Baijiu, vodka and the white spirits challenge for Diageo - Analysis

The trials and tribulations of the white spirits category proved of interest to the analyst community in their notes following the release of Diageo's first-half results. On the one hand, baijiu is having a great time in China. On the other, vodka continues to struggle in the US.

In the regional breakdown of its results for the six months to the end of December, Diageo said baijiu sales in Greater China leapt by 80% in the period, thanks to "improved execution and expanded distribution". Meanwhile, in the US, Smirnoff sales slipped by 2% with Ciroc and Ketel One falling 12% and 13%, respectively.

"Strong growth from China, driven by Diageo's Shui Jing Fang, saw the group's Asia Pacific division strongly beat consensus," wrote Societe Generale analyst Laurence Whyatt. "The main negative from the sales numbers was North America, where ... the vodka brands continue to struggle, with Smirnoff negative and both Ciroc and Ketel One down double-digits."

Societe Generale has trimmed its full-year expectations for North America, with growth now expected to be 2.8%, down from 3.8%. "On the other hand," Whyatt added, "we have raised our Asia Pacific growth estimate to 7.6% from 5.5%."

Elsewhere, Asia Pacific was described as a "huge improvement" by Bryan Garnier analyst Virginie Roumage. She said the performance was down to "exeptional growth in China driven by baijiu" as well as "some pricing benefits in South East Asia".

In a conference call following the results announcement, Diageo CEO Ivan Menezes added some detail behind the success of Shui Jing Fang. Brand marketing has "significantly improved", he said, while "innovation is much stronger". 

"When I go to China," he told analysts, "I meet our distributors in the baijiu business every year, and I have to say the confidence we have from the distribution system against the brand continues to be very strong.

"The scale of the business is at its peak. So, it's ahead of where it was in the pre-anti-extravagance period. And, we're very confident about the growth in the high-end of the baijiu market, which is where we participate. Brand health is really strong - it continues to build. We've got geographic expansion opportunities."

Menezes also outlined several plans for the US vodka business, including the continued roll-out of the Ketel 'Your Soda' campaign, which highlights the vodka & soda serve. He said the initiative, which launched in the first half, reminds consumers that Ketel One is "a family-made vodka, 100% non-GMO and crafted to be an exceptionally smooth".

"We will continue to build momentum behind it in the second half with a strong local and national media plan, and continue to engage consumers at lifestyle events in key markets."

He said the growth of the vodka & soda serve in the US, particularly among female consumers, is being driven by a move away from wine.  

On Ciroc, the company plans to bring back the Ciroc Summer Colada as well as focus on the core three variants - Blue, Apple and Peach - with digital and social media, sampling and local events.

"In super-premium vodka," Menezes noted, "we know we have more to do."

Meanwhile, Smirnoff has shown some improvement in the US since H1 fiscal-2017, when sales were down 5% (compared to this H1's 2% decrease).

"Smirnoff depletion volume declined 1%," said Menezes. "Brand equity scores improved as it continued to remind consumers that it is a quality vodka at a great price, through a campaign involving celebrity influencers, new packaging and quality cues and local activation against multi-cultural Millennial consumers."

The road ahead for white spirits, then, is not clear-cut.

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