The alcoholic beverage industry is filled to the brim with brawling competition. Fickle consumers and challenging economic environments keep major players on their toes. But liquor behemoth Diageo (NYSE: DEO ) stands unswerving.
Diageo reported on Thursday that total full-year sales rose 10%, citing Latin America and the Caribbean as key growth drivers. China, India, Russia, Eastern Europe, and Turkey also contributed mightily. Sales of spirits rose 12% and accounted for 80% of the company's growth.
I see several reasons for Diageo's continued success.
Fully stocked top-shelf bar
The world's largest liquor company by revenue, Diageo boasts an extremely diverse source of revenue and profits. Spirits account for 72% of net sales, beer accounts for 22% of net sales, and wine and champagne account for 6% of net sales. No individual spirit category comprises more than 27% of Diageo's sales. Eight of the top 20 premium spirits brands are housed in Diageo's watering hole, including Smirnoff, Johnnie Walker, Guinness, Baileys, Captain Morgan, Jose Cuervo, Tanqueray, and Crown Royal. Whatever your poison, Diageo can pour it.
Thirsty emerging markets
Although Diageo operates in 180 countries, it's slated developing markets as a key driver for growth. The company spends $0.72 of every marketing dollar in emerging markets. Diageo is the No. 1 international spirits company in Africa, Latin America, and Asia. These markets comprise one-third of Diageo's net sales, up from 22% in 2005, and are expected to make up half of Diageo's net sales by 2015.
Big bets on brown liquor
Diageo will invest $1.5 billion in Scotch whisky production over the next several years as emerging market consumers' taste for the brown elixir grows. Diageo sees huge potential, as scotch consumption in Brazil is four servings per capita versus 44 in a mature market. The company enjoyed 50% net sales growth in its scotch brands over the past five years, and scotch represented 23% of Diageo's net sales last year. Pure-play spirits competitor Beam (Nasdaq: BEAM ) wants a piece of the action. It acquired Irish whiskey producer Cooley Distillery earlier this year.
Acquisitions play on Diageo's strength -- developing new products, marketing them, and leveraging its vast global distribution infrastructure. As such, the company's been on an acquisition bender in emerging markets. It gobbled up Chinese baijiu producer Shui Jing Fang, Turkish raki maker Mey Icki, and leading Brazilian cachaca brand Ypioca. Those liquors may not mean much to us Americans, but they certainly do to those nations' collective 1.6 billion inhabitants.
More recently, Diageo is in talks to acquiring the world's largest tequila brand, Jose Cuervo, which Diageo currently distributes. CEO Paul Walsh states that while Diageo is interested in making wise acquisitions, it'll only do so after it demonstrates strong profit growth with its existing portfolio. Shareholders like how that tastes -- the stock has returned nearly 60% during the past five years.
Beer before liquor
As beer demand declines, the industry undergoes massive consolidation, and megabrewers are also taking big swigs of acquisitions. Belgium brewer Anheuser-Busch InBev (NYSE: BUD ) had secured the coveted No. 1 and No. 2 beer brands for years, but lost the No. 2 position to Coors last year. It's been a fight to death ever since. In April, AB InBev agreed to buy Dominican Republic's Cervecceria Nacional Dominicana. Molson Coors (NYSE: TAP ) quickly followed with an announcement to buy Eastern European brewer StarBev. More recently, AB InBev announced it intends to buy out the remaining stake in Mexican brewer Grupo Modelo that it doesn't already own.
And thanks to U.S. antitrust laws, unlikely beneficiary Constellation Brands (NYSE: STZ ) will enjoy spillover effects. AB InBev will sell a stake to Constellation, which will solely distribute Grupo Modelo products in the U.S. This deal couldn't come at a better time for Constellation, as an anticipated drying up of domestic grape supply has U.S. wineries scrambling to plant new vines and increase capacity. Since it takes five years for new grapevine plantings to show up in our favorite pinots, Constellation will benefit from product diversification, as it's primarily a wine company with a much smaller spirits and beer portfolio.
Foolish bottom line
Even though Diageo's forward P/E of 17 is a slight premium to competitors, frankly, so are its brands. Would you pay up for a better product? I know I would. I'll gladly pay a justified premium for stellar brands, amazing diversification, a strong balance sheet, a track record of successful integration, and vast geographic reach.
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