Should Diageo Sell Its Beer Business?

Diageo (NYSE: DEO  ) , the world's biggest spirits maker, has seen growth slow, and one of the culprits has been its beer business. Despite having two of the world's most recognizable brands in Guinness and Red Stripe -- and a plan to expand into growing markets -- the company is selling less suds than it had in the past.

In fact, beer volume declined 12% in the six-month period reported in January. In July, CEO Ivan Menezes spoke on Diageo's troubles. "We need to crack the code in beer," he said. Six months later, it's still looking for the decoder ring. In the meantime, its beer troubles may have deepened.

With that in mind, could Diageo be better off to sell its beer operations, allowing the company to concentrate on in spirits business, and particularly on the high end, where it is seeing the biggest growth? It could it have a potential suitor in either Anheuser-Busch InBev (NYSE: BUD  ) or SABMiller (NASDAQOTH: SBMRY  ) . Both have shown a healthy appetite for acquisitions.

Sales flag in Africa and Ireland
Diageo saw beer drinkers in parts of Africa, a key area for Diageo where beer makes up nearly 70% of sales, turn away from premium brands toward cheaper brews. As a result, in the past six moths, it sold 17% less beer in the country than it had in the prior-year period.

But its beer-drinking troubles didn't stop there. In Ireland, beer volumes were down 8%. That's shocking, considering that Ireland is the home of Diegeo's Guinness, Kilkenny, Smithwick's, and Harp labels. Guinness, Kilkenny, and Smithwick's all date back to the 1700's.

Potential suitors
Beer made up a significant 22% of Diageo's net sales in the last fiscal year. So, selling off the beer business is no small consideration. At the same time, it's the business the company is struggling with more than any other. And its valuable brands could be of great interest to companies like A-B InBev and SABMiller.

A-B has already acquired many of the world's most famous beer labels. Consider the lineup: Budweiser, Beck's, Bass, Leffe, Stella Artois, Brahma, Boddington's, Franziskaner, Spaten, among many others. Guinness, Red Stripe, and Kilkenny would fit well into A-B InBev's portfolio. What's more, A-B has and success pushing into new markets with old labels. Flagship Budweiser has been a shrinking brand in the U.S. for years. But global sales of Bud were up 8.1% in the last-reported quarter, and 7.5% year to date.

SABMiller, meanwhile, has a strong presence in Africa, with popular labels in South Africa, Botswana, Zimbabwe, and Tanzania. It's also a company that has had success in reviving old European labels that are steeped in history, but have seen sales taper. Pilsner Urquell, a 172-year-old label SAB acquired in 1999, has since become a key brand in the megabrewer's growth. The beer saw a 17% uptick in sales in the U.K. Over the six months ended last September, and the company credited Urquell for reviving its beer sales in the country.

Rays of hope?
This is far from an open-and-shut case. Part of the recent trouble in Africa was due to tax changes. In Kenya, a large beer market for Diageo, duties on beer brand Senator Keg increased. That was passed on to the consumer, Diageo says, and the consumer responded by buying less, and maybe a lot less. Other brands sold well -- excluding Senator, beer sales in Kenya were up an impressive 23%.

But CEO Menezes confessed that the company made poor moves in beer, particularly in Africa. It did not anticipate the shift to value brands, and it did not respond quickly enough to the trend once it was under way, he said. Not only did Diageo not see it coming, it raised beer prices in October, something Menezes now calls "not the right thing to do in this environment."

There were bright spots in beer, however. The company says its value Dubic brand is now doing well in Africa, and it's looking to better adjust its pricing to deal with any further trade-down. In North America, Guinness is again growing, as Diageo steps up marketing efforts.

The Foolish bottom line
With A-B InBev pushing harder into emerging markets, and the U.S. still being taken by storm by craft beer, Diageo and its beer brands must find their place. If the company cannot crack that beer code, it may be prudent to consider selling its breweries to one of the beer makers who has the key. That would allow the company to concentrate on what it does best: selling spirits, and getting drinkers to trade up into its pricier, higher-margin brands.

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