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Diageo F21 Interim Results Investor Q&A Call

Date: Thursday, 28th January 2021

Conference Time: 09:30 (UTC+00:00)

Ivan Menezes: Hello, everyone. Kathy and I welcome you to our interim results call. I hope you and families are staying well during this time.

I'm pleased and encouraged by our financial results for the first half of fiscal '21. We delivered a strong performance in a challenging operating environment. We returned to top line organic sales growth in the half, driven by strong sequential improvement across our regions compared to the second half of fiscal '20. This was ahead of our expectations at the start of the fiscal year.

In particular, we delivered strong growth in North America, our largest and most profitable market. Consumer demand in North America has been extremely resilient, and spirits continues to take share from beer and wine. We also benefited from the replenishment of stock levels by distributors and retailers.

Across regions, we have rapidly responded to increased demand of the off-trade channel, delivering broad-based category growth and market share gains. Our strategic actions in recent years have created an agile business, with a strong position in fast-growing markets such as the US and China, and in high growth categories, including US whiskey, Canadian whisky, tequila and gin.

Our deep understanding of consumer behavior using proprietary tools and data meant we were able to pivot quickly to at home occasions and convenience and invest effectively in marketing and innovation. We are strengthening brand equity, premiumising our portfolio and expanding our digital capabilities, including in e-commerce.

Our business continues to be impacted by the on-trade channel restrictions and the reduction in global travel. This impacts our beer and scotch performance in particular.

Due to the ongoing volatility, we're not providing specific guidance for the second half of fiscal '21. However, we will be lapping the second half of fiscal '20, which was significantly impacted by the onset of COVID-19.

So we expect to see improvement across all regions versus this weak comparative period. We also expect continued momentum in North America, augmented by lapping inventory reductions by distributors.

The pace of recovery in other regions will be more closely aligned with the gradual reopening of the on-trade and the degree to which restrictions continue to be in place. We expect travel retail to continue to be heavily impacted by the reduction in international travel.

Despite the challenges created by COVID-19, I am cautiously optimistic about the outlook for our business. Today, we announced a 2% increase in our interim dividend. This reflects our confidence that Diageo will continue to navigate strongly in this environment and that the fundamental growth drivers for our business remain intact.

I'm confident in our people, our strategy, the resilience of our business and our ability to deliver long-term shareholder value.

And with that, I'll open the line for questions for Kathy and myself.

Operator: We will now take our first question. It comes from Simon Hales of Citi.

Simon Hales: A couple of questions, please. Obviously, I think Kathy talked in the presentation about the strong data analytic tools that you've now got in place with Catalyst and Radar coming onto stream and the benefits they've had as you've pivoted to focus on those more off-premise occasions. I think, Kathy, you talked in the presentation about the further reinvestment in insight tools in North America. I wonder if you could just maybe frame the levels of investment that we perhaps need to continue to see in these tools over the next sort of few years. And also, more generally, how widespread now is the rollout of these insight tools all across the organization? And how widely are they been using? You obviously flagged North America a lot, but more generally.

And then secondly, I wonder if I could just ask a little bit about e-commerce. I think, Ivan, you said that e-commerce is clearly gathering momentum in spirits having historically been low versus other FMCG. How should we think about the potential medium-term implications of growth in that trade channel from a value and a margin standpoint at the group level? And I appreciate it varies very much by market depending on the type of e-commerce channel. But I think if you look at something like Drizly, I think you've historically said in the U.S., you tend to sell more premium brands through the Drizly platform. But does that come at an accretive margin? Or are you having to pay more away for those third-party sites to get your brand in the right place?

Ivan Menezes: Okay. Simon, thanks. Kathy, you take the first. I'll take the second.

Kathryn Mikells: Yes. Thanks so much, Ivan. So look, as we think about our reinvestment rate, I'd say we have always felt good about the ongoing building capabilities that we've continued to invest in to just ensure that the choices we're making are really going to drive good returns from that investments that we're making. And you would have seen in the first half, overall, our reinvestment rate was pretty similar to what we would have seen in the prior period. And we've clearly looked to significantly upweight our investment relative to what you would have seen in the second half of fiscal '20, and specifically, the fourth quarter of fiscal '20, where we really made the decision that certain investments in A&P were just not going to earn a return, and we therefore decreased our A&P spending in the fourth quarter pretty significantly.

As I look at that continued investments in tools, clearly, North America is always the first market, if not one of the first markets, we're looking to invest in just because it's our largest market and it tends to be the market that has the richest data set. But Radar as an example, which Ivan would have talked about a little bit when we announced preliminaries at the end of fiscal '20, that's something that we expanded very quickly, a bit over a 2-month period over the summer, and it's covering about 80% of the company's A&P. So clearly, we look to expand these tools and deploy them in our biggest markets with pace. And I think you can see that based on that number.

As I look forward to what we've done in this first half and our expectations for the second half, I'm expecting to see our reinvestment rate in the second half go up relative to a pre-COVID period as we've gained more confidence in the programs that we're investing behind. And I think you really see that in terms of the off-trade share gains that we've had, especially in the markets where we have the largest off-trade businesses, the US, GB, France, Australia. Germany would be another one we've seen really good gains behind our investment. And so as we look to the second half, I would

tell you, we're going to continue to put more money behind the programs that are working, that tends to be over-indexing into category and brands within markets that already have momentum. And obviously, we're seeing that come through our results in this first half. And so we're going to continue to invest really smartly in the second half, looking to gain that quality market share.

Ivan Menezes: On e-commerce, I'd say pre-COVID, it was roughly about 2% of the business was in e- commerce. It's clearly accelerated. And in our business, it's still small, but it's growing very fast. So it's under 5%, but growing rapidly. And what we're seeing, just to give you an example of the speed, say in GB, in the UK, it took 10 years to step up 5 points of alcohol penetration in e-commerce. And with COVID, 8 points got added in 4 months of penetration, so a significant increase.

Our businesses, we pivoted very quickly and moved teams and dollars into e-commerce right around the world, from Colombia to Uganda. It's not just Germany, China, US, UK. And we are seeing acceleration, I mean, significant growth in this channel, as you'd expect, off a small base, but really accelerating. What I'm pleased about is we're gaining market share. And typically, our market share on e-commerce platforms tends to be higher than our market share in brick-and-mortar. Point 1.

Point 2, to your question. We actually sell a more premium mix in e-commerce than we do in brick- and-mortar as well. Now some of this is deliberate. So for example, we've done a lot on whisky and premium whisky and gifting and indulgence are two consumer motivations that have really gone up through COVID. And so our margins too are strong. I anticipate e-commerce continuing to grow very nicely. We certainly want to lead in this channel. And as I said, we are putting the investment behind it strongly. On platforms like Drizly in the US, we're doing very well. Our brands performed strongly in that channel. And spirits does particularly well on a platform like Drizly. But also in the United States, within states, you've got retailers whose e-commerce platforms have actually significantly picked up through COVID. So we're working closely with our distributors and retailers to make sure we can kind of support them effectively in that growth. So I remain confident that this is the long-term sustained trend.

In some markets, we've broken new ground. For example, home delivery in some states in India, which didn't exist before. And our teams and the industry are hoping to retain that round going forward or take-home cocktails in New York from the on-trade. So to me, this is going to be an attractive segment. And we are very focused on keeping it a premium and profitable one.

Operator: Our next question comes from Sanjeet Aujla of Crédit Suisse.

Sanjeet Aujla: Ivan and Kathy, a couple of questions, please, on the US. I was hoping you might be able to break down that 15% growth in US spirits a bit further. I think you talked about 3 points of distributor restocking. What sort of benefit did you get in with retailer restocking? I'm really trying to think about your underlying sellout trends there relative to the market in the first half period. That's the first question. And then just on the outlook for the US spirits market, we saw a bit of a slowdown, I think, in some of the Scanner data through November and December. How are you feeling about the category as we go into the first half of 2021?

Ivan Menezes: Sure. I'm happy to take that. If you look at our US business, we had underlying depletion growth in double-digits. And as we indicated, US spirits had about 3 points of distributor restocking impact in that 15% growth. Consumer offtake, if we take Nielsen-NABCA combined, we're growing in the mid-teens. Our market share performance in Nielsen and NABCA channels has sequentially improved. So the improvement in the run rate has steadily got better as we went through the half. And I would say in the first 3 weeks of January in Nielsen, we've had share gains.

We measure this every week. So consumer uptake is strong and has continued. Thanksgiving was a little weaker. Christmas and New Year came in a little stronger. Clearly, in the second half, we are lapping a much weaker period with the onset of COVID last year.

But I would just point to the long-term trends in the US and say that, spirits penetration through COVID has increased. The penetration of spirits has gone up 3 times that of beer and wine. The increase in penetration has been 3 times greater. So I do expect those habits to stick. And you do see the long-term trends of both premiumisation, and spirits growing ahead of beer and wine, continuing. Now clearly, you will have a reversion to norm as we come through this period. But the fundamentals of sustained quality growth and continued premiumisation, we feel very confident about.

On retailer inventory, I think what you've got to remember is, when we were in June, there was a huge degree of anxiety on what the world was going to look like and what forward demand was going to look like, for retailers, for distributors, for us. And so everyone was tight on working capital. And we certainly, right across the world, were very focused on ensuring we ended up with very healthy levels of inventory assuming a cautious outlook on forward demand and very healthy levels of receivables right through the business everywhere. Clearly, as the growth accelerated, retailers started accelerating their buying. So there is some impact there, but it's purely responding to the end consumer demand and the refilling of the pipeline as demand came in stronger than I'd say retailers expected at the end of June.

Operator: Our next question comes from Mitch Collett of Deutsche Bank.

Mitch Collet: I have two questions, if that's okay. Just to come back to stock levels. Can you just confirm where you think stock levels are at the end of the first half by region or just highlight any areas where you think it might be different to where it should be? I appreciate that's difficult because of understanding demand at the same time. And then secondly, I appreciate it's very difficult to give guidance for this year. But if we think longer-term and the mix shift towards premium that you've highlighted in the slides, combined with the strong growth in the US and the productivity savings that I hope are still applicable, is there any reason why you can't get back to the previous peak in terms of profitability, which I think was 32% at the EBIT line in F19 or even perhaps beyond it given all those positive drivers?

Kathryn Mikells: So I'm happy to take that question. Look, if we think about stock levels, I'd say we felt incredibly good about where we ended fiscal '20. I think the shift towards a sellout culture when Ivan first stepped in as CEO and then just the ongoing focus on being consumer-centric and really focusing on consumer trends and consumer offtake has enabled us to adjust our stock levels across the globe very quickly. The company acts in a much faster, sharper manner. So we felt very good about where we ended fiscal '20. And I'd say as we've ended this half, again, we feel pretty good about overall stock levels in terms of stock in trade.

The global travel duty free business, I'd say that has experienced a more dramatic shift in demand as international travel has just declined so significantly. And so it has taken longer, I'd say, to get stock levels in that particular part of the business down to where we want it.

If we looked at that impact, at a total Diageo level, the impact of needing to start to reseed stock levels after the end of fiscal, Ivan mentioned that was worth 3 points in our US Spirits business. That refilling of stock and trade was worth about 1.5 points at a total Diageo level.