Diageo : 2021 Preliminary Results Q&A transcript

Diageo F21 Preliminary Results Investor Q&A Call

Date: Thursday, 29th July 2021

Conference Time: 09:30 (UTC+00:00)

Ivan Menezes: Hello everyone and thank you for joining our preliminary results call for fiscal 21. I'm delighted to welcome Lavanya, our new CFO. Lavanya and I are sitting in Park Royal in our office on a sunny day in London, a rare occasion. Great to have you here Lavanya.

I hope you've had a chance to read our press release and watch our presentation webcast on diageo.com. Diageo delivered an excellent set of results in fiscal 21. We performed very strongly across all our key financial metrics while continuing to invest in long-term growth and building on our successful ESG track record.

Organic sales up 16% in fiscal 21 and up 6% compared to fiscal 19 on a constant basis. All of our regions grew organic top line with 3 of the 5 growing net sales above fiscal 19 on a constant basis.

North America, our largest and most profitable market, performed particularly strongly. We also delivered excellent cash flow generation. Our strong foundation going into the pandemic enabled us to respond quickly to changing consumer trends and we have emerged stronger. We are benefiting from our broad geographic footprint, well positioned portfolio, data analytics and tools and creativity and our lean cost base.

We upweighted our investment in effective marketing and consumer-led innovation, and we gained or held off-trade market share in over 85% of total net sales in measured markets creating strong momentum for sustainable long-term growth.

While we expect near-term volatility in some markets, we believe we are well positioned in fiscal 22 to benefit from both the resilience in the off-trade and the recovery in the on-trade. I am optimistic about the growth prospects for our industry and for Diageo. Spirits continues to gain share of total beverage alcohol globally and premiumization trends remain strong.

The 5% increase in our final dividend and the restart of our capital return program in May reflects our confidence in the long-term outlook while delivering consistent returns for shareholders.

Before we move to Q&A, I'll just turn it over to Lavanya to say a few words.

Lavanya Chandrashekar: Thank you Ivan. I'm honored to be stepping into the role of the CFO, especially at such an exciting time of growth for Diageo. I look forward to building on Kathy's tremendous achievements, partnering with Ivan and the team to drive sustainable top line growth while using productivity to enable smart reinvestment and drive value for shareholders.

From my prior role as CFO of our North America region, I know first-hand how effective Diageo is when we make focused strategic choices and invest consistently behind them. While I have had the chance to meet many of you, I look forward to meeting those of you who I haven't met very soon.

I'll now hand the call back to the operator to open the phone lines for your questions.

Operator: Thank you. We will now take our first question from Simon Hales from Citi. Please go ahead.

Simon Hales: Thank you. Good morning, Ivan. An official welcome Lavanya, to you, in your new role. I have 3 questions, please. Firstly, we've obviously seen a significant up-weighting of marketing investment through 2021 and more generally in recent years. I know you talk about in your outlook statement the desire to continue that reinvestment as we look forward as well. But how should we think about the overall rate of investment in 2022 and beyond? How do we think it develops as a percentage of sales? I'm just trying to get an idea of where things are headed and where your spend priorities really are in 2022. So that's the sort of first broad question.

Secondly, if you could talk a little bit more about the inflationary pressures that you're seeing as we head into the new fiscal year? Is that more on the distribution and logistics side? Or is it sort of on the COGS side that you're starting to see some building pressures there? Is there any skew between H1 and H2 when we think about how that will hit the P&L from a modeling standpoint? And how confident are you in your ability to pass some of those things through in terms of pricing?

And then, finally, just a quick one around the tax rate guidance. What are the drivers of that sort of higher tax rate of 22% to 24% going forward, please?

Ivan Menezes: Great, thanks Simon. I'll take the first, just give you a headline on inflation, but then turn it over to Lavanya on inflation and tax. Marketing investments; so I would say the way to think about our approach and philosophy is: number one, we see good quality, sustainable growth in this category for Diageo. The premiumization trends are strong, spirits gaining from beer and wine. Secondly, our tools and analytics of understanding marketing effectiveness, as we've talked about before, is I really feel very good about and they keep getting stronger and better. Third, the shape of the economics of our P&L with very positive price mix and strong cost discipline on everything that the consumer doesn't feel and touch, gives us the confidence that we have the ability to deliver margin expansion, as you saw in these results, while upweighting marketing.

Now having said all of that, we don't have a percent of sales philosophy for the next few years. We actually build our marketing investment plans bottom-up and teams have to justify them. But our orientation is to invest behind quality sustainable growth because we can deliver strong economics with that.

Diageo is well funded in terms of our level of marketing investment right now. Our share of voice is very strong. We've significantly upweighted media spend across the markets, and you can see the results in market share because we put an enormous focus on what we call quality market share. And we really assess that carefully. It has to be brand equity, consumer-led market share performance. So I'm feeling good about where we are. Could you see us increase it? Yes, you could. But we don't have a strategic posture to upweight our marketing spend in the year there. We build it on the basis of the business case and the opportunities we see. Certainly our orientation will be to lean in to invest where we see the opportunities, and we certainly get the return, as hopefully, you can see in these results.

On inflation, I'll turn over to Lavanya, I just have a headline comment I'd like to make, which is: the nature of the Diageo business is we can take inflation in our stride. The nature of current inflation. Lavanya will talk more about what we're seeing happening. And again, it starts with strong mix and trading up in these numbers. Our reserve brands, the top 25% of our portfolio was up 36%, the Johnnie Walker Blues and Casamigos and Cîrocs of the world. As you know, those are higher-margin businesses.

We are doubling down on our cost productivity, which has been now a muscle the company has built well. Our brands are strong, just to your earlier question, and brand health is strong. Our ability to manage price and mix as well is strong. Then the final point I'd say on categories like whiskey; the Johnnie Walker Black Label we sell today, it's useful to remember, the liquid was distilled at least 12 years ago. So we do have a buffer in the nature of our stocks and how they flow through the system.

I'll turn over to Lavanya to address the specifics on inflation.

Lavanya Chandrashekar: Simon, to answer your question on inflation specifically, you asked where are we seeing it come through? Is it in COGS or sitting in distribution logistics? It is in both cases. To start, our inflation rate has been around 3%. What we're seeing come through now is picking up a couple of points. We're definitely seeing the pressure from a commodity perspective: oil, corn, aluminum are all going up. From the distribution logistics perspective, it's really supply and demand. As demand has picked up, rates have gone up.

I won't comment specifically about if it's going to be higher or lower from a modeling perspective or half 1 versus half 2. It's hard to predict in these very volatile times. At present we definitely see inflation picking up.

As Ivan said, we have multiple tools in our arsenal to deal with inflation. First and foremost, I'd say one of the biggest tools that we have is the premiumization trend. It's strong. Half our growth has come from the super-premium plus part of our portfolio in fiscal 21. And as Ivan mentioned, this part of our portfolio has better margins.

The second thing is volume leverage. We've grown 11% volume in fiscal 21. I think that's a big differentiation versus a lot of broader CPG businesses and that enables us better fixed cost absorption that flows through to the bottom line.

The third is we are able to take pricing where it is required. We've taken pricing on Baileys in North America. In higher inflation markets such as Nigeria and Turkey and we have taken several rounds of pricing. We've been successful at growing the business in all of these places. Baileys in US Spirits is up 31% on 17% volume growth. We've really been able to demonstrate our ability to what I would call walk and chew gum at the same time.

The last thing I would say is our culture of everyday efficiency which Ivan referred to. It's really embedded into our culture now. In fiscal 21, everyday efficiency was able to offset inflation. Going forward we are confident in our ability to take inflation in our stride and continue to support our brands as they deserve to be.

Your next question was on tax rate. I'll be brief on that. This year our effective tax rate went up from 21.7% in fiscal 20 to 22.2% in fiscal 21. It is really a combination of drivers but the biggest one is market mix. As our business grows and in markets such as China and the U.S our effective tax rate has increased. As we look at fiscal 22 that is going to continue to be a factor resulting in our tax rate guidance going up. In addition to that there are known external factors such as the proposed increase in the U.S. headline rate. We don't know exactly how much it will be or what the timing is but we are assuming right now that it will happen sometime during the course of fiscal 22. In addition to that - overall the tax environment with governments seeking to recover from the impact of COVID and the G7 agreement on minimum taxation

• we expect all of these to contribute to the higher effective tax rate in our guidance but also the wider range that we have put out as our effective tax rate guidance.

Operator: We will take our next question from Sanjeet Aujla from Credit Suisse.

Sanjeet Aujla: Hi Ivan, Lavanya. A couple of questions from me, please. Firstly, on the U.S., Ivan, in your outlook comments, you're talking about the market reverting back to mid-single-digit levels on this high base. And I guess given the importance of tequila now in your portfolio and the significant upweight in marketing spend you've had, seems like you're going to continue on that journey, would you expect to be growing ahead of the category through F22?

My second question is really on margins. Again, I appreciate you're not giving any guidance for fiscal 22. But when I look at an organic basis, I think your margins at the end of fiscal 21 are still 170 basis points below fiscal 19 levels. Would you expect to fully recover that in the fullness of time over the next 2, 3 years? How should we think about that? Thank you.

Ivan Menezes: Okay. I'll take the first and hand to Lavanya on the margins. On the U.S. market, firstly, we clearly see the U.S. industry momentum remaining robust. As the on-trade comes back, it is coming back strong. I love the American consumers' enthusiasm to socialize outside the home. Bars and restaurants are full. And we are, by the way, also growing market share in the recovery of the on-trade to the extent that you can measure it through NABCA and what we pick up from our distributors. We're doing very well on the on-trade recovery.

Going forward, what I'm really pleased about is the share momentum in the U.S. You may or may not have seen the most recent Nielsen that just came out a couple of days ago. Even in the last 4 weeks, that momentum is continuing. If you look at the last 12 months, 6 months, 3 months, our share momentum has steadily improved and we're now running 50, 60 basis points of market share gains in the last month and 3 months.

That, in part, is driven by the momentum in the portfolio. Yes, Tequila is strong and we still see a lot of runway for our tequila business; both Don Julio and Casamigos are doing really well. But it's also the full portfolio. Our whisk(e)y business, Crown Royal, Johnnie Walker, Baileys, as you saw in these numbers are up 31%. So I expect us to continue. We are in a position where we should be able to outperform and gain share as we go through fiscal 22.

Lavanya Chandrashekar: I'll answer your second question on margin. As we discussed in our earnings update at interims as well as at the end of fiscal 20, part of what has caused our margin pressure has been mix or region/market mix. The shutdown of the global travel business has impacted our scotch portfolio, particularly as scotch is one of our better margin products within the portfolio. Then the second piece of it is the shut down in the on-trade has significantly impacted our beer business, especially in Europe and Turkey. That has also led us to be significantly impacted from a margin perspective.

The question on do we expect margins to revert to fiscal 19 levels. I think it's a matter of recovering from COVID and as our scotch business grows and we gain back our beer business in the on-trade in Europe, those will substantially help us to recover margin back to fiscal 19 levels. And on top of that, all of the things that I mentioned in my last answer to Simon. Premiumization, volume leverage and a combination of revenue growth management supported by headline pricing will also be key drivers in us being able to recover margins over time.

Operator: We will take our next question from Andrea Pistacchi from Bank of America.

Andrea Pistacchi: Morning Ivan and morning Lavanya, 2 questions, please. The first one on your outlook commentary where you say that you expect near-term volatility in some markets. Are you seeing anything, are you referring to anything specific that you're already seeing, maybe any markets that have deteriorated? Or is it more of a general comment around potential risk of lockdowns? And I think you flagged India in the prepared remarks as a market that could be volatile, elsewhere where do you see some risks?

And then on the U.S., you were saying you're referring to the last 3, 6 months where you've been gaining share and this has come across clearly in the data we've been seeing. How do you see, since the reopening, and since you've been facing the more difficult comps in the off-trade, how has the market been performing in the last 3 or 4 months? Would you have a number for the market depletions?

Ivan Menezes: I'll take the first, and Lavanya can cover the second on the U.S. market. We don't have a particularly more sophisticated crystal ball as to how the virus and the pandemic impacts are going to play out. We have scenarios, and obviously we model against scenarios. I am cautiously optimistic and confident. However, we know the nature of the pandemic that things can turn, quickly, and so that's what's reflected in the statement and that's also our caution in not giving guidance. If I take the specifics, we know what's happening in South Africa, right? On, off, on, off, and it's just reopened a couple of days ago. Could it go into prohibition again? It could. India has been up and down. Parts of Southeast Asia are tough. Indonesia. I'm talking about the virus and the pandemic. So, it's no more than that. We don't have any particular geography we are concerned about. We are hopeful that the European reopening will continue and the U.S. reopening will stay, of the on-trade momentum that I talked about earlier. That's what's behind our statement there. It isn't any particular specific concern in one geography. It's just recognizing that with the Delta variant and the numbers are going up and down. That's why we just want to be cautious. Now we're very much focused on what we can control and what we can drive. Building our business, gaining market share. I mean that's what we're focused on.

Lavanya Chandrashekar: Yes. I'll answer the second part of your question, Andrea. In terms of the U.S. market, what we have seen happen here over the last 3 or 4 months is a very strong reopening of the on- premise. By our estimate, about 85% of the on-premise is now open and what we're seeing is what we predicted, which is consumers coming back to celebrate with family and friends and enjoying a wonderful cocktail in their neighborhood bar or restaurant. That's essentially what we're seeing. In terms of the market itself, we're seeing the market continue to be very resilient. More importantly what we are really proud of is that we are continuing to gain share in the market. Both Nielsen as well as NABCA, we are growing share strongly on our U.S. business, both spirits as a percentage of spirits but, equally importantly, we are growing share of total beverage alcohol.

Andrea Pistacchi: Just a quick follow-up on that, Lavanya. You say about 85% of outlets have reopened. When you think of on-trade spend, would you say that, in the recent month or 2, on-trade spend is back to or very close to pre-pandemic levels in the U.S.?

Ivan Menezes: Yes. The on-trade-- there are geographic differences but, if you look at Florida and Texas, it is absolutely back and ahead and it's coming back strongly. As I talk to our distributors in the last few days, the on-trade recovery is definitely very close back to pre-pandemic levels if not ahead of it. And it's coming back strong with premium brands. Tequila and spirits are doing very well in the recovery of the