Company Strategic Review 2001 - Part Three
The journey to become a pure premium drinks business has four hurdles at the moment, the sale of the Burger King and Pillsbury food divisions, which are depressing results, the disposal of non-core drinks assets and, perhaps most frustrating, the completion of its joint acquisition with Pernod Ricard of the Seagram drinks business.
Despite growing impatience over the Seagram deal, which has been sitting with regulatory authorities for a year now, development of the drinks business has been far from stagnant during the last 12 months.
Firstly, as drinks analyst Canadean points out in its Strategic Review 2001: "As might be expected from this skilled acquisition and merger team, integration plans [for the Seagram brands] are well-advanced."
This will include the disentangling of distribution agreements and absorption of the acquired brands into the enlarged business that should result in significant savings, which should be seen after a year's work, according to Canadean.
But even with Seagram aside this has been a year of transition for Diageo as it merged its UDV and Guinness businesses. The division delivered operating profit up 11% to £1.4bn on turnover up 6.5% at £7.6bn.
Canadean says: "Much of the growth was due to the performance of Smirnoff and its ready-to-drink (RTD) extensions. At 18.4m cases, it accounts for over 20% of spirits volumes, nearly 10% of Premium Drinks sales revenues, and an estimated 16% of profits."
The focus on Smirnoff Ice and its parent brand Smirnoff at this year's annual results underlines Diageo's strategy to choose the brand as its flagship, with aspirations to make it the world's number one spirits brand.
To do this Diageo is focussing on its best markets, the UK, US and Ireland, as well as targeting others with high potential. New markets for the parent brand and its RTD off-spring will continue to be investigated, as will new flavour extensions, new delivery and new customers.
"The innovation has rubbed off on other brands as well," says Canadean. "Gordon's Space is selling well in Greece, Bundaberg & Cola in Australia, J&B Twist in the Iberian Peninsula, and the latest invention is Archer's Aqua - recently launched to outstanding success in the UK."
Indeed RTD's now make up some 3m cases from the premium drinks sales of 108m cases and are worth £450m in sales and £130m in operating profits in 2001.
Walsh says that the company's strategic agenda is now firmly in place, but the success over the next year may be down to factors outside its control. The Seagram deal has still to get US regulatory approval and Diageo may be forced to sell its rum drink Malibu to satisfy the FTC.
However, while the Seagram deal will bring some extra 20m in case sales and £200m in operating profit, much of its success rests with winning the court case with Allied Domecq for the Captain Morgan brand.
Captain Morgan is by far and away the prize jewel of the Seagram portfolio for Diageo and, as well as some £90m in profits, is also capable of considerable expansion.
The effects of the world economic slowdown could also, like every other drinks business, have an affect on Diageo's performance this year, especially in travel retail and at the premium end. However Canadean says: "World economic conditions are clearly outside its control, but the company is well spread geographically and with an exceptionally broad-based portfolio. It is likely to weather the storm better than most."
It's been a mixed year for Brown-Forman. After last year's acquisitions of a 45% stake in Finlandia vodka and another stake in Glenmorangie, the company failed in its bid to acquire the Seagram drinks business with Bacardi and has since made no more significant acquisitions.
Furthermore after the millennium boom its Korbel "Champagne" fell 32% and profits from the sale of used Bourbon barrels to the Scotch industry have also dropped as whisky production has been curtailed. And yet the company managed to produce record results once more.
Sales growth slowed to 2% but profits increased 8%, thanks mainly to the continued success of Brown-Forman's efforts to upgrade its current portfolio of wines and spirits through packaging and marketing initiatives. The Finlandia acquisition is proving particularly fruitful with sales through B-F at 1.2m cases.
More importantly perhaps, value and operating profits of the brand have doubled. And all this was achieved against the backdrop of a slowing US economy.
Brown-Forman's strategy is a three-pronged attack which includes efforts to build its existing brands, particularly its flagship Jack Daniels, broaden its geographical reach, including new markets such as Korea and Mexico and widen its portfolio.
Of its existing brands Jack Daniels continues to lead the way. The brand showed growth of 6% in volumes and stretched its geographical reach considerably during the year. "The group is seeing the result of two years of unremitting marketing effort to spread the word about its famous Jack Daniels Tennessee Whiskey," says Canadean in its Strategic Review 2001 of the company.
Southern Comfort has also continued to make headway on the market with sales up 2% in the US and gross profit up over 10%. The group's wines have also performed, particularly Bolla and Sonoma Cutrer in the US.
"The strategy is producing greater volumes and higher growth in gross profit, enabling further investment. On the assumption that 'if it ain't broke don't fix it,' Brown-Forman's management has little reason to shift direction," says Canadean.
As part of this, do expect to see further acquisitions to expand the portfolio. The company has an option to increase its stake in Glenmorangie to just under 30% when appropriate, while it may be required to take the remaining 55% in Finlandia from its Finnish partner in the next two years. "Both these brands are valuable acquisitions," says Canadean.
Canadean, though, does remain concerned about recent trading statements, which indicate that two factors do threaten to dampen the company's performance - the softening US economy and the strength of the dollar particularly compared to the Euro, the pound, the Australian dollar and the Yen.
Indeed, the company reported that first quarter results for 2001/2002 showed operating profit for beverages down 9% on revenues up 1%. However, the company is to invest around US$20m in implementing a business improvement strategy, taking a close look in particular at the supply chain. This comes on the back of significant investments in IT and training over the last three years.
Indeed to conclude Canadean says: "Brown-Forman is likely to continue to out-perform most of the rest of the industry for more years to come."
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