Diageo, the world’s leading spirits company, faces mounting pressure to reassess its medium-term sales growth targets. With the upcoming interim results announcement on February 4th, new CFO Nik Jhangiani will address investor concerns regarding the feasibility of maintaining the 5% to 7% annual sales growth objective established in 2021, given the current industry downturn.
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The spirits sector has experienced a significant slowdown due to high inflation and interest rates impacting consumer spending. This challenging environment, coupled with a recent profit warning triggered by excess inventory in Latin America, has raised doubts about the attainability of Diageo’s ambitious target. Kai Lehmann, a senior analyst at Flossbach von Storch, a major Diageo investor, expressed skepticism, stating that achieving 7% growth in the medium to long term is unlikely.
New CEO Debra Crew, who assumed leadership in June 2023, acknowledged the difficulty in predicting when the current headwinds will subside and allow the company to return to its targeted growth trajectory. Diageo’s organic sales declined by 0.6% last year, further highlighting the challenging market conditions. While Lehmann has directly addressed his concerns with both Crew and Jhangiani, he suggests that adjusting the target may not be necessary if the company remains confident in its ability to achieve it.
Resetting Expectations in a Changing Market
The 5% to 7% growth target was set during a period of unprecedented demand fueled by the COVID-19 pandemic, which saw Diageo’s organic net sales surge by 16% in 2021. However, the current economic landscape presents a stark contrast, leading several major investors to question the upper limit of the target’s feasibility.
One investor suggested a slight adjustment to 4%-6% growth. This revised target would still position Diageo above competitors like Pernod Ricard, which maintains a 7% growth target, and Remy Cointreau, aiming for “high single-digit” growth from 2025-26, despite analyst skepticism.
In July 2023, Crew defended Diageo’s ambitions, citing long-term growth drivers such as population growth, rising incomes in emerging markets, and the company’s successful premiumization strategy. However, revising the target downward could signal a weakening of these drivers. Some investors believe that a short-term share price impact would be preferable to maintaining overly ambitious goals.
Navigating Long-Term Challenges and Premiumization Strategy
Beyond immediate economic concerns, the industry faces potential long-term challenges, including changing consumer behavior and rising demand for weight-loss drugs. Recent declines in the price-earnings ratios of Diageo, Pernod Ricard, and Remy Cointreau reflect these concerns. Furthermore, potential U.S. tariffs pose a threat to sales of key products like tequila.
Diageo has also faced specific challenges, including the recent profit warning and subsequent management changes. Fundsmith, a significant investor, divested its holdings in Diageo, citing management concerns and early indications of weight-loss drugs impacting sales. Recent reports, denied by the company, suggested a potential sale of its flagship Guinness beer brand.
While acknowledging the current difficulties, some investors, including Joseph Gabelli of Gabelli Funds, believe Diageo’s challenges are primarily cyclical rather than indicative of fundamental societal shifts. They maintain that the company remains well-positioned for future growth.
A central question revolves around Diageo’s ability to sustain its premiumization strategy, which has driven significant growth in recent years. With the premium portfolio now representing over 70% of sales in developed markets, some analysts and investors believe that its contribution to growth may slow. Kunal Kothari, UK equity manager at Aviva Investors, a major Diageo shareholder, suggests that the company’s cyclical nature should be considered when setting long-term growth targets.
In conclusion, Diageo’s upcoming results announcement will be closely watched as the company navigates a challenging market environment and addresses investor concerns regarding its medium-term growth prospects. The decision to maintain or revise the current sales target will signal Diageo’s outlook for the future of the spirits sector and its own ability to adapt to evolving consumer trends and economic realities.
