Diageo plc (DGE) Earnings Call Transcript & Summary

Good morning, and welcome to Diageo's F '24 Preliminary Results Q&A conference. Your call today will be hosted by Debra, Diageo's CEO and Lavanya, Diageo's CFO. This conference is being recorded. [Operator Instructions] We are now ready to start the call. Debra, please go ahead.

Good morning, and thank you for joining our preliminary results call for fiscal '24. I hope you've had a chance to read our press release and watch our presentation on diageo.com. Fiscal '24 was a challenging year for both our industry and Diageo as we navigated a volatile operating environment across the globe. Group organic net sales declined 0.6% and the main driver was materially weaker performance in LAC, our Latin America and Caribbean region. For perspective, if you exclude LAC, organic net sales grew plus 1.8%, driven by resilient growth in Africa, Asia Pacific and Europe regions. This offset the decline in North America, which was attributable to a cautious consumer environment, retailer inventory adjustments and the impact of lapping inventory replenishment in the prior year. We made good progress against our strategic priorities, and we ended fiscal '24 gaining or holding share in over 75% of our net sales value in measured markets, including in the U.S. We also took deliberate actions to improve on near-term execution, and these include meeting our commitment to improve our inventory position in LAC, stepping up our route to market across several key markets, including our most significant transformation in at least a decade in our U.S. [ SPEARs ] organization. And delivering a record productivity savings of nearly $700 million. We've also generated $2.6 billion in free cash flow while continuing to invest for long-term growth. Looking ahead to fiscal '25, the consumer environment continues to be challenging, and we expect the challenges we saw towards the end of fiscal '24 to persist. Our focus continues to be on strengthening our business's resilience and investing smartly in strategic initiatives to enable us to return to growth when the consumer environment improves. I continue to believe in the long-term fundamentals of TBA Diageo's advantaged position within it and our ability to grow ahead of TBA and gain quality market share. We will open it up for questions. Can we get the questions started?

[Operator Instructions] Our first question for today comes from Simon Hales of Citi.

A couple of questions from me. I just want to understand -- make sure I understand sort of your comments around where inventory levels are in trade as we head into fiscal 2025. I think if I interpreted the remarks and the prepared presentation correctly, what you're saying is that although we could see a further ongoing deterioration in demand and that would naturally led to some ongoing destocking throughout the supply chain. In the absence of further deterioration in demand, you kind of think that stock levels are appropriate now in most markets, perhaps with the exception of Mexico. Is that the right way to think about it? Have I got that correct? Or are you still expecting in the U.S. to see further wholesale or retailer destocking in the first half? That's my first question. And then secondly, again, in the prepared remarks, I think it is one in the [indiscernible] slides, she called out the different performance through the year as the different price peers within your portfolio clearly, value has outperformed the premium segments of the portfolio this year. I wonder if you could talk about how we've exited year in terms of the performance of the different price points. Is there any sign at all that premium is starting to see some improvement relative to value, I suppose, particularly once we ex-out the LAC destocking effect.

Yes. So I'll go ahead and take the first one on inventory levels and kind of step through the world so you can -- so we'll do that and then I'll pass to Lavanya to follow up on the price to your question. So first of all, we ended up in really good inventory levels, I would say, really across the world. Let me start with LAC since that's been the one that we have committed at the interims that we would get back to more appropriate levels, and that's where we have done significant destocking, working with the wholesalers and customers in the region. In LAC, we have delivered on the commitments that we set out at the interims. We did call out Mexico specifically in the presentation. And the reason that we did it isn't so much that we're -- we think we have a bunch of inventory left. It's just the volatile environment that we're still seeing in that market. We're still seeing significant competitive activity. There's some down trading in Tequila and Scotch, which, of course, is important to us. And we're not gaining share. And so because of this, we do believe we're at certainly more appropriate levels for the environment, but it is just -- it's still a deteriorating situation. So versus having some kind of big bounce back, we're just calling out that it really is about the consumer situation there. But certainly, we would expect our performance overall to more align to that consumer demand going forward. So that's Latin America. Stepping around the rest of the globe, we're really seeing very normal kind of -- our historic kind of forward days cover as we step around the world, we have called out a couple of other inventory things in APAC, our SJF business they were quite low going into the last fiscal, just not really knowing when we were going to emerge out of COVID. Then they restocked at the beginning in the first half of fiscal -- of our fiscal '23, the back half of the calendar year '23. And so we're going to have to lap that this year, we're going to have to lap that restocking in China and APAC. And then also, look, the U.S. situation, we have not -- we are fine on distributor inventory. We have been fine, we ended with the same level of date. We actually have taken out some inventory just getting it appropriate for the environment. But overall, we have complete transparency in the U.S. So we haven't had any problems at the wholesaler level at all. And really from a retailer destocking, this is the third round that we see of retailer destocking. That's left to do with -- frankly, I think that's more about interest rates remaining high and you just don't see retailers wanting to be caught long. And also if you do the calculus on this, it's not really worth it for them in many cases, to hold a lot of extra inventory. And they're just not wanting to anticipate the consumer at all. Like I said, this is our third round. I remember first talking to you guys about this back at our Scotch Investor Day, more than a year ago. So this is -- we're now seeing inventory levels this isn't -- like I said, at this point, it really isn't about even the coming out of the pandemic. This is more about just in a high interest rate environment, how they're choosing to manage their stock. So look, I think overall, we feel like we're in good position. We do have to navigate to your point, we are having to navigate a volatile world but we are managing this quite closely. And as you can imagine, we've gone around and tested the robustness of our -- of what we can see we've strengthened our consumer insights to just making sure that we stay as close as possible to the situation. So we don't have any kind of repeat of where we've been. Lavanya, I'll pass it to you for the price of your questions.

Thank you, Debra. Hello, Simon. So let me just start off by framing that while we do see some pockets of that trading across the world, premiumization continues to be a tailwind for the category and for our business. What's driving the growth of the value here in fiscal '24, it's really been the growth of the very strong performance of Beer in Africa and Oban whiskey in India, Oban whiskey in India grow almost double digits. So that's what's driving the growth and value here. If you look at the premium tier, that and above. That was significantly impacted by Latin America. Latin America is a much more premium business for us and very heavily scotch business, as you know. And as we took down the inventory levels in trade in Latin America down to a more appropriate level at the end of the year that impacted the numbers for the premium here. The premiums here would have grown at 3.7%. If not, if you exclude the impact of Latin America. More broadly speaking, it's scotch and tequila, which are -- which play in our premium and super premium and above price tiers. And you really look at and in Scotch, as Debra shared in her presentation, we're gaining share in 9 out of our 10 largest markets. So this is a business that's in good health. And as we lap some of those sort of onetime things that happened in fiscal '24 and actually back even in fiscal '23 like the sale of final inventories in Russia as well as the recommitment of inventory levels in North America, we will come out of these and a cost base. If you look at our largest region in the U.S. more than 100% of the growth of the category is still coming from the super premium and above price segments. So premiumization does continue to be a tailwind for us and these numbers, that's why we took some time to explain these numbers out in the presentation.

Yes. One other thing I'll just add to what Lavanya said. The Tequila also did impact this. So I think we shared a couple of these in the press release, but just to highlight for you, remember, we were lapping the restocking of Tequila because this was one that because of the high demand, we recovered late from the glass shortages. So Tequila is impacting this as well. If you take a look at Don Julio, the underlying depletions I think a plus 21% compared to the shipment show up is plus 12%. By the way, those underlying depletions do align with the Nielsen/NABCA consumption as well of plus 20%. And then Casamigos is showing that minus 22%. Actually, if you look at depletions, while still down is only down minus 9%. If you look at the Nielsen/NABCA in the last 12 months, it's minus 7%. So you can see through there, that definitely impacted that shipment analysis, and that would have shown up in the super premiums here. Thank you, Simon.

Our next question comes from Edward Mundy of Jefferies.

Two questions for me as well, please. The first is really on your best estimate on the timing of recovery for the industry within the U.S. And I know the slide and now you've given some quite useful charts just showing the more recent trends. I guess first part is, what do you think the industry is growing at both the stills versus RTDs? Are you able to put any time frame on when you see the industry might get back to that sort of mid-single-digit run rate? And then what do you think is the bridge to get back towards that middle single run rate? Is it volume? Is it mix or price? Is it RTDs rolling? Is it destocking comes to an end? I mean, how do you think about the bridge back towards that sort of 4 to 5-ish run rate. And the second question is on Guinness, if I can, it's a brand that's very well distributed. I mean you haven't really grown through distribution gains because most pubs in both U.K. and Ireland, you've essentially brought new consumers into it or you've got existing consumers to drink more. Could you maybe just deconstruct what's made Guinness so successful is such a good story. Do you think it's going to be sticky? And are there any learnings from Guinness that could be applied to some of your other brands?

Yes. I'll start with -- let me start with the U.S. and then I'll come back to Guinness. So look, going through the industry, I mean we do believe in fiscal '24, the U.S. industry grew in low single digits. If you take a look at that and break that out, it's probably more 1% to 2% if you include things like the spear-paced RTDs, it is probably more flat to 1% if you think about core Spirits. And look, it wasn't even through the year. So we were seeing improvements and then it dipped down, and we saw a slight improvement again and then it dipped down to it. But it most likely is in the low single digits as you look at it. And if you look at NABCA, that's what NABCA and because that captures everything, it's not the most vibrant states, but because it captures everything that gives you a good point in context. Volumes were down on core Spirits, if you exclude all the RTDs, but 2/3 of that volume decline is in vodka and rum. So I look at that and you look at the heat that you still have on the Tequila category, which is growing things like plus 7%, still even tucked into that low single-digit number. And I think the mix for us still makes us feel good because remember, our North American Whiskey business is bigger than our vodka and rum business. So as we look at the industry, it's kind of sitting there in low single digits, but it is being dragged down by volume. Price mix actually in the industry is holding up okay. So it really is about volume. In price mix you would ask to break out between the ready-to-drink and core Spirits or kind of the bottle. Core spirit's price mix was probably 2% to 3%. We were above that for the year. So we kind of look at that and feel pretty good. When you have RTDs in there, it does bring down the price mix. So I do think it's important to break that out. But I think on core Spirits, price mix is starting to work its way back. And it's because, as Lavanya mentioned earlier, we -- actually over 100% of the growth is in the super premium plus price tiers in the industry. We also saw household penetration, of course, Spirits plus 2%. So what you're seeing when you see these lower volumes is really the units per basket are down. And that is from this pressure, if you think about vodka and rum, these are the more standard kind of based spirit. And so those are those households that are under pressure that are buying a little less. We're not really seeing the down trading when people do go into buy, they are buying still the brands that they want. And then we are still seeing Spirits gain from Beer and Wine in the U.S. So overall TBA household penetration had a flattish, spirit plus 1%, Beer is kind of flat and then Wine we're seeing is minus 1%. So that's a little bit about the industry. As far as the time frame to recovery, when you break through all the noise and get around all these shipments and lapse, which thankfully, what is it going to take to get back? Well, we clearly need to finish the rollout of all of that COVID super cycle. Fortunately, I think we're largely at the end of that. Certainly, from our big lapse, we don't have that in our numbers as we roll forward. So that's a positive. But the consumer recovery and I do think things like rate cuts will certainly help if we get a rate cut in the U.S. The uncertainty with things like the political environment and some of that is when you do some of these and you look into consumer sentiment, that's weighing on consumers a bit because we're even seeing consumers with a little extra money being a little more cautious in their spending. So it really is hard to predict. I know I said 6 months ago that it would be 6 to 18 months. The only update I'll give you is that it wasn't 6 months. And it was not linear as we've kind of said, there was a great July 4. If you saw the Nielsen for July 4, we started to see a pretty decent Spirits growth there in July. But sentiment is still -- it's quite cautious. So I'm just hesitant to put out any time frame on it. What we're trying to do is really set ourselves up with getting back to share growth. We've got great share momentum in the U.S. on core Spirits, not just in TBA but on core Spirits. And so that's really what we're focused on, on getting back there. Guinness. Let's talk about Guinness because Guinness is a great news story. So plus 15%, and it's being driven in our largest markets. And even in our home market of Ireland, to your point, there's not a lot of places you can't buy Guinness in Ireland. That being said, I do think the innovation agenda has helped us tremendously. The nitrous surge that's the cap. We don't have it in the U.S., but in Ireland and GB, it's a cap you can kind of put on the top of the Guinness can, and it gives you just the perfect core of Guinness. That has done really well for us. Guinness 0.0 is just we literally can't make enough of it. And we've more than doubled the business in GB as well that's really helping us. I would say, from a consumer standpoint, we've broadened the consumer. We still have the classic rugby labs, but we are also bringing more women into the franchise. And we're just continuing also from a marketing and experience, I think the brand has done some really great social media. We've let kind of consumers take over some of the conversation about where is the best pint poured, which is -- people really get into this. And so that's been really great. And so what I do think is sustainable is I think we have built, we've stayed very true to the liquid. We stay true to the consumer while expanding that base. And look, we just signed. We're official sponsors of the Premier League and we're very excited about that. We've got a great history with Six Nations. But of course, Premier League is quite a global audience. And so we're excited about where that can take Guinness going forward.

[Operator Instructions] Our next question comes from Celine Pannuti from JPMorgan.

I have one question and one follow-up. So my first question is just wanted to I understand your -- a clarification on your outlook. Are you hinting because you said that growth will return when consumer confidence will return. So are you hinting to flat organic growth for fiscal year '25? And within that, what are the moving parts? Because I saw that your price mix, even though you mentioned was positive in the U.S. decelerated to 0.7% in the second half. So is price mix still positive as you bake that into fiscal year '25? And then I think you also mentioned that organic EBIT margin will be line for with H2, which was down 100 basis points. So is that as well the base for fiscal year '25. And within that, could you elaborate a bit which regions are driving this decline? Then my second question is really on I think about the midterm outlook where you have not yet seen when the investor demand will be turned. I mean CapEx investment is quite elevated now for several years, you have more than doubled your CapEx investment and you continue to invest in maturing inventory. I wanted to understand what kind of volume growth underpins these investments. And whether your consumer insight program that sorting of rolling out, how does it inform you in terms that the behavior are economical versus structural in terms of the weakening demand in volume?

Okay. Well, I'll start with just first on fiscal '25 and a little bit about our guidance there. Look, what we're saying there is when the consumer environment improves, we will return to growth. So as far as where does that land us on the year, it really does depend upon when we start seeing some of these better trends on the consumer. While we certainly exited the year with more momentum with our share gains, the category and the industry kind of more limped into the end of the fiscal. And so that's what we're pointing out. So whether it's going to be flat or above will depend upon when that consumer environment improves. And so that's why we're kind of flagging that exit rate on the industry in the U.S. Look, I think operating margins, we flagged also the negative pressure there. The pressure is coming from multiple places. It really is about -- and you mentioned first of all, North America. North America price mix, we would expect to be positive. There's part of what did impact us in the second half as you remember the Tequila numbers, the Tequila numbers that we talked through, the difference in the shipments versus the underlying consumer. So that's one that definitely negatively impact us as we had to lap that Tequila restocking from prior year. And so that's what's going on underneath that. So now moving on to margins, several things. So the strategic investments that we made in the second half of the year will, of course, carry over into the first half. We talked about the digital investments that we're making and also some of the route to market investments that we've made as well, so that continues. And by the way, that would have hit some of our North America margins in the second half. We also things like salary inflation, particularly in emerging markets is another place where we would expect that to continue to roll forward. Also that pressure on the top line impact our -- and particularly the pressure on the top line in NAM does impact our margins. It does impact our -- the leverage that we get with our cost structure. So that's why if the year improves, like you do see that coming kind of right along with growth. So we are very focused on productivity and pricing to really offset inflation. But these are some of the mechanical things and the roll forwards, et cetera, that we're seeing from the second half and the first half that we're trying to flag. I don't know if you would add anything to that, Lavanya.

No, I think you covered it perfectly.

And then on the midterm, so for CapEx, I'm going to talk about a little bit of where our CapEx spending was this year and where it was.

Sure. So Celine, I mean, when we think about CapEx and maturing stock, looking to start with maturing stock, maybe I then come to CapEx. Maturing stock, the way we think about the investments we make in maturing stocks is we'll be looking at long-term projected volume growth rates. And this is based off of both looking at historic volume growth rates, but also modeling forward based on what we see happening with the consumer. And so these are not based on the next 3 years or the next 5 years volume growth rate, but much longer-term projections of volume growth rate. And the way to think about it perhaps from a modeling perspective would be to the easiest way it would be sort of looking at historic volume growth base, which typically would have been a combination of population growth as well as the growth from moving -- consumers moving out of Beer and Wine into spirit. And then the third is volume growth that you get in emerging markets as GDP and earnings levels increase in these emerging markets. So the combination of the three is what really drives the maturing stock investments. On CapEx, a significant portion of our CapEx investment this year was the projects that we had announced. So we started the construction of a second distillery for a second brewery for Guinness in Ireland. And if you look at the growth rates that we've had on Guinness this year, you can understand why we need to put in that investment and Guinness is an extremely asset-light model. Unlike like Beer businesses, most of our global Guinness volume comes out of one factory in Ireland, which we are now trying to bring the second one, also to keep pace with growth of Guinness 0.0. So that's been a part of it. The other project that I will mention is we're building out a new distillery for single malt whiskey in China in Yunnan. Now that's going to come -- that we just started to make liquid to put into barrels now. We're not going to see the benefit of that come through for many, many years, but it could be delicious liquid I'm sure when it comes out. But again, the reason I mentioned this is because a lot of our CapEx investments are of this nature. They have much more long-term in nature, and that's what's driving the CapEx growth. What we have guided to is that we do expect the level of CapEx investment to say on for fiscal '25 and '26. And then come back to more -- close back down as a percentage of NSV back to historic levels after that.

And then I think you had a final question of consumer insights and what we were doing around consumer insights. And so yes, look, we are strengthening our -- and I mentioned this consumer choice framework. This is our proprietary network -- or our network data. This is our proprietary data that we use to look at occasions and how those are growing around the world. Some of that we featured at our Capital Markets Day. But we are taking it to all of our major markets, and that will be in place really by the end of the calendar year, we will literally have it everywhere that we want it to be. And that's enabling us to really identify these pockets of growth and actively move resources. And in this kind of volatile environment, it has been very important for us to get underneath and to be able to shift as appropriate. And we have done that in several places just to make sure that we're getting the right A&P deployed in the right place, the right liquid allocations to put in the right place and where we've decided to sort of invest in route to market. And of course, this even goes down into our U.S. route-to-market changes as well.

Thank you. Our next question comes from Mitch Collett from Deutsche Bank.

First question, given you're retaining your 5 to 7 medium-term guidance. I appreciate next year feels a long way off, but it sounds like fiscal '25 is unlikely to be back in that range. Can you give us your sense of confidence that perhaps fiscal '26 could see within that range? And really, other than the consumer changing, is there anything you can please to get yourself back there? And then as an add on some of that, my second question is, it's obviously been a very challenging year for spirit as a category. And by the sounds of it, it's been getting more challenging as the year has progressed. So what gives you the confidence that those challenges are cyclical and not structural. And I'd love to get your thought process around why you think things recover?

Yes. I mean, so let's talk a little bit about the medium-term guidance. And we have flagged, yes, certainly, for fiscal '25 given the current consumer environment, we're really focused on driving execution, strengthening our resilience and market share and that when the consumer environment improves, we will return to growth. And depending upon where that happens in the year, that will be how we progress back. We do remain confident in the long-term fundamentals and do believe this is not structural but is more cyclical and near term in nature. If you think about what underpins the fundamentals of our medium-term guidance, the demographic trends the rising incomes in developing world, Spirits gaining share occasions from Beer and Wine, the long-standing trend of premiumization. I walked through some of those in the U.S., which you can continue to see that spirit is gaining share from Beer and Wine occasions, the long-standing trend of premiumization being there. You see what's happening for us in India. Some of our African markets on Spirits growth. And so -- and then look, demo trends. I know there's been a lot of noise about Gen Z. So let me talk about that for a second because actually, as we look at Gen Z in the U.S., and while they're reporting kind of higher preference for moderation, we're actually seeing Spirits penetration up plus 3%. And in fact, they're more likely to purchase Spirits than millennials were at the same age. And so we're seeing -- look, whether it's the RTDs that are now spirit space that are bringing people into Spirits earlier. But we really see those demo trends, we don't see that cutting against us. We really do see that supporting the ongoing long-term trends that we've seen. And things like premiumization, look, we did see down trading in Europe and in APAC, but you see where their price mix. The price mix actually was plus 4%. So you had nice performance there on premiumization within our portfolio, we can handle that within our kind of broad portfolio. We were still able to get that despite what was happening. So that's some of the things that we can do to kind of pull forward on our own destiny. And this is why I do believe our portfolio is positioned really well in the right categories. When you look at what is still growing, it is Tequila, it is -- we're seeing pockets of Whiskey also continuing to do well. While there's some down trading in there. We've got a nice broad portfolio that can catch people. So that's why we're really focused on the quality market share because that helps us outperform even in a more pressured market. But we do believe those long-term fundamentals are there and that this really will be much more about consumers and so the volume pressure that we're feeling on consumers. But look, some of them still carried in maybe a little bit. They're drinking further down into their bar. That maybe they have built up during COVID. So the further we're getting away from this super cycle, and we're really into more of a normal cycle. We are seeing consumers come back and buying. It's just they had their own inventory. Now you go into an economic pressure situation, and we are seeing a little less volume than what you would expect but don't forget the noise also that we have in some of the volume that will roll off as we go forward, what have I not addressed. Good.

Our next question comes from Olivier Nicolai from Goldman Sachs.