Diageo and Pernod Ricard both expected to continue profit growth

As Diageo and Pernod Ricard approach the close of their financial years, already analysts are looking for clues about the strength of their numbers, with both companies predicted to continue their seemingly inexorable growth in profits.

The world’s top two premium alcohol companies, Diageo and Pernod Ricard, are just closing their books on the financial year. Diageo will unveil is annual results at the end of July, its French rival a few weeks later.

Diageo has said previously that it expects organic net sales to improve in mid single digits and Pernod Ricard recently hinted that its comparable figures would be toward the top end of the 4% to 6% it forecast at the turn of the year. In the six months to Christmas 2017, Diageo grew organic profits by 6.7%

The key to both groups’ growth is premiumisation, getting consumers to trade up to better qualities at higher prices while at the same time strictly controlling costs. The latest figures, for instance, will show whether Diageo has met a three-year target to improve margins by 175 basis points. Pernod Ricard has its own, undisclosed targets, but recent interviews with chairman and chief executive Alexandre Ricard exude an air of confidence.

Both companies are tailoring their portfolios to premium and super premium lines. Note how Diageo has put $1 billion worth of brands under the hammer. They include Seagrams VO, Myer’s Rum and Popov vodka, which can all be classified at the commodity end of the market.

The reason is simply to have the financial firepower to move on more desirable brands in niche markets as they become available. Hence Diageo’s snapping up the super-premium Casamigos tequila last year for an eye-watering $1 billion. Pernod Ricard too has an extremely strong balance sheet and freely acknowledges that it looks at many opportunities every year but rarely moves because of the need to puts its own premiumisation stamp on brands.

In the US, the world’s biggest spirits market, (it accounts for 33% of Diageo’s sales) both companies indicate robust progress with the only real (but nevertheless significant) headache being their main vodka lines, Smirnoff and Absolut respectively, which are facing an onslaught from craft offerings. Absolut, for instance, represents one in every five bottles Pernod Ricard sells in the US, so re-establishing growth is of prime importance and a task the company acknowledges will take at least a further few years.

But the overall US market is buoyant. Just a decade ago, at the onset of the global financial crisis, value spirits (those costing $12 or less per bottle) accounted for 40% of total sales according to the Distilled Spirits Council of the US; those costing $20 or more per bottle took less than 25% of the market.

Premiumisation has changed all that. Last year value spirits took only 33% of the market, the same as premium offerings. And recent Neilsen figures show high end spirits taking 55% of total volumes and 62% of dollar sales, with the ultra-premium sector showing the greatest acceleration.

But is there a ceiling to how much consumers will pay for top end alcohols? How far does price elasticity stretch?

Note how the market in China collapsed virtually overnight when Beijing clamped down on the practice of gifting (bribing) officials and it became socially questionable to been seen consuming super-premium products. That caused turmoil in the cognac market especially. Pernod Ricard’s sales in China fell by 20% in 2015. Rival Remy Cointreau, the cognac market leader there, was even harder hit. Diageo’s scotch sales suffered.

As the Neilsen figures show, Americans are enthusiastic to be moved up market even if consumers in Europe are proving more resilient possibly because they have been exposed to the process longer than most.

But despite the US firmly remaining the most important profit centre for both groups, they each are looking to the sun rising in the East.

Pernod Ricard’s sales to China alone grew by 19% in the first nine months of the financial year just ending, evidence indeed that the market is rebounding strongly, so much so that the French group had to limit sales of Martell in the fourth quarter to conserve supplies for other markets and underpin price rises. Sales of the Chivas range of whiskies have turned the corner after five years of decline there.

The China rebound seems across the board. For instance Remy Cointreau recently reported strong demand for its premium cognacs and it raised its forecast for the coming year.

Imported spirits still take only about 1% of the China market, with demand for scotch trailing Cognac. But Diageo views the market with enormous enthusiasm backed by large marketing budgets. And critically it has a foot in the premium end of the dominant baijiu business, which today accounts for about two thirds of all spending by Chinese on alcohol. At present, however, Diageo targets the premium travel market.

Meanwhile China’s market for wine is predicted to be the world’s second most valuable in two years’ time, which will benefit Pernod Ricard, notably with its Australian brands.

Indeed, Alexandre Ricard reckons the whole of his portfolio there is now in growth mode and with the burgeoning middle class set to exceed 600 million people by 2024 compared with just 437 million today, he foresees imported spirits doubling their market penetration by 2025. And today Pernod Ricard supplies China with 44% of its imported spirits.

Some 50% of the world’s whiskey (approaching 200 million cases ) is consumed in India, mostly local brands. But India has the largest number of young adults between 18 and 28 in the world with a growing proportion entering the middle class, ripe for moving upmarket to premium imported brands. Consumption per capita is growing month on month.

Despite the recent turmoil at United Spirits, by far the market leader in India, Diageo has turned the company around; it is now much more dynamic and resilient than when taken over in 2013. The product line is being trimmed to market leaders such as McDowell’s No1 and a growing emphasis on Johnnie Walker and its global glamour. The profits flow is picking up steam.

Yet despite Diageo being the biggest player in India’s spirits market with about a 40% share, Pernod Ricard is the leading importer. India is the second largest contributor (after the US) to the French group’s global sales and the French company is reckoned to be the fastest growing multinational on the Sub-continent.

In the past year India’s market for alcohol has been hit by currency disruption, large changes to distribution patterns enforced by the national government, and excise duty hike at the state level. Yet the major players have taken these setbacks in their stride. The detail in the next accounts will be pored over.

Long-term, however, increasing per capita income, increasing awareness of desirable brands and their growing social acceptability only add to the attraction of Asia to both Diageo and Pernod Ricard.

Only this week, Diageo has made an offer to raise its stake in China’s Sichuan Shuijingfang Company Limited as it moves to take control of the Shui Jing Fang baijiu brand.

In a statement released on Monday (25 June) Diageo said it had approached the board of directors of Sichuan Shuijingfang Company Limited (SJF) with a proposal for a “partial tender offer” to increase its stake in the company from 39.71% to 60% at an offer price of RMB62 per share (£7.12).