NEWS ANALYSIS: Looking after number one

The world’s two largest drinks brand owners, Diageo and Pernod Ricard, have both seen impressive returns over the past year. Ron Emler pores over their results as the two giants battle for domination

In late 2005, Patrick Ricard, the chairman and chief executive of Pernod Ricard, predicted: “If we continue on the same track, in ten years time we should be close to becoming number one.” He was targeting Diageo, which styles itself as “the world’s leading premium drinks business”.

Analysts have regarded Pernod Ricard as more vibrant than its bigger rival, largely because of its takeover activity, notably grabbing Allied Domecq in 2005 in partnership with Fortune Brands. In 2001, Pernod Ricard had taken over 38% of Seagram’s wine and spirits operations. Diageo grabbed the lion’s share of Seagram but since then its acquisitions have been infills to its portfolio, such as Bushmills Irish whiskey.

The stock market values Diageo at about £27 billion, while Pernod Ricard has a worth of about £12bn. In the 2006/07 financial year, the value of Diageo’s sales was almost £7.5bn, while Pernod Ricard’s were worth £4.6bn. In terms of nine-litre case equivalents, Diageo sold more than 141m, while Pernod Ricard achieved just over 100m. 

Both companies have enjoyed a buoyant financial year. Diageo’s net sales were 7% ahead and its “global priority brands” delivered operating profit growth of 9%. Meanwhile, Pernod Ricard’s 15 “strategic brands” grew by 9% in volume and 13% in value.

Portfolio content

Pierre Pringuet, Pernod Ricard’s managing director, says his company has “the most comprehensive portfolio in the business”. Diageo does not own a Champagne, such as Pernod Ricard’s Mumm and Perrier Jouët. Nor does it have its own Cognac. It does, however, own 34% of Moët Hennessy and Paul Walsh, Diageo’s chief executive, says he is very happy with the relationship.

For its part, Pernod Ricard wants a Tequila, having surrendered Sauza to Beam Global as part of the break up of Allied. It also failed to land Herradura last year. Diageo, on the other hand, has Jose Cuervo, which sells 4.5m cases annually. 

Nor does the French group own a premium vodka. It holds the distribution rights to Stolichnaya outside Russia and is negotiating to buy the brand. Meanwhile, Diageo has Smirnoff, which sells more than 23m cases every year.

Pernod Ricard sold more than 23m cases of wine in 2006, based largely on Orlando Wyndham in Australia, Bodegas y Bebidas from Spain, and Montana – New Zealand’s biggest producer.

Diageo’s wine interests centre on premium Californian marques, such as Chalone (it sells about 12m cases a year), but Diageo has been cautious about buying into wines because it is anxious not to dilute the returns it earns on its capital. It rejected Montana because it did not meet its financial criteria.

The other main difference in portfolio content, apart from the aniseed spirits range so important for Pernod Ricard’s cashflow in France, is beer. Diageo’s Guinness is the world’s leading stout, selling the equivalent of 11.3m nine-litre cases a year. The group has other production interests, notably East African Breweries. Pernod Ricard is not a player in the beer market.

Diageo is the leader in spirits, while Pernod Ricard comes in second place; both have 17 of the top 100 spirits brands. Pernod Ricard is fourth in world wine sales and Diageo fifth.

Both companies have been rolling out impressive statistics. For instance, Johnnie Walker’s sales have topped the 15m case mark to make it the third best selling spirit by volume. Equally, Pernod Ricard’s Chivas Regal topped 4m cases and The Glenlivet broke through a million. Both groups achieved organic growth of more than 9% in the past year but Diageo increased the sales value of its “global priority brands” by 7%, while Pernod Ricard’s “strategic brands” put on 13%.

At Pernod Ricard, Stolichnaya’s volumes grew by 17%, Martell and Montana by 17%, Havana Club, Perrier Jouët and The Glenlivet by 15%, while Ballantine’s and Jameson put on 11%. Diageo’s Johnnie Walker grew by 14% (to achieve net sales of £1 billion), Smirnoff by 6% (a £500m increase in value) and Baileys by 10%.

Percentages are relative, however. Johnnie Walker’s 14% growth equates to extra sales of nearly 1.4m cases. The Glenlivet’s 15% growth is equivalent to about 150,000 cases. 

Both groups focus on their core brands, moving consumers onto premium styles, increasing the prices they charge and the margins they earn. Diageo is forthright in saying that its operating margins rose by 40 basis points in the past year; Pernod Ricard’s Pringuet says that margins “are moving in the right direction” from the 20.7% achieved in 2005/06.

Shareholders in both companies have enjoyed a profitable ride. Since 1998, Diageo’s shares have more than doubled to nearly £11 while Pernod Ricard’s have soared from £21 to about £111. In addition, the French group’s investors were given extra shares in 2003 and earlier this year. Meanwhile, Diageo’s finance director, Nick Rose, says that since it was formed in 1997, Diageo has returned more than £18bn to shareholders through dividends and share buybacks.

Both companies have operations in every significant market but soon after the Seagram takeover in 2001, Diageo focused on North America, which now generates just under 40% of its operating profits from 33% of its sales. Walsh says that for the past three years Diageo has consistently outperformed the US market, the most profitable globally. He also says that demographics are working in Diageo’s favour in America as younger age groups, notably in the expanding Hispanic population, gravitate towards premium spirits.

Pernod Ricard is looking to capitalise on the same trend – especially if it can win the trade dispute that excludes Havana Club rum from the US. But only 28% of its sales come from its Americas region (which includes Central and South America).

Walsh boasts that Diageo is the market leader in every developing market – except China. You can sense the determination as he says that last year Diageo closed the gap on Pernod Ricard by six market share points. “We intend to be number one in China one day… In all of the other emerging markets, we are number one. And that’s our goal,” he says. For his part Patrick Ricard says: “We are the clear leader in China and intend to remain so.” 

While Pernod Ricard is comparatively weak in Africa, Nigeria has overtaken Ireland as the second largest market for Guinness. Despite speculation about the Dublin brewery, Walsh is clear that Guinness will remain in Diageo’s portfolio. It generates considerable free cashflow, and is a useful lever in developing fast-growing African markets.

Closing the gap?
And free cashflow is a significant difference between the two drinks giants. Diageo has an extra £1.4bn to spend from last year’s operations, and while Pernod Ricard is paying down its debt at record pace, it remains burdened by the financing of the Allied Domecq takeover in 2005. Significantly, Pringuet was asked recently if the French group could afford to buy both the Absolut and Stolichnaya vodka brands, if the regulators would allow. His answer was a rueful “probably not”. Meanwhile, M. Ricard has said that buying Stolichnaya is his priority, despite keeping his Absolut options open.

Diageo is in the market for Absolut and Walsh seems confident about legally being able to put it in the same portfolio as Smirnoff, the world’s best-selling spirit brand. He says it is not a “must have” brand, but he would have no difficulty in funding the purchase, although he is renowned for not over paying.

Acquisitions (especially in Tequila) could help M. Ricard’s company close the gap on his rival, as would getting Havana Club into the US. Diageo has less scope to add to its portfolio, apart from strategic infills, such as Bushmills. It could, however, take a different view about wine should margins improve.

For all its growth since 2001, Pernod Ricard is firmly in second place. And that’s where Walsh wants it to remain, despite eight years remaining on M. Ricard’s timetable.

© db October 2007