue to invest in this business to continue to drive growth. You've heard us say many times that we are only a 4.7% market share of total beverage alcohol and our ambition to get to a 6% market share is very much strong. Second, we are continuing to see inflation that although it has slowed, it continues to be there. And so that is influencing our guidance on operating profit. Third, we will accelerate productivity as we go through the next several years. You've heard me talk about our supply agility program, and the expectations that we have that it will help make resilience for our supply chain deliver incremental operating profit as well as help from a cash and a carbon perspective. So this is the program that as the benefits of it start to come through, it will help from an operating profit perspective as well. I'm not putting a timeframe specifically around this simply because of the uncertainty that exists in the marketplace today. So as we do see inflation moderate and as we see the benefits of our accelerated productivity comes through, we do expect that despite increasing investment behind our business, we will see operating margin improvement.

Just coming back to Debra, your comment on Mexico. Do you think that's specifically a spirits comment? Or do you think that's an overall consumer comment?

Well, that would be like overall for consumer, but certainly spirits have been impacted more than beer.

The next question comes from Edward Mundy from Jefferies.

Two questions from me, please. The first is you're talking to improvement, I think, in the second half of '24. Does that mean growth in both revenues and profits for the second half of '24? Just help us calibrate our fiscal '24 numbers. And then second of all, on the sort of medium-term framework of 5% to 7%. Clearly, we've been through this super cycle. You do operate in a particularly good industry, and you do have a great footprint and a great portfolio. I guess the question is why not bring this back down to 4% to 6%, which is where the guidance was before? And then why are you stuck with the 5% to 7%?

So Lavanya, do you want to...

I'll just take the first one.

So yes, why don't you take the first one? And then...

Yes. So in terms of our guidance for this fiscal year, what we are guiding to is that we will see gradual improvement in both organic net sales and operating profit in the second half of fiscal '24 compared to the first half of fiscal '24. So that's what we're guiding to. And then...

Yes. As far as why not go back to 4% to 6%, and I mean this is something we certainly will dive more into. But look, from an industry, we are -- it is an attractive industry. And we have a great advantaged portfolio and footprint that we expect to grow ahead of that industry growth. So we are seeing the industry get back to those mid -- that mid-single digit. We do feel very confident in our footprint, and we are investing against that. So those are really the 3 components. And as I mentioned, we can certainly talk a lot more about that next week.

The next question comes from Andrea Pistacchi from Bank of America.

Two from me, please. One on the U.S. So at your full year results, which you then sort of confirmed at the AGM, on the U.S., I think the message was that the market is growing around the low end of mid-single digits, maybe because of a couple of things like prepared cocktails, et cetera. You're growing a bit below that now. And then in H1, you've also got some more difficult comps. So has anything really changed on the U.S.? And I think in the press release that your comment on the U.S. is that -- or on North America, you expect gradual improvement in organic net sales growth in the first half. Does this suggests that you're actually expecting some growth in North America in the first half? And then the second question, please, slightly broad a bit, again, focused on U.S. and Europe is about pricing. So in this 1H, you're benefiting from price increases that you put through mainly at the beginning of the year. So how are you feeling about pricing over the next 12 months in the more difficult consumer environment? And what are you seeing in the U.S. in terms of pricing environment? There's been some commentary, for example, on the -- in cognac. Obviously, you're not directly exposed to that, but cognac being very competitive, is that specific to that category? Or are you seeing anything slightly broader?

I'll take the first one, and then Lavanya, if you want to take the second one.

Yes.

Look, all we're saying at this point from a North America perspective is that we are expecting sequential improvement from the second half of last fiscal. Clearly, right now is an important time for the industry as you -- this is a high seasonal business. So certainly, we are -- it's underway, but we are expecting sequential improvement. And then Lavanya?

Yes, I'd just add from a pricing perspective, we're definitely seeing the rate of price increases that were being taken both within our business, but more broadly within the industry and even more broadly within consumer products is moderating as we -- as time has gone by. And so what we're asking on pricing is we have the right -- we have a great suite of tools and data and capabilities to be able to analyze and understand where there is pricing opportunity and where we -- what's the right kind of the equation between trade spend, headline pricing to be able to get to the right equation between volume, price and mix. And so what we're seeing right now is moderation in pricing. There is definitely -- in some parts of the world, there is definitely more pressure such as in Latin America where we are seeing some downtrading. But broadly speaking, I would say that we're -- this industry, in general, doesn't have an environment where there is dramatic changes in the pricing environment. So if we find at any point in time that we are slightly out of kilter on price, we will make the adjustments. But those will happen in both actions.

The next question comes from Simon Hales from Citi.

Two for me, please. Can I just come back to the destock issue? I mean I think over the last sort of decade at Diageo, you've clearly been focused on sort of sell-in, not sort of sell-out and not sell-in as a strategy. And I think we were of the view that the destock cycles that we've seen historically would be less of an issue sort of going forward when we saw macro weakness. From what you're saying today, Debra, it feels that outside of a lot of maybe your Tier 1 wholesalers, you're perhaps still struggling in some markets to still see the inventory levels we might see in trade. So I just wonder, is that fair, is that harsh against that backdrop? And how do we think about your visibility now on how much more stock levels you really think are left in LAC, in Latin America? Do you think the destock will be done by the end of the first half? So a bit of a broad waffly first question. And then secondly, if I can just ask you about Europe a little bit. You flagged the weakening in the Middle East having some impact on the division of late. Are you also seeing a bit of a slowdown from a broader consumer standpoint across Western Europe yet? Some of the other FMCGs have been calling that out in recent weeks. I wonder if you've seen it.

Yes. I'll start with Europe and then I don't know, Lavanya, if you want to take the destock. So look, I mean, in Europe, we still have strong momentum, I would say. It's just certainly since the tensions have escalated in the Middle East, we definitely are seeing a more cautious consumer. So that's a few weeks. Overall, we still feel good about our momentum in Europe. We are gaining share. So that certainly helps us. But it's -- I would say it's just been a little tempered certainly in the last few weeks. And of course, we are a leading spirits company. Within actually the Middle East, we have, in effect, stopped trading. So certainly, there has been an impact there and that rolls into our Europe numbers.

So Simon, yes, on your question on destock, we are indeed a sell-out culture, and we have very strong controls around the reporting of this and the tracking of inventory levels at our direct customers. What has happened in Latin America is while we have good visibility of the inventory levels at our distributors, we have less visibility to the inventory levels at the wholesalers and the retailers that they sell to. And as Debra mentioned, over the last 2 fiscals, we have taken multiple rounds of pricing. And this was -- at least in the beginning of these price increases, it was in an environment of very benign interest rates. And so what we believe has happened is that this part of the channel that's below the distributors, they have purchased ahead of consumption. And it was hard to see, as Debra mentioned, how much of this was actual consumption versus how much of this was inventory increases in the layers? But in terms of our own visibility to distributors' inventory levels, those are strong. We have regular reporting about it. This is -- you heard me talk about this. This is a part of our routine financial assurance committee process, and so we definitely continue to be a sell-out culture.

The next question comes from Mitch Collett from Deutsche Bank.

I'd love to ask again about the U.S. So you've said that you expect a sequential improvement versus 2H. I guess that means better than minus 2.6% in terms of organic sales growth for both 1H '24 and full year '24. Can you perhaps give some color on why it's going to improve versus the second half of '23? The industry data certainly seems to have got worse and tequila growth specifically for you seems to have slowed. That's my first question. And then secondly, could you talk about the time period more specifically for the medium-term guidance? I'm guessing given what you said about 1H, F '24 won't be within the range. But does that medium-term guidance start in FY '25? Do you think F '25, I appreciate it's a long way away, is likely to be within your medium-term guidance?

Yes. So I'll start with your second question. I mean the medium-term guidance is medium-term guidance. We don't have a big time frame that we're assigning to that. Your other question about the U.S., so I mean we are in the middle of the half, but we are still expecting sequential improvement. And we're seeing actually some green shoots in many parts of the industry. I know that there's been a lot of reporting from other competitors and other things. And it is a market that's quite volatile right now, but we are in a critical period and we still expect sequential improvement.

Okay. On your question on medium-term guidance. Yes, I think it is safe to say that fiscal '24 is not going to be within our medium-term guidance. And in terms of what -- when does medium-term guidance come into place? Look, I think we need to look at this medium-term guidance from a perspective of that is what we expect to structurally be able to grow, right? And that is anchored in the fact that our medium-term guidance, the confidence comes from the fact that we -- TBA continues to be an attractive category. International spirits within TBA is growing faster than the rest of the category. Our footprint is clearly advantaged in terms of the geographies and the brand portfolio that we have across this business. And we are investing behind the business, and we will continue to expect to pursue our ambition of growing share in this business. So uncertainty exists in the near term. But I do expect that over the medium term, we will be able to deliver between 5% and 7% growth on the top line.

The next question comes from Cedric Lecasble from Stifel.

Yes. Most of the questions have been answered. I have one remaining. If you had to quantify the impact of Lat Am in this morning's communication and change in tone, would you say Lat Am is 50% of the move, 70% of the move? We understand that there are some other moving parts hurting the business or making it a little more challenging in the short term. So what would be the weight, the precise weight of Lat Am in your change of view this morning?

Thanks. Lavanya?

Yes. So Cedric, what we have said in our RNS is that -- we've issued this guidance because of the change in outlook in Latin America. And just to reiterate what's in the guidance, we are seeing sequential improvement in our biggest and most -- probably the most important market for this business in North America. We're seeing sequential improvement in Africa. We are seeing strong momentum in Europe and in APAC, and in APAC despite the slower-than-expected recovery in China. Latin America is about 11% of our business. This was as of the end of fiscal '23. And as we have said in our press release, this has -- this business has -- is now expected to decline above 20%. So I mean you can do the math in terms of the percentage of impact that we are seeing from the Latin America business.

The next question comes from Chris Pitcher from Redburn Atlantic.

Can I dig into Latin America? Again, sorry to come back. But over the years, you guys had theoretically moved your business away from the sort of the free trade zones, the use of wholesalers, and there was a big focus on the domestic business and having greater visibility. You also invested significantly in your primary scotches, which were meant to soften any economic impact. And yet looking at the numbers today, this is not as bad but almost as bad as what happened in COVID when it was a supply restriction. This is nothing like the sort of decline we've seen in previous economic cycles. So are you comfortable that the work that was done in Latin America really worked and reduced the cyclicality? Or is there a major overhaul of your reporting and route-to-market structure that needs to happen in order to avoid something of this magnitude? And then secondly, on the medium-term guidance. I appreciate the 5% to 7% reflects the structural growth of your business, but it doesn't reflect the cyclicality. Your main competitor has a wider range. Have you considered widening the range just to better reflect the reality of operating in a more cyclical distilled spirits market?

So I'll take the first one. I mean just on Latin America, in general, I mean, our business has grown. Over the last 4 years, we still are looking at a 15% CAGR. So -- and it continues to be margin accretive to the growth -- to the group importantly. So our business, overall, we feel very good about what we have built in Latin America over the past several years, and that business has premiumized. It is, of course, still an emerging market. And in emerging markets, it's never a straight line. And certainly, there is volatility. And as we premiumize, clearly, with this consumer environment, with downtrading, we have had to invest against price as well. So we're not only suffering from the decline, but we're also suffering from having to -- even through the inventory, we're having to spend a fair amount in trade. But still overall, and in the long run, we feel good about what we are building and have built in Latin America. But we did have to come out this morning with this announcement because we were no longer seeing the sequential improvement at the group level. This has caused us to no longer see at the group level that sequential improvement that we had previously guided to. So per our regulatory requirements, we absolutely wanted to get out to the market as soon as was appropriate. And -- so that's what's happened in Latin America. But overall, in the long run kind of scope of the business, we still feel very good about what we've built there. Lavanya, do you want to say anything about medium term?

Yes. Just to clarify, what do you mean by when you use the word cyclical? Chris, are you there? Okay. So I'm just going to -- I'm going to get to it because we have specified even though it's cyclical. What I will say about this business is that it is our business, our portfolio is that it is extremely resilient. And you will see more of this next week during our Capital Markets Day. And so I don't want to steal all of the thunder of next week. But one of the things that you will see next week in our Capital Markets Day is we have a very broad portfolio. Our presence in this category spans across every type of international spirit. So scotch is a big part of our business, but also we have a strong presence in premium beer with Guinness in Europe and North America. We have a great portfolio within tequila, within gin, within rum. I can go on. And we also have a deep portfolio from a price point perspective. And so -- and our presence across geography, because not every geography moves in the same direction from an economic, macroeconomic perspective. And so one of the things that it really works for Diageo is the breadth of portfolio and footprint that we have, which is what gives us real resilience. So depending on what's happening with the consumer in terms of what type of spirits they are more interested in, or depending on what's happening from a macroeconomic perspective, this category -- our portfolio within this category really is very resilient. And so that's what gives us the confidence in our medium-term guidance. But yes, I guess, more on that next week.

Yes. So thanks. We're at time. So just -- I wanted to thank you for joining us this morning on this call. And for those of you who we will be seeing next week, we look forward to it. And for those not, I think it is going to be webcast, so you'll be able to see it as well. Thank you very much.