High excitement as Diageo chief spells out fresh strategy

The hugely awaited fresh strategy accompanying the full-year numbers has been met with high excitement by investors, as Diageo (LSE:DGE) sets out its stall to revitalise what had become something of an ailing business.

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The strategy will be divulged in fuller detail during the Capital Markets Day on Thursday afternoon, but the building blocks have been revealed and the initial reaction is one of heightened expectations.

Diageo will concentrate on three particular pillars, namely a tighter focus on the width and depth of its brand offerings, more customer engagement relating to changing trends, and an agile operating framework. The latter will result in cost savings of $850 million (£631 million) over the next two years and $1 billion over the next three, while equally importantly allowing investment in the turnaround without reducing operating profit.

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In addition Guinness, the jewel in the crown, will receive accelerated investment to capitalise on the growing opportunity. Apparently exempt from the concerns seen elsewhere by geography, habits or price, the stout continues to produce sales growth, with double-digit hikes having previously been established for the fifth consecutive year. Sales of this famous brand are estimated to be responsible for around two-thirds of beer sales for the group and 12% of total revenue, and one which Diageo is keen to build on.

Some of this recognition of a new world had already been put in play, with a cut to the dividend, a restructure of the business and the acknowledgement of a cost-conscious consumer likely to shape the group’s intentions. The likelihood of less profitable mainstream offerings will not signal the end of Diageo’s premiumisation agenda, but rather the offering will be widened and complementary in serving different markets, such as North America which has been the source of particular weakness more recently.

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This is not to say that there is a clear path ahead. It remains to be seen whether the concerns overhanging the sector as a whole are cyclical or societal. There is some debate as to whether the younger consumer market is a growth area at all given changing attitudes, although the growing proliferation of the “moderation”, low to no-alcohol drinks could provide an opportunity. In addition, the pandemic “drink at home” boom has long since subsided, on top of which some are questioning whether the exponential growth in weight-loss drugs is a contributing factor to falling sales.

As such, the results themselves were something of a sideshow, and in any event provided few surprises. The numbers also accentuated both the need for and the scale of core changes to the business, with US and Chinese white spirits in particular need of attention.

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Organic net sales for the year ended 39 June declined by 2% and operating profit by 27.2% to $3.16 billion. However, this number included $900 million of restructuring charges already incurred as well as $1.5 billion of impairment charges across certain brands and geographies. Without those latter factors, adjusted operating profit rose by 2% to $5.68 billion, marginally ahead of expectations.

Free cash flow of $3.2 billion was up by 17%, although this will be tested given the financial demands of the new strategy and indeed is expected to fall to $2 billion next year.

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More broadly, there was growth in Europe, Latin America and Africa, but the Asia Pacific and North America provided the headwinds of which investors were acutely aware. The outlook for the coming year, which will largely be seen as one of stability as the new growth strategy settles in, with Diageo guiding for flat organic net sales and low to mid-digit adjusted operating profit growth.

The reaction to Diageo’s resolute update was immediate, positive and one of relief for an overdue transformation. Indeed, the share price performance has underlined the scale of the remedial work which needs to be undertaken, with a decline of 14% over the last year as compared to a gain of 19% for the wider FTSE100, a drop of 31% over the last two years and a vertiginous decline of 60% from the record set in December 2021.

The tenure of the new CEO may be in its early stages and the turnaround proper not yet in train, but the group’s longstanding supporters are clearly in evidence, which should result in the market consensus of the shares as a buy consolidating on prospects for Diageo’s new phase.