Diageo clearly has high hopes for the spirits market in Mexico

Diageo clearly has high hopes for the spirits market in Mexico

Last week, Diageo announced plans to invest US$400m on its operations in Mexico. While the headlines centred on the company's Don Julio Tequila operations, the country itself is ripe for growth. Richard Woodard investigates.

It’s no secret that Diageo’s Tequila strategy has been slightly messy in the recent past – it’s a topic that this column has tackled more than once over the last couple of years, after all. But, with the recent full acquisition of the Don Julio brand, there are increasing signs that the company might yet manage to pluck triumph from the jaws of potential disaster.

Here’s how.

The recent announcement that the multinational will spend US$400m over five years on Don Julio – including the cost of buying out former Jose Cuervo partners the Beckmann family, who also gain Bushmills – is an eye-catching one. Where’s the money going? Ostensibly, entirely on Tequila: The expansion of local production, bottling, water treatment, agave farming. And, a shiny new heritage centre in Atotonilco as well.

Lovely.

It seems to make sense for a brand that’s flying in the US, but let’s keep a little perspective here. Don Julio has nothing like the scale of Jose Cuervo (or indeed Patrón, which, given its value focus, is a more meaningful comparison). The brand barely scrapes into the volume top ten in its home market of Mexico, and lags the Cuervo colossus by close to 1m cases in annual sales there (as the soon-to-be-published Global Tequila Insights report, compiled by just-drinks in association with the IWSR, will make clear). Whatever Don Julio’s anticipated growth trajectory, $400m seems like a mighty big bet on its future.

But, take a step back and the investment begins to make more sense. Let’s return to Diageo’s announcement of the Don Julio investment programme, and the words of chief executive Ivan Menezes: “Mexico is a country of enormous opportunity and will form an important part of Diageo’s future.” The deal, the press release goes on to inform us, “expands Diageo’s leading position in Mexico and broadens its participation in fast-growing premium spirits sector”.

Over half the Mexican population is now officially “middle class”, and the proportion of LDA consumers will reach 64% in the next four years. “This represents a significant opportunity within international spirits, which currently have relatively low penetration versus beer and local spirits,” Diageo concludes.

We might add a couple more statistical snippets to back this up: GDP growth in Mexico is back on the right track after an iffy 2013, hitting an estimated 2.4% last year before rising to a forecast 3.5% in 2015 and holding steady at about 3.8% for the next few years.

It all makes Mexico very much the place to be if you’re a global drinks powerhouse with an unrivalled roster of premium brands. But, while Diageo already holds a strong position in the market, there’s work still to do – and the company’s Tequila investment can establish a powerful bridgehead into the market to enable that work to be done.

Five years ago, Diageo’s brands accounted for more than two-thirds of Mexico’s Scotch whisky volumes but, by 2013, that share had drifted well below 60%, with value brands eroding the sales of products such as J&B and Buchanan’s (as detailed by the Global Scotch Whisky Insights Report from just-drinks and the IWSR).

As a million-case brand, Johnnie Walker remains the marquee market leader, and the company’s strongest priority. But, if consumers switch from mainstream Tequila and brandy into value Scotch, the tactical use of lower-priced products such as the increasingly influential Black and White will become more important. Diageo will hope to trade these consumers up, in time, to the Johnnie Walker franchise.

The position with vodka is somewhat more problematic. In 2011, Smirnoff - produced and distributed in Mexico by Diageo’s then Tequila partner, Casa Cuervo - was closing in on market leadership after overtaking Absolut. Now, after an alarming couple of years since the parting of the ways between Cuervo and Diageo, the vodka brand has lost roughly one quarter of its volumes, leaving it some distance behind Absolut. The Swedish brand, meanwhile, is closely tracking market leader Oso Negro, which, as it happens, is produced by Cuervo.

As we’ve noted before, the earlier-than-planned ending of the Smirnoff agreement between Diageo and Cuervo – negotiated as part of the Don Julio acquisition – should go some way to resolving this rather awkward set of circumstances.

Mexico’s rum market has been far from enticing in recent years, but Diageo’s Captain Morgan brand has bucked the trend of long-running declines, growing at a three-figure CAGR thanks to innovative tactics like La Bomba – a pre-mixed on-trade serve in the form of a cannonball. In an otherwise moribund market, spiced rum is where it’s at – and that’s Captain Morgan’s biggest strength.

Further opportunities exist in gin, where Tanqueray is building off a small base and looking to capitalise on a growing appetite for premium-and-above gins. If the “gin tonica” trend could be imported from Spain, category sales could build very quickly.

To sum up: is Don Julio important to Diageo’s future operations, both in Mexico and elsewhere? Absolutely. Is that the only reason for this $400m investment? Absolutely not.

This investment smacks of a company which can see the size of the opportunity in Mexico and wants to grab it with both hands – something that was hard to do in the past, particularly if it was over-reliant on local partners with their own, sometimes somewhat distracting, brands and priorities.

If there’s a cautionary “but” here, it lies in Mexico’s somewhat patchy economic record. The country’s GDP graph is a frantic cardiograph, with euphoric surges punctuated by deflating dips.

Diageo’s investment is, it says, “subject to the market continuing to perform in line with expectations”. With Mexico, that’s a wise addendum to an otherwise positive vote of confidence in one of the world’s most promising emerging markets.