Chris Mercer

In the Spotlight - Diageo Shakes and Stirs

By Chris Mercer | 27 May 2011

Storm clouds gather over Diageo in Europe

Storm clouds gather over Diageo in Europe

President Barack Obama this week became one of a dying breed by ordering a Guinness in an Irish pub, a trend that has prompted brand owner Diageo to launch a global review of the way it allocates resources. Here, just-drinks looks at the market reaction.

I'll wager that it's been a topsy-turvy week for Diageo's PR department. Since video footage appeared of US President Barack Obama supping Guinness and eulogising about his chance meeting with the beer in Shannon airport, all the fuss has been about Diageo's desire to move resources out of Europe.

Short of adopting a Chinese symbol for its name, Diageo has made its intentions pretty clear. Resources need to be reallocated to emerging markets, particularly in Asia, Africa and Latin America, where growing numbers of consumers appear to have forgotten that the world's economy remains depressed.

By 'world', read mostly Europe and North America. The drinks giant has launched a review of its global operations, but there has been a particular focus on restructuring in Europe, where recession has hit hard in important regional markets for the group, such as Greece, Spain and Ireland.     

In Ireland, Diageo is looking to shave off up to EUR8m (US$11.4m) in labour costs. "President Obama's massive publicity boost for Guinness has left a bitter aftertaste," said the Irish Independent this week.

Timing aside, some analysts were not surprised to hear of Diageo's review.

"We have been saying for some time that the volume declines in Europe may be not only cyclical but also, at least in part, structural," said Morningstar analyst Philip Gorham. Gorham warned that drinks volumes "may not rebound to prerecession levels for many years to come in some Western European markets".

In Ireland alone, Guinness net sales fell by 5% in Diageo's previous fiscal year, even though the group gained market share. Around 40% of Guinness volumes are now consumed in Africa, with Nigeria a bigger market for the black stuff than Ireland. 

In the first nine months of Diageo's current fiscal year, to the end of March, the group's net sales in its Europe business declined by 3%.

Andy Smith, head of consumer equity research at MF Global, said that cost cutting in Europe will "clearly be positive" for Diageo's shareholders. "Further costs savings in the region would help Diageo counter-act the negative channel mix and generally difficult conditions the Western European region is seeing," he said.

In an earlier Spotlight, I highlighted that analysts at both Sanford Bernstein and Evolution Securities issued notes debating whether Pernod Ricard's operating model gives the group a competitive advantage over Diageo.

This week, the Telegraph newspaper's Damian Reece picked up on Diageo's "devolution" to a more regional structure. One of the oft-cited differences between Diageo and Pernod Ricard has been the former's centralised structure in contrast to the latter's regional approach.

Following this thread, Reece wrote: "If [Diageo CEO Paul] Walsh is devolving authority to the regions, that means the centre itself could shrink significantly. The reshaping of Diageo could have a way to go yet."

In addition, last weekend, Walsh said in an interview with The Times that high personal tax rates mean that the company is finding it harder to recruit people to its headquarters in the UK.

At the same time, Walsh underlined the firm's thinking on Asia, Latin America and Africa. "This year I expect emerging markets will be about 35% of our total business — and in the next three years I think it could easily get to 50%,” he told the paper.

Diageo has yet to finish its review, but it has already announced the break-up of its 'international divison', in favour of a separate Diageo Latin America and Caribbean and Diageo Africa. Travel retail will move to Diageo Asia Pacific's jurisdiction.

I'm sure that Diageo would strongly disagree that it is seeking, in any way, to emulate the operating model of its great rival, Pernod Ricard.

Given the way emerging markets have propelled Diageo's sales in the last couple of years, it shouldn't be a great surprise that the group is seeking to reallocate resources. Multinational brewers, beset by stagnant beer consumption in Western Europe since the global recession was but a dot on the horizon, have been heading this way for some time.

We're likely to see most of the multinational drinks giants treading further down this path over the next few years.

Sectors: Beer & cider, Emerging markets – BRIC, Spirits

Companies: Diageo, Guinness, Pernod, Ricard

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