Emerging markets will be key in 2015

The one certainty about 2015 is that a drive by drinks companies to expand into emerging countries will continue.

All the global spirits players want to make niche acquisitions in countries where ownership of a prestigious local brand provides accelerated access to that market for their premium international products, at the same time as adding another profitable line to their portfolios, especially if it can be exploited in the travel sector. If that cannot be achieved, they are setting up their own local sales organisations rather than dealing with local agents. The trend has been evident for more than a decade during which Diageo, Pernod Ricard, Beam, Davide Campari and Rémy Cointreau among others have all entered new profitable markets as growth in mature regions such as Western Europe has slowed and stagnated, especially following the 2008 global financial crisis.

While the tactic has delivered enormous potential and, in some cases, healthy contributions, events of the past couple of years have brought to the fore the problems of dealing with the differing business systems and governments of emerging markets. The past few years have been strewn with examples. For instance, no sooner had Diageo completed its 2012 takeover of Mey Icki, Turkey’s largest spirits group, than the government introduced advertising and sales restrictions which put a brake on developing its undoubted potential.

Similarly, within 12 months of taking control of Shui Jing Fang in China, Diageo has had to write down the value of its purchase of the baijiu producer after sales fell by 78% in the wake of Beijing’s crackdown on ostentatious entertaining and gifting. The same government action hit Rémy Cointreau hard as China accounts for more than half the sales and margins of its flagship Rémy Martin Cognac. Similarly, Pernod Ricard, the largest spirits importer to China, acknowledges that it has been affected by widespread trading down the quality and price scale, with a consequent effect on margins and earnings.

USL boss Vijay Mallya

Despite undertaking extensive due diligence, Diageo’s £1.9bn deal to win control of India’s United Spirits remains beset by difficulties. Diageo now controls 55% of the company but has yet to find itself fully in the driving seat. In late November, USL minority shareholders were asked to approve a series of resolutions, including agreeing to USL producing and marketing various Diageo international brands in India. They refused to back the plan, so temporarily at least, it cannot be put into action. Much of the discontent surrounds inter-company loan transactions undertaken by USL’s chairman, Vijay Mallya, just before Diageo’s majority control was achieved. Investors and institutions used the vote to protest that Mallya remains chairman of the company and thus privy to the inquiry being undertaken into those very deals. Diageo and Mallya could not vote on the motions because they were interested parties.

Doubtless Diageo will eventually win approval for the production plans, but the episode extends its timescale and emphasises the inherent problems of dealing with differing commercial, business and legal systems. Local analysis of documents at India’s Registrar of Companies suggest that over the past two years the market’s dynamics have changed from general expansion, in which USL as the largest player grabbed the biggest share, to clever marketing to grab market share.

For instance, in its latest year USL’s sales in India rose by just 1% but Pernod Ricard’s jumped by 19%. Both Pernod Ricard and local producer Allied Blenders have grown significantly faster than USL over the past four years and reports suggest the trend has been magnified in the past few months. Undoubtedly the scope to bring its renowned marketing machine into play to reverse that trend is part of the attraction of USL to Diageo, but at present it has one hand tied behind its back.

Diageo believes India could account for 10% of its business within a few years, such are the population dynamics. Meanwhile, while it sorts out its local difficulties its rivals are grabbing market share they intend keeping.

Could Russia be the next emerging market headache? The dispute with the West over Ukraine has generated economic sanctions that are biting deeply into the economy. A recession is almost inevitable in 2015. So far Russia has excluded spirits from the ban it has imposed on some Western imports in response to the sanctions, but Jack Daniels Tennessee Honey and Kentucky Gentleman have been removed from the shelves under the pretext of violating consumer safety. An extension of the retaliation to exclude whiskies and brandies, which are 70% of Russia’s spirits imports, would wipe $1.4bn from the global sales market.

Seat of power: St Basil’s Catherdral, Moscow

The shenanigans of the Venezuelan government and its devaluations have been a thorn in producers’ sides for several years. The highly volatile regime in Buenos Aires causes anxiety and the rapid slowdown of Brazil’s economy has trimmed the immediate profits prospects in South America.

Meanwhile eyes are turning to Africa, where local products dominate markets and thus the potential for international spirits is thought to be huge. Diageo has long-standing brewing interests in Nigeria and Kenya and a couple of years ago took over other East African brewers. They are profitable in their own right but also provide excellent coat-tails for Diageo to use in widening distribution of its global spirits brands. Pernod Ricard is spreading its influence through setting up its own arms in six (largely Francophone) countries and has plans to open a further seven. But African politics are volatile, not least from the rising influence of strict Islam in a number of nations. And governments, eager to raise revenues from whatever source, have looked at the lesson set by Britain (in particular by Alistair Darling) and imposed heavy duty increases.

Cameroon’s latest budget contained a 40% increase to discourage consumption of “products not deemed essential” which the local brewers, France’s Castel Group and Guinness (Diageo) say in representations to the government could cause a “market collapse”. Cameroon’s action follows a swingeing duty increase in Kenya last year, which hit Diageo’s Tusker beer brand hard. So while all the major players reaffirm their faith that emerging markets have huge growth potential, all are aware of the pitfalls and obstacles that can be thrown in their way. All expect their profits to improve but volatility and changing scenarios mean that caution is the watchword.