Diageo appears to be making light of the economic downturn, turning in highly respectable year-end figures late last month, but some brands performed better than others. In the second part of this special just-drinks interview, Olly Wehring gets Paul Walsh’s assessment of how some of Diageo’s key brands are faring, and also found time to ask him how long he might be thinking of remaining at the helm.

As Diageo’s rhetoric – its mantra perhaps – has long insisted, this giant company is built on its brands. So it is to the company’s brands that my discussion with CEO Paul Walsh naturally turns.

Late last month, in announcing a 2% lift in full-year net profit, and an 8% rise in sales, Walsh noted that the Jose Cuervo Tequila brand had struggled in the year to the end of June, with volumes down by 4% and values sliding by 5%. In North America, which includes the world's biggest spirits market, the US, Diageo has been looking to “premiumise” the brand, increasing prices in some US states, and weighting advertising spend toward the summer season. How successful, historically, does Walsh feel Diageo has been at this premiumisation push for existing brands?

“The best example of that, I think, would be Smirnoff,” says Walsh. “Eight years ago, Smirnoff was a bit of a dusty brand in the US. We've totally contemporised it, we've moved it several price points and, as you can see from the numbers, it's thriving. So, it certainly can be done. Scotch is another example – it used to be quite a ponderous category. Through a variety of means we've managed to drive the revitalisation of Scotch. So, you can do it and we intend to do it with Cuervo.”

In the super-premium Tequila market, Walsh saves a special mention for the performance of a competitor, Patrón, but he feels Diageo also has this base covered. “We have a brand called Don Julio that is also growing well,” he says. “So, just because Cuervo's not there doesn't mean we're not playing in the super-premium Tequila space. But we do have to freshen up the Cuervo brand and we're working with the brand owners to do that. It's a work in progress, but you will see some new products coming to market, among other things.”

Another worrisome brand performance in Diageo's last fiscal year has come from cream liqueur brand Baileys. Celebrating the first anniversary of the rollout of flavour extension, if 'celebrating' is a fair description, the company saw volumes for Baileys struggle to manage a 1% lift, with sales up by only 6% in value terms – compared to value sales growth of 12% and 14% for Smirnoff and Johnnie Walker respectively. “When you back out the pipeline fill, the base brand is doing phenomenally well, as are the flavours,” Walsh says, defending the performance. Walsh is also aware of the risks posed to the parent brand when a drinks company goes down the flavour-extension path. “I think you have to be very disciplined,” he says. “You have to be very careful that you don't over-populate a brand with too many flavours. If you like to see presence on a shelf or a back bar, then flavour-proliferation is a wonderful way to go. However, I think you have to be very disciplined in moving SKUs out when they don't turn, and putting new ones in. I think we've done that pretty well with Smirnoff. If there's a hot new flavour out there, such as pomegranate, we'll come in with pomegranate. If that starts to wane, we'll pull that and come in with a new flavour.

“So, it's good to keep the line fresh. However, you have to watch the base offering like a hawk and make sure that you're not getting undue cannibalisation of the parent. If you do, then over time you risk trivialising that brand.” Walsh uses recent acquisition Ketel One as an example of how best to do it. “Ketel One has only one flavour extension – Ketel Citroen,” he notes. “If you contrast this to some of the other premium vodkas out there, they've gone crazy on flavours, and it isn't sustainable.”

Paul Walsh, CEO of Diageo

Mention of Ketel One brings us neatly on to one of Diageo's higher profile wheelings and dealings of the last 12 months. In February this year, the company bought a 50% interest in a new company formed with the owners of Ketel One, the Nolet family from the Netherlands. The new alliance – which cost Diageo US$900m – will own the exclusive global rights to sell, market and distribute the vodka brand, which already performs well in the US. It is here that Walsh believes Diageo's priorities for the brand lie. “First of all, we need to keep it growing in the US,” he says. Further afield, however, is where Walsh believes Ketel's future lies. “A lot of growth – not dissimilar to what Bacardi has achieved with Grey Goose – can come from moving it into other markets,” he notes. “They do not have very good presence outside of the US. That's where we can play a huge role.” This approach appears to have already begun, with Diageo Australia taking on national distribution of Ketel One and its variant late last month.

One area that inevitably requires covering when talking to the head of the largest spirits company in the world, is that of consolidation within the industry. No stranger to mega purchases, Walsh is still surprised by the size of the most recent major acquisition, with InBev set to pay US$52bn for Anheuser-Busch later this year. “The size of some of the deals are mindblowing,” Walsh says, “and the size of the debt that these companies are carrying in the current environment is heady.” Transactions of this size, however, are not sustainable, Walsh believes. “I think consolidation will continue, but I think it will be mainly focused on those smaller or even family companies that will be absorbed into larger entities. I don't see many more deals of the size we've seen with InBev and Anheuser-Busch, but I do think it will continue with the smaller companies.”

Should anyone have the money, I ask, how much would Diageo go for? “We're at GBP10 per share at the moment, that gives us a market cap of around $26bn,” he says. “Add our debt, that's an enterprise value of $32bn. These days, 30% premium's the norm, so you've got to be in the region of 40%. So I'd say about $80bn.

“I don't think anything is prohibitive,” he adds. “People are prepared to loan the money, even in these times. Nor do I think it should be prohibitive. If someone thinks they can run this business better than we are, and they're prepared to pay for that privilege, then our shareholders should have that choice. I'm very sanguine about it – I'm an avid free-trader.”

On the subject of acquisitions, Pernod Ricard declared earlier this year that it had caught up with Diageo as “the co-leader of the global wine and spirits industry”, when it bought Vin & Sprit for $8.88bn. The boast drew a wry response (/blogdetail.aspx?id=1384&lk=s) from Walsh when I asked him about it in April. How does he feel now about Pernod's boast? Does the position of number one really matter? “It does matter,” he says. “We don't want to surrender that position. What makes me chuckle is the selective nature of the analysis. First of all, they did it only on volume, adding [Pernod's] volumes from India and some very low-price point brands in Eastern Europe. Then they ignored our 34% investment in [Moet Hennessy Louis Vuitton's wines and spirits unit] Moet Hennessy, then they take out Jose Cuervo because they say we only distribute it, we don't own it. They ignore all our beer business, all our RTD business, and then they say that, in that analysis, we're almost as big as Diageo.

“I actually find that quite amusing, and also quite flattering, because it shows they want to be like us. Now, internally, I use that to signify how intent they are at growing, and therefore how determined we have to be.”

Winding up, I ask Walsh how much longer he sees himself at Diageo's helm. Having become CEO of Diageo eight years ago, is he thinking of heading off into the sunset at any point soon? “I hope not,” he smiles. “I'm 53, I think I'm pretty energetic, and I love what I do, I love this business and I love this sector in which we operate. There are two very simple tests that I have in my life. The first is, on a Monday morning, am I looking forward to the week ahead? So far, even when I'm on vacation, I love it when I'm coming back. The other test is, when you are stuck at an airport, your flight's been delayed, the air conditioning units don't work and you're having your luggage rifled through by security. Are you still looking forward to going to your team in whatever market? I still put a huge tick against that. I thrive on it.

“I can't see me doing anything else,” he concludes. “I would always work, but I could never work for another drinks company – my heart is here.”