Diageo : 2023 Interim Results Q&A transcript

Diageo Interim Results 2023

Q&A Call Transcript

Thursday, 26th January 2023

Diageo Interim Results 2023 Q&A Call

Thursday, 26th January 2023

Ivan Menezes

Chief Executive Officer, Diageo

Hi everyone and thank you for joining our Interim Results call. I hope you have had a chance to read our press release and watch the presentation webcast on diageo.com.

I am pleased with our results for the first half of fiscal 2023. We delivered organic topline and operating profit growth above our medium-term guidance. Net sales up 9%, with growth across all regions. Volume grew 2%. Even as we implemented strategic price increases, operating profit up 10%, organic margin expanded 9 basis points. We generated £800 million of free cash flow, fuelling continued investment in long-term growth. We expect to deliver stronger free cash flow in the second half as we lap more normalised working capital movements.

We continued to gain or hold share in the majority of our markets, 75%. Our super- premium-plus brands grew organic net sales by 12%. I am particularly pleased with the strong growth in scotch, up 19%, tequila up 28% and Guinness up 17%. On a constant basis, Diageo is 36% bigger than before pre-COVID and with a four-year CAGR of organic net sales of 8%.

In North America, organic net sales grew 3%, lapping strong double-digit growth in the first half of fiscal 2022. US spirits' net sales grew 2%, on top of strong double-digit growth for four consecutive halves, and we had depletions ahead of shipments. Our US spirits business is 44% larger than fiscal 2019, with net sales growing at a four-year CAGR of 9.4%. We took price and held share of TBA. As expected, growth in the US spirits category is normalising, trending towards a historical mid-single-digit range. Consumer demand remains resilient and the market continues to premiumise. 33% of American drinkers surveyed said they had spent $50 or more on a bottle of alcohol in 2022, and that was up from just 24% in 2021.

In Europe, organic net sales grew 10% and we maintained volume despite the challenging economic environment. Asia-Pac grew 17%, despite Greater China, which only grew 2%. Latin America grew sales by 20% and delivered the highest margin across all our regions in the half. This business is 64% larger versus fiscal 2019, with net sales growing at a four-year CAGR of 15%. I am very proud of our performance in Latin America. In Africa, net sales grew by 6%, with growth across all markets. We are delivering consistent returns for shareholders, increasing our interim dividend by 5%, and today I am pleased to announce an additional return of capital to shareholders up to £500 million in fiscal 2023.

As I look ahead to the second half of fiscal 2023, I am pleased with our start in January and the resilience of our business. I am confident in our strategy and ability to deliver our medium-term guidance.

With that, I will turn it to the operator. Let us take our first question.

Q&A

Sanjeet Aujla (Credit Suisse): Morning Ivan and Lavanya. Couple from me, please. Firstly, could you just give us a sense of where you see US spirits sell-out trends at the moment and how that contrasts with inventory levels and the numbers you have given us on

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the shipments and depletions so far in the first half? Secondly, would just love some early thoughts on how Chinese New Year has gone. Thanks.

Ivan Menezes: Sure. Hi Sanjeet. The US consumer is robust. If you look at the industry, we see it growing at about 4%-5%. I have said this for a long time - a couple of years or more - that post-COVID we expect to the industry to come back to that mid-single-digit growth range, and what I am really pleased about is the consumer, through the last six months, has come to that range, so we are feeling very good about it. Within that, premiumisation remains strong; you see in our numbers our super-premium-plus business grew 10% in the US. So feeling really good about the health of the US consumer. The spirits industry has 20 years of volume growth, taking share of TBA, outperforming beer and wine. Premiumisation is strong and I quoted those numbers of the robustness of about $50 a bottle. Overall, strong, robust and pretty much where we expected it to be.

If I turn to Chinese New Year, clearly there is three pieces to Chinese New Year: the sell-in before, what happens in the couple of weeks and what happens after. The sell-in before, we were cautious, obviously, with the lockdowns and the COVID conditions in China. Actual Chinese New Year itself is subdued in terms of socialising and consumption, and certainly, the large events are more subdued. We remain optimistic about China recovering fast, both for us scotch business and for baijiu, and as we go into Q3 and Q4 we are very much playing into assuming a strong recovery. Obviously, we have to watch it week by week, but I am feeling positive about the China consumer environment going forward.

Sanjeet Aujla: Got it. Just a quick follow-up there on the US. If you think the industry is growing 4%-5% in sell-out terms, do you think Diageo is outperforming that? Just a quick word on where you think inventory levels are and how comfortable you are with that in the US.

Ivan Menezes: Yeah. I will turn it to Lavanya.

Lavanya Chandrashekar: Yes. I will answer to your question on inventory in a bit, but in terms of our performance in the US itself we are holding share of TBA in the US, so we are feeling good about that. Obviously, we were growing share and we would like to go back to that, and Ivan has a very strong point of view on that, I know.

Coming back to inventory levels, fiscal 2022, we ended fiscal 2022 with healthy inventory levels. We talked about this in July when we announced our results and inventory levels were back to close to where it was pre-COVID. A little bit higher on imports, just because the supply chain was longer, but broadly back to pre-COVID levels on inventory levels. Where we ended the half, we ended with inventory levels at distributors slightly below where we ended last fiscal year. Not because we wanted to destock or we needed to destock, but just because December was a really good month and so a lot of depletions happened toward the end of December especially, which has led to inventory levels being a little lower.

We feel good about where inventory levels are and we are lapping the replenishment of inventory last year, because if you go back to the start of fiscal 2021 - fiscal 2022, sorry, we were coming off of a very, very, very high growth rate in fiscal 2021; fiscal 2021 we grew 24% on US spirits. So when we started fiscal 2022 it was very low levels of inventory across the entire supply chain, which we replenished through the year. Some brands came in faster;

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some brands came in a little later in terms of when supply was available. So that is what we are lapping here on ships versus depletes.

Ivan Menezes: I will just add, we have held TBA share. I think if you look below that, what I am really pleased with is we are gaining substantial share in the on-trade. The on-trade in the US, and NABCA has the most reliable data here, so if you look at NABCA on-trade it is about 20% bigger than pre-COVID and we have gained outside share. To me, that is a huge measure of the health of our brands and the portfolio. Even in these last six months, we gained over 100 basis points of on-trade shares in NABCA.

Sanjeet Aujla: Great. Thank you Ivan and Lavanya.

Olivier Nicolai (Goldman Sachs): Hi, good morning Ivan and Lavanya. Just a couple of questions, please. First on the US, just following up there. As comps normalise, should we assume a strong sales performance in H2 in North America in terms of organic sales growth? Then if we think about the margins, obviously margins were down in H1 in North America. When could we expect a stabilisation in margins in the US or, at least, a gross margin inflection to start with? Then, just on FX, a quick question for you, Lavanya. You flagged that you were expecting a £300 million positive impact on FX for this year. How much transactional FX impact do you expect this year, and is it fair to assume further transactional FX impact in fiscal 2024? Thank you very much.

Ivan Menezes: Yeah. Maybe I will take the first part on US top-line and Lavanya on margins and FX. Yes, we do anticipate, as I talked about earlier, the US industry should be in solid mid-single-digit growth in the second half. We expect to perform in line, ideally better, but that is our going-in view.

Focusing on the consumer, I think we feel positive about our ability of consumer offtake to be in the mid-single-digit range. Now, we have an intense sell-out culture, so as we look at managing the depletions and shipments you will recall from last year's results, because we were in the restocking phase, we had shipments ahead of depletions three points when we closed out the year. So we will lap through all that stuff, but to me that is just supply chain. The most important thing is ensuring we are well-positioned to win with the consumer, and we have got phenomenal marketing plans, great innovation. We have got Super Bowl coming up and Crown Royal is going to be on the Super Bowl for the first time, really excited about that. The team has significant ammunition behind our brands going into H2, so I am feeling good about our ability to win with the consumer.

Lavanya Chandrashekar: Olivier, to your question on margins in North America. Look, I will just start off by reminding us that North America has very, very strong margins, 41% operating margin. It was the highest margin region for this business, just got toppled by Latin America who surpassed them by 30 basis points. One of our strategies has been to invest in North America for growth, because every point of growth in North America comes with really, really strong margins. What you are seeing in the margin story is a bit of that, and we have invested strongly in A&P, also in digital and capabilities to enable continued strong growth of the business in North America.

The gross margin, some of it is inflation and the impact of that is what we are seeing there, but, again, we have many levers to offset inflation: premiumisation, volume growth, pricing and the work that we do on revenue growth management. All of that helps us to offset

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inflation. I am not concerned about where the margins are in North America; I think it is a very health P&L and business in the US.

On FX, that was your second question. In terms of transactional FX impact, not really expecting much in terms of transactional FX impact. Our major currency pairs are hedged and, as you saw in the first half, we really did not have any impact from a transactional perspective on FX.

Olivier Nicolai: Thank you very much Lavanya and Ivan.

Ivan Menezes: Thank you.

Pinar Ergun (Morgan Stanley): Good morning. Thanks for taking my questions. I have one on marketing. Diageo has invested very significantly into marketing in recent years and you are indicating that the investment will rise faster than sales in H2. How do we reconcile that with your expectation of moderating sales growth across all regions, and specifically in the US, are your market shares evolving in line with your expectations, given the investment that has gone into this region? Then two clarifications, I guess. One is on the free cash flow. Can you please take us through the different moving parts here; how the creditor balance shifted so much and so on? Then on capital allocation, has your thinking evolved at all now that the cost of borrowing has gone up substantially? Does that change how you approach buybacks, M&A and so on? Thank you so much.

Ivan Menezes (Chief Executive, Diageo): Thanks, Pinar. I will take the first two on marketing and share. Marketing, as you know, we built a lot of sophistication in the data and analytics and tools we now have to assess marketing effectiveness. As we look to the second half, we see very good opportunities to step up the investment behind our brands. That is why we indicated in the second half, we intend to increase our reinvestment rate. This is built up by market, by brand and very much with the degree of confidence on returns. Now, our marketing is not just to make the second half-sales number. It is about the next three years. Everything in our business upweights in marketing are not for short-term return alone. You do get some short-term impact but the bulk of the impact really comes down the road. In line with our goal to be a very reliable top-tier compounder this flywheel of Diageo of upweight investment, drive efficiency and get quality top line growth. It is really in that context because we really want to ensure we are setting ourselves up well for the quality of growth through the medium-term. However, it is going against very specific brand opportunities where we have a high degree of confidence in the return that we will get from this investment. I have to say the quality of our marketing continues to step up significantly and I feel really good about that.

On market share firstly at a global level where 75% of the world is in green. That is a high benchmark and I am pleased with that. In the US context, we are holding share at TBA. We are coming off a period where we have grown significant share and we have also taken price ahead of the industry, if you look at the last three years. Flat share in the first half but fully expect and want to do better, as Lavanya alluded to earlier. We want to get back into the share growth mode in the US and I expect in the medium-term we will do that. That also takes me to the point, when you look at our portfolio in the US, we have got a phenomenal tequila portfolio which has still a long way to run. We are the leader in whisky and whisky is a hot category. Innovation we have got a lot of exciting things in the pipeline that are going

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