WSD: Diageo: Premium Vodka Boosts Earnings, Scotch and Wine Decline

FILED AUGUST 1, 2009

Dear Client:

Fiscal 2009 was a tough year for almost everyone in the alcohol business – not to mention just about every other industry – and Diageo was no exception. It certainly felt the sting of the recession in the year ended June 30, but overall the world’s largest spirits company still experienced growth. In his prepared remarks, chief Paul Walsh noted that “while the economic downturn has affected all markets, the response of customers and consumers has not been uniform and therefore the impact on our business has been varied.” Europe was the weakest region for Diageo, while gin and wine were “weaker” than other spirits categories and scotch and liqueurs were “most impacted by de-stocking.”

PREMIUM STRATEGY. When a reporter asked if Diageo’s premium business model is working in the current climate, Paul responded: Our business model is totally viable, our strategy is the right strategy, but that doesn’t mean you don’t adapt to the circumstances around you...in the US we’re probably giving more attention to our sharper price point brands than we did 10 months ago...”

He noted that premium brands “are performing very, very well...these are brands people still aspire too and have an incredibly strong image.” He noted that Diageo’s ultra premium brands are also growing although at a slower rate. “A year or so ago we were probably looking at 15-20% growth, and now we’re growing at about 5%” growth. One way they’ve dealt with trading down is by introducing smaller package sizes for premium and ultra premium brands.

Overall marketing spend declined -9% in North America as Diageo reduced investment behind ready to drink (RTDs) brands and experienced increased media inflation. They instead focused their dollars behind premium spirits, namely Ciroc Vodka. In all share of voice in spirits grew 4%.

NORTH AMERICAN ENVIRONMENT

SPIRITS. Volumes were flat in North America, while net sales grew 1%. Total spirits volume grew 1% while price/mix grew 3%. “Despite the difficult economic climate, the total beverage alcohol market in the United States remained in growth,” said the company. Premium spirits was most resilient, namely Smirnoff vodka, Captain Morgan and Jose Cuervo. Based on IRI data, Diageo’s share of US spirits was 30%, an organic decline of 0.2 percentage points in the year and an increase of 1.4 percentage points from brand additions, Ketel One vodka and Zacapa rum.

Vodka remained the strongest spirits category in the US. Diageo outperformed the category as a whole, growing net sales 16% led by Smirnoff in the premium segment and Ciroc and Ketel One (which performed ahead of expectations) at higher price points.

SMIRNOFF. Smirnoff vodka experienced a lot of success in the year as consumers increasingly traded down from super-premium to premium brands in the U.S. It was also helped by “higher marketing spend,” said the company, and price increases on Smirnoff Red.

JOHNNIE WALKER was hurt by the economic climate along with other scotch brands. Johnnie Walker Red Label net sales declined 2% and Black Label declined 7%. In the super deluxe segment, Johnnie Walker Blue Label experienced double digit declines and marketing spend was re-directed towards Johnnie Walker Black Label.

CAPTAIN MORGAN had a strong year and delivered volume and net sales growth and share gains. Price/mix rose 4% through prices increases on Original Spiced Rum and the launch of the higher priced Captain Morgan 100, along with increased marketing spend behind the ‘Got a little Captain in you’ television campaign.

JOSE CUERVO grew volume 3% and net sales 4% in North America. Share gains on Jose Cuervo Gold driven by an increase in distribution points and the launch of Jose Cuervo Silver more than offset weakness in the on-premise.

TANQUERAY net sales declined 12% in line with volumes as price increases on the flagship brand were offset by faster declines on Tanqueray No.10 and Rangpur.

CROWN ROYAL net sales declined 1% due to the impact of the higher priced Reserve and Cask 16 variants.

VALUE SPIRITS were a shining beacon in fiscal 2009 after years of struggling. Net sales of Gordon’s gin grew 9%, followed by Gordon’s vodka (up 11%) and Popov vodka (up 14%). When defending his premium strategy, Paul noted that “these [value] brands are already in our portfolio, we maybe just need to give them more emphasis in this current environment.”

WINE – NOT SO GOOD. Net sales of wine declined -7% due to the economy and consumers trading down from price points above $25, said the company. Chalone Wines were most affected. To offset this, Diageo increased promotional activity in the second half and launched a number of new wines at price-points of $10 and below.

A reporter asked if Paul regrets entering the wine business, to which he replied: “I don’t regret wine in the portfolio. I’m rather pleased our wine business isn’t at the scale people a few years ago were suggesting it should be. It’s harder hit than spirits with regards to trading down...particularly evident in US.”

Ivan Menezes chimed in, explaining that “in the US you’re seeing more pronounced down trading in the wine environment...top end restaurant in major cities – say wine that was over $60 a bottle has significantly come down. People are going for far more affordable wines.”

When purchasing wines at retail stores for at-home consumption, people tend “to drop one or two price points,” Ivan concluded.

RTDS SLOW GROWTH, PROMPT INNOVATION. The planned destock of RTDs in the US, together with weakness in the segment there and in Europe, contributed to the overall decline of the category. Net sales declined -8% in North America. Diageo still launched several new Smirnoff Ice flavors, however, and a range of ready to serve Smirnoff Cocktails, reflecting the trend for increased at-home consumption.

“We’ve made a lot of money out of the category” over the past few years, said Paul. At first RTDs were incredible, and then they flattened and eventually declined. Nonetheless, Paul said they’re still an important category. We’ve had some “extremely profitable new product launches,” he said, and the RTD brand “pays rent to the parent brand. It enhances the vitality of the brand it borrowed from.”

He said if he could go back, he’d do the RTD category again. “Yes...the economics and brand attributes suggest we would.”

DE-STOCKING. Paul echoed the sentiment of other companies in pointing out that de-stocking, particularly in markets like the U.S., are up to distributors and retailers. He doesn’t seem to expect that de-stocking will continue, though, and acknowledged that the smaller inventories are likely here to stay. “Some distributors...were good business people and of their own volition decided to contract their inventory levels...The retailers also started to shrink their inventories...what we learned is it has a very fast impact on your business. And when you have weakening consumer demand it gives you an exaggerated picture...we do not believe going forward this inventory will come back into the system. We believe distributors and retailers will continue to operate in this new efficient way...they will smarten their operations and we will continue to help them operate more efficiently.”

AMERICAN BOYCOTT OF SCOTTISH GOODS. When asked if Diageo is concerned about American boycotts of scotch, Paul said, “We don’t really know at this stage. It’s a situation we’re looking at with great interest. We will see if it gains traction and see what interventions we have to make to offset an impact. This is a reaction to a political decision. I hope good Scottish product made by good Scottish people is not prejudiced because of political expediency.”

WHEN WILL THE ECONOMY RECOVER? “It’s in the second half we’ll start to expect real fundamental improvements in categories and our markets. If that happens, it will be a very strong platform for fiscal 2011,” said Paul.

ACQUISITIONS. Is Diageo interested in purchasing Moet Hennessey? “This is an old chestnut,” said Paul. “I think I’ve said many times if ever the 66% is available we’d be interested. Beyond that it’s not appropriate to comment. At the right price we’d be interested.”

He later stressed to Bloomberg Television that “we won’t waste our balance sheet on nice-to-haves...If something comes along that is of strategic importance we will move.”

In terms of negotiations with United Spirits Limited, Paul said he didn’t miss the boat by dropping out of negotiation with Vijay Mallya. “No. I know his price expectation, you don’t,” he replied which was met with laughs.

FORMER ALCOHOL REGULATOR WARNS AGAINST LAX RULES

Proponents of strict alcohol regulation in this country are claiming you only need to look at the British to see why de-regulation is a bad idea. Author of the new report, The Dangers of Alcohol Deregulation: The United Kingdom Experience, Pamela Erickson says, “as part of a growing globalization trend across the alcohol industry, some have called for alcohol deregulation in the United States...I suggest that the answer is a resounding 'no.' Alcohol should be regulated - and the deregulation of alcohol has many dangerous and unintended consequences for society." Pamela is a former state regulator and ceo of Public Action Management (PAM).

She claims the UK gradually deregulated alcohol to the point where society now treats it “much the same as any other product.” Wine, beer and spirits are sold almost everywhere and can be purchased 24 hours a day, she says.

It’s also become cheaper in the UK, particularly in grocery stores “where four large supermarket chains gained 75% of the market and became locked in a price war driving alcohol prices ever lower.” Those cheap prices have led consumers to drink primarily at home, she said, but there are also plenty of scenes “of drunken debauchery with people spilling out at closing time vomiting, urinating and passing out.”

The best way to deal with the misuse of alcohol, according to the report, is “controlling the price of alcohol.” Of course this means increased taxes and other kinds of initiatives the industry is generally against, but she says raising taxes alone will not solve the problem. “The tendency is to use tax measures alone to control prices. As the science indicates, multiple measures are needed to achieve balance in the marketplace,” said Pamela. “Ironically, the United Kingdom exemplifies the problem of using taxes alone to control prices. The U.K. has some of the highest taxes on alcohol among European countries.”

MOET HENNESSEY USA REVIEWING CREATIVE DUTIES FOR BELVEDERE

Moet Hennessey USA is currently reviewing creative duties for its Belvedere vodka brand, with present agency Berlin Cameron United defending, reports AdWeek.com. Sources tell the publication that MH is looking at about 6 different shops with plans to comprise a list of 3 or 4.

The search is being conducted by Roth Associates in New York and is expected to be completed in October or early November. Account billings are estimated at $15 million. This does not include media duties which remain at Havas' MPG in New York.

WSD BRIEFS:

RNDC SIGNS DEAL WITH ARMAND DE BRIGNAC. Armand de Brignac Champagne and Republic National Distributing Company (RNDC) are partnering in the states of Florida, Texas, Kentucky, Oklahoma, New Mexico (National Distributing Company), North Dakota, and South Dakota. RNDC already distributes the champagne brand in Maryland, South Carolina, and Washington D.C.

ANGOSTURA CHIEF SLIPS AWAY. Local reports claim Angostura Ltd ceo Iain Grant spent his last day at the company on Tuesday. He joined the company in July 2008 and no reason was given for his departure. Sources told the Express that CL Financial “Dr Shafeek Sultan-Khan and another board member visited Angostura and reassured staff members that the company will continue to operate normally following Grant's departure.”


“Live each season as it passes; breathe the air, drink the drink, taste the fruit, and resign yourself to the influences of each.”
Henry David Thoreau

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