Amidst the doom and despond of the economic downturn, Diageo demonstrated its power and resilience by turning in full-year sales and profit growth. In the first of a special, two-part just-drinks interview, Olly Wehring spoke with Diageo chief executive Paul Walsh about the recent performance, future acquisition plans in spirits, wine and even beer, and the controversial issue of the alleged links between ready-to-drink brands (RTDs) and alcohol misuse.

Less than 24 hours after delivering Diageo's latest set of full-year results, Paul Walsh is back at the coalface, but doesn't look too wiped by what he himself describes as "a pretty intense day". But then, if your company were to greet the current downturn with a 2% lift in net profit, and an 8% rise in sales, chances are you'd be pretty happy to go "back to the day job", as Walsh himself admits.

Looking at the results more closely, however, and there are certainly some areas performing less satisfactorily than others for the world's largest alcoholic drinks company. One area that appears to be struggling is the company's portfolio of value brands, such as Popov vodka and Scoresby Scotch whisky, in North America. While Diageo's so-called priority and reserve brands, such as Johnnie Walker and Smirnoff, delivered volume growth in the region, it is these value brands that appear to be hindering performance.

Walsh, however, believes that this is not an immediate cause of concern. "They're still generating cash flow," he says. "They're not losing money, they're fine. They're not growing profit, but they're still profitable. It's not as if we've got something that's burning cash."

Considering Diageo's size, however, divesting such value brands could give the company more beneficial opportunities, loosening the shackles of anti-trust regulators in the UK and the US. Walsh is reluctant to go down this route, however. "All it does is strengthen the competition if we sell [the brands] to them," he says. "Our plan is to keep them and see if we can put a bit more emphasis behind them, but it's not a priority, we'll just let them sit there."

One other area of concern appears to be Asia Pacific, which includes two of the fabled 'BRIC' markets, India and China. Considering how dynamic these two markets are supposed to be, a lift in full-year sales of only 2% ought to raise an eyebrow, while a 12% fall in operating profit must set the alarm bells ringing. Walsh, however, believes that perils and pitfalls beset the route of all companies that operate in these markets. "The thing I've always said about emerging markets," he says, "is that these markets are not going to deliver on a linear basis. There are going to be twists and turns both economically and politically. The whole business structure is embryonic - one has to expect setbacks.

"I believe, and I say this to all our investors, that the long-term promise from the emerging markets is real, but it's not a straight line. You better expect some twists and turns here."

In the plus column, meanwhile, is Diageo's performance in its notoriously downbeat home market of the UK. The company saw a strong performance from Guinness and an increased focus on the off-trade in the country help lift sales and operating profit in Europe both by 3% in the year to the end of June.

What's gone right here, then? Walsh has nothing but praise for Guinness' role in the UK. "What we've done with Guinness in recent years is focus on a quality drive," he says. "We've put huge resources behind training licensees in how to deliver the perfect pint. There's something about the affinity that people have for Guinness versus any other long alcoholic drink, where they expect so much from the brand and the quality. If that isn't delivered, there is huge alienation. We also have a very high standard, when it comes to Guinness advertising, that we have to hit. Finally, we have our sports sponsorship for Guinness through rugby. We've tried to sharpen our focus and put better activation around the brand - coupled with our drive on quality, I think that's really paying off."

Guinness has consistently been the subject of rumours of a possible sale by Diageo, but the company appears to have put paid to these with its recent EUR650m (US$1bn) investment in its brewery infrastructure in Ireland. More recent speculation, however, linked Diageo with a move for UK-based premium beer company Cobra. While Diageo moved to distance itself from talk of a takeover, is this a sign that Walsh is looking to beer for future purchases?

Paul Walsh, CEO of Diageo

"Most beers in their home markets in the developed world are under pressure," Walsh points out. "Take a look at classic mainstream beer in the US, Guinness in Ireland, ale in the UK or lager in Australia. As the consumer wants to premiumise in the beer space, they're looking for something else. In the US, it's either micro-brews or premium imports. Fortunately, in many developed markets, Guinness is a premium import and is doing very well in that category. If there are other brands that we can pick up that satisfy that profile, we'd be interested.

Walsh says Diageo is happy with its current position in the beer business, but adds that, "in certain markets, we do lack access to a premium lager offering. When that's the case, we will partner with another player."

Elsewhere on the buying front, meanwhile, Walsh feels there are still opportunities out there, and recent transactions have shown that the company will continue to sniff around. "There are brands out there that we could acquire," Walsh continues. "I think we're in a very fortunate position. We have the balance sheet to basically do what we want. However, we have such a well-stocked portfolio that we don't have to do anything."

That said, in the last 12 months, Diageo has bought a 50% stake in premium vodka brand Ketel One, secured the global distribution of Zacapa rum, and bought Californian winery Rosenblum Cellars. "I think the interesting thing with these companies is that they all have family ownership, and they want to deal with Diageo," says Walsh. "The global distribution that we can offer them and the marketing that we are coming forward with is best in place."

In Australia, there appear to be a wealth of wine opportunities for a company like Diageo. With the possibility of a demerger at Foster's, and the recently-announced divestment of certain assets at Constellation Wines Australia, would Walsh like to get in amongst it all down under? It would appear not. "I don't want to be too specific or critical, but what I would say is that, in the wine category, fools and money can easily be parted," he says. "It is a category that brings with it far more capital intensity without the margin structure that will fund that capital. Therefore, unless you buy very wisely and exercise huge discipline, you will not get the economic returns. If you look over the last few years, our name has been associated with a host of wine brands, some of which we have been very public about - we did look at [Pernod Ricard's New Zealand brand] Montana, where we had an option to buy it, and we walked away from it."

The problem in Australia, Walsh agrees, is a misbalance of volume and price. "If you look at some of the wine brands that are speculated to be on the market, because there has been so much land devoted to vines in Australia, the wine producers have had to move volume," he says. "In order to move volume, they have been very reliant on price. Also, they've line-extended brands down the price spectrum, whereas classic marketers have been taught to do it the other way.

"When you put all that together, it's probably not for us. There are some quite nice brands in the Foster's portfolio, but there are others that are best suited to other people than ourselves."

Staying with Australia, the recent leap in excise on RTDs in the country has hampered net sales there for Diageo. Coupled with the continuing attacks on the RTD sector by responsible drinking groups, could this signal the beginning of the end for the RTD? "We still make money on it; it isn't going anywhere," Walsh says. "There is a nucleus of consumers in the US and the UK who like it - why wouldn't you make sure they have it? It is in decline, but it's still profitable."

But at what point does RTD become more trouble than it's worth? Walsh is most forthright in his opinions on this matter. "I don't think there's a rational debate around this," he says."This category is purchased by legal-drinking-age consumers. There's no evidence that they binge drink on those products. It's very interesting that underage consumption - and excessive consumption within that consumer group - usually comes in the form of cocktails that they have made on their own. That's usually a cheapest-on-display brand that they mix with a soft drink." Subsequently, Walsh believes, RTD has taken too much flak for being the harbinger of binge drinking. "Evidence does not indicate that (RTD) is the source of all the problems, as people make it out to be.

"I do think that some of the branding in the category has been foolish," Walsh concedes. "I think it's unfortunate that the RTD brands that don't pass themselves off as anything other than an alcohol product have borne the wrath of the politicians and the regulators.

"In those markets where (RTD) is on the wane, we will just allow it to drift," Walsh concludes. "At some point, would we pull it? Probably, but not yet. It still has sufficient scale and mass."