Walsh puts on a brave face

Paul Walsh, Diageo’s chief executive, expressed surprise yesterday when the group’s shares slipped by 4% on the announcement of its half-year results to 31 December. He shrugged off the market’s reaction by stressing that “momentum is building in our business”.

The key fact, no matter how brave a face Mr Walsh sought to put on the figures, was that compared with the same period a year ago Diageo’s operating profit was only 2% up, compared with analysts’ forecasts of a 6% rise. In addition, while organic sales had been expected to increase by about 4.5%, they were just 4% ahead.

The strong recovery in emerging markets is still to counter-balance the difficulties in Europe where volumes fell by 2%, net sales were 3% lower and operating profit fell by 9%, reflecting intense completion and pressure on margins. Although Walsh sought to stress the growth in markets such as Russia, investors focused on the 13% net sales decline in Iberia, Greece and Ireland. Nor is any improvement in those markets expected in the immediate future. In Britain net sales grew by 1% but margins were eroded.

Walsh said that he was confident that in the full financial year the group “will improve on the organic operating profit we delivered in fiscal 2010”, but he fell short of increasing the profits guidance for the full year issued six months ago. Analysts have pencilled in profits growth of about 8%, so that leaves Diageo with much to do in the second half. That said, investors will suspend further judgement until Pernod Ricard announces its first half results next week. The French company is predicted to increase its earnings by about 14%.

More encouragingly, Walsh pointed to the longer term by saying that difficulties in the European market for Scotch, where demand is more focussed on standard blends, would allow the group to age its stocks for longer to take advantage of burgeoning demand for premium offerings with much higher margins in emerging markets.

He also pointed out that growth in super- and ultra-premium brands such as Ketel One and Cîroc had increased by more than 20% across a broad base of markets and promised that marketing spend would be increasingly targeted on growth opportunities for premium lines. This, he pointed out, was a vindication of the premiumisation policy.

He said “the first job” was to generate cash, which Diageo was doing “constantly”. In the first six months of this year free cash flow was £775 million, compared with £904m last time. The interim dividend was increased by 6%.

Diageo has a very strong balance sheet, but Walsh cautioned that a “transformational” takeover would be “challenging” to achieve because there “are not many gaps in the portfolio”. The long-held ambition to take control of Moët Hennessy at the right price is unaltered, but after last week’s results from LVMH, the price has certainly not fallen. Additionally, although Walsh said he would “look at anything that comes up”, the prospect of Diageo playing a large part in any break up of Fortune Brands’ Beam Global is not high because “overlaps [in the portfolios] make it more challenging”.

The implication is that Diageo is much more likely to seek bolt-on acquisitions in emerging markets to allow it access to local brands and to provide control of its routes to market. In that respect Walsh was unable to hide frustration that his £610m bid to take control of Sui Jing Fang is still awaiting approval from Beijing a year after the deal was announced.

Finance on Friday, 11.02.2011