Tequila Continues to Drive Diageo PLC's Growth

Scotch is no longer the highlight of the spirits business.

Travis Hoium
Travis Hoium
Aug 2, 2018 at 2:05PM
Consumer Goods

Diageo PLC (NYSE:DEO) continues to be one of the strongest spirits companies in the world, riding the wave of popular liquors all around the globe. For years, the company relied on scotch to drive sales increases, but in its recently completed fiscal 2018, it was gin and tequila that saw the growth. 

Here's a look at the overall numbers and some detail on what drove Diageo's earnings growth over the past year. 

Friends clink glasses with spirits in them.

Image source: Getty Images.

Diageo PLC results: The raw numbers

Metric Fiscal 2018 Fiscal 2017 Year-Over-Year Change
Sales GBP 12.2 billion ($14.6 billion) GBP 12.1 billion($15.8 billion) 1% 
Net income GBP 3.0 billion ($3.9 billion) GBP 2.7 billion ($3.5 billion) 14% 
Basic EPS GBP 121.7 pence ($1.59) GBP 106.0 pence ($1.38) 15% 

Conversion rate of 1.30 GBP to 1.0 USD. Data source: Diageo PLC 2018 earnings release. 

What happened with Diageo PLC this quarter? 

The 1% sales growth figure doesn't tell the story of how strongly Diageo performed in 2018. Here's where volume and prices shined over the past year: 

  • Organic net sales growth was 5%, but that was offset almost entirely by a negative exchange rate. The company said 2.5% of the organic growth was from volume and 2.5% was from price and mix improvement
  • Operating margin increased from 29.5% to 30.3% in 2018 on the back of lower operating costs and lower costs from exchange rates (which has a positive impact on costs). 
  • On an organic basis at Diageo, Latin America and the Caribbean had 5% volume growth and 7% net sales growth in 2018. Asia-Pacific volume increased 2%, but net sales jumped 9% during the year. 
  • In North America -- Diageo's largest segment, with 34% of sales -- tequila continues to be a strength, with Don Julio organic volume up 36% and net sales soaring 30%. Vodka struggled during 2018, with Ciroc organic sales down 4% and Ketel One decreasing 2%. 
  • Globally, tequila is the best spirit for Diageo, with 35% volume organic growth and a 56% increase in reported sales, including acquisitions. Gin was also strong, posting 17% organic volume growth and 14% reported sales growth. Scotch, which has led the company's growth for years, had just 3% volume growth and a 1% increase in reported sales. 
  • Free cash flow for the year was GBP 2.52 billion ($3.29 billion), and GBP 1.51 billion ($1.97 billion) of that was returned to shareholders in the form of share buybacks and another GBP 1.58 billion ($2.06 billion) was paid as dividends. 

What management had to say

Diageo has adjusted its portfolio to gain exposure to growing trends, like the popularity of tequila, as evidenced by its acquisition of Casamigos last year. You can see in the results that owning a broad number of spirits and brands has helped the business overall. CEO Ivan Menezes said this about how the company sees the future: "Our financial performance expectations are unchanged and we expect to continue to invest in the business to deliver our mid-term guidance of consistent mid-single digit organic net sales growth and 175bps of organic operating margin expansion for the three years ending 30 June 2019."

The margin expansion will leverage sales growth and is what's helping drive a double-digit increase on the bottom line. 

Looking forward

Spirit preferences have clearly changed recently, but that hasn't hurt Diageo's results and that's a testament to the business and how it's built to strategically benefit from all major markets. Looking forward, investors should anticipate continued steady growth and, if management is right, margin expansion. What I would watch is if prices continue to rise as consumers trend away from high-end scotch to tequila and gin, which can be at a lower price point. For now, the shift doesn't appear to be harming the business one bit.