Diageo will issue a Q1 trading update tomorrow

Diageo will issue a Q1 trading update tomorrow

Diageo's acquisitions of local spirits producers in emerging markets may not prove as successful as the company believes, with one analyst suggesting that local spirits competitors "dance to different rhythms" than the firm's international rivals.

In the last three years, Diageo has made a spate of local player purchases, including ShuiJingFang in China, Mey Icki in Turkey, Ypioca in Brazil and India's United Spirits. Each transaction has been made for different reasons, varying from exploiting the opportunity to premiumise the local company's brands, to improving Diageo's distribution footprint in the country, to using the local brands as the 'door-opener' for the company's international brands.

In a note to clients earlier this week, however, Investec shifted its coverage of the drinks giant from 'Hold' to 'Sell', arguing that it is concerned by, among other things, "risks from emerging markets following Unilever’s warning".

“Diageo's strategic rationale for entering local spirits has never been entirely clear to us,” the analyst said in the note. “Diageo had a weak position in Turkey, and leveraging Mey Icki’s dominant local scale and distribution platform … strengthened significantly Diageo’s route to market.

“However, in China and now India, there is no immediate intention to combine Diageo's international spirit distribution platforms with the newly-acquired entities. This may well remain the long term goal, but, in the medium term, value creation is going to be a question of whether Diageo can improve and ‘professionalise’  United Spirits' and ShuiJingFang’s commercial approach.”

At the same time, Investec said, the company risks entering a spirits arena with different rules to the ones that it is used to. “Diageo is now participating in market segments that dance to different rhythms to their core business of international spirits,” the analyst said.

“These are markets that ... are local, not global. They expose Diageo to local competitors, who choose to play a different game in terms of pricing and branding, and who might have different and less rational return expectations than Diageo is used to." 

The local spirits brands that the company has acquired are also “much less likely to travel across borders and are therefore a less straightforward fit” for the multinational drinks company, Investec suggested.

Late last month, Anglo Dutch food company Unilever warned that its Q3 performance was being hampered by a slowdown across its emerging markets. “We think that the read-across from Unilever’s Q3 sales warning is likely to be negative for Diageo,” warned Investec. “If Unilever is struggling to sell US$2 bottles of shampoo to hard-pressed emerging market consumers, we would expect Diageo to struggle even more to sell a $15 bottle of Scotch,” the analyst said.

Diageo is set to release its Q1 trading update tomorrow.