1. Art and Diseño

Diageo interim results presentation scripts. 29/01/2015
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• Good morning and thank you for joining the webcast.
• Today I am going to look at the key drivers of performance in the half and Deirdre will take you through the results announcement we released earlier today.
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• I am going to start by looking at the half in the context of our performance ambition.
• Diageo is the leader in an attractive industry with a compelling future. When we look at the long term opportunity for spirits in the US, the opportunity for beer and spirits in the emerging markets where there will be over a billion new consumers in the next 10 years, and the opportunity globally to grow our reserve brands as the number of high net worth individuals increases, we can see that despite the current environment Diageo’s growth potential is undiminished.
• Even in a tough environment the strength of our business has come through. We have delivered share gains and margin improvement and driven better cash performance. We have continued to invest in proven growth drivers in marketing and route to consumer. Our market teams are now focused on sell out not sell in and depletions are now ahead of shipments.
• The long term opportunity and the strength of our business are important to bear in mind as we look at what this set of interim results says about Diageo. 3
• In these first six months of the year the global trends we saw in fiscal 14 continued.
• In the US the full benefit of the economic recovery has not yet reached all consumers. A number of Western European countries are finding growth tough to achieve and deflation is a possibility so consumer confidence is subdued.
• Geopolitical events including sanctions on Russia and the anti extravagance measures in China continue to impact consumer demand for international spirits. • These conditions were compounded by currency volatility which distorted trading in some of our key scotch markets, and currency devaluations impacted the price of imported goods for local consumers.
• While falling oil and commodity prices will benefit developed market consumers, there are no clear indications of which consumer sectors will see increased spend, although the on trade has traditionally benefitted when oil prices fall. There are, of course, negative impacts on those economies which are dependent on oil revenue for growth.
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• In a challenging world, the robustness of strategy is even more important. Our strategy is clear and it is creating a stronger business.
• This half we completed the acquisition of USL. As I will come onto, we have established the strategic priorities and the integration, while not complete, is well on track. Sales of Diageo brands in India are up as are sales of USL brands. It is a great start.
• We entered into an agreement to acquire the 50% of Don Julio we did not own and sell Bushmills. This will give us full control of an exciting brand in a high growth segment of the tequila market and it will strengthen our position in Mexico now that Smirnoff is back with us and we have Don Julio in the market. • We continue to leverage Ypioca, transferring Smirnoff to local production and expanding coverage of our international brands in Brazil. In Turkey, premiumisation drove double digit net sales growth of our raki brands and we gained share in international spirits.
• We are getting better visibility on customer depletions as we reduce the level of inventory in trade and reach better trade terms with our business partners. We need to absorb the impact on net sales growth,
but these stock reductions are part of the solution – one that will provide us with much clearer insights on how the consumer is behaving, helping to inform our commercial strategies and investment decisions.
• Our route to consumer programme underpins this focus on the consumer. This means everything we do is being driven by sell out not sell in. • We are also reaching new consumers and new occasions with scale innovations. Haig Club, for example, has been designed to introduce new consumers to the scotch category.
• We’ve increased the focus of our senior management on improving cash performance by introducing an annual cash conversion metric into our incentive programmes.
Continued
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• And we’ve done all of this while maintaining our discipline on cost and margin improved in the half despite the market mix going against us as we reduced inventory.
• In December we introduced an ambitious new set of targets for alcohol, communities and the environment to create a positive role for alcohol in society through partnerships and programmes which impact misuse; to equip people, particularly women, with skills and resources to build a better future for themselves; and make our products and business operations even more environmentally sustainable. • By better articulating who Diageo is and what we stand for we will engage our people around our ambition and drive the culture and behaviour change we need to become one of the most trusted and respected consumer products companies in the world. • With that as context, let’s look at the performance of the 21 markets in more detail.
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• The performance of our markets in the half breaks down broadly into three groups. Those where our performance has been particularly challenged; those where our performance was stable, which are mostly developed markets; and those markets, mostly emerging markets, where we have seen good performance despite the effects of the global economy and currency volatility.
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• In terms of net sales in the half, those markets I think of as being challenged saw net sales decline £94m, in total our developed markets were almost flat, and the growing emerging markets saw net sales increase £87m in aggregate.
• This chart also illustrates the global nature of our business. We do expect to have a more stable performance from developed markets and a degree of volatility in the emerging markets.
• But as I said earlier on, the opportunity in the emerging markets is based on strong demographics and long term economic growth. We are building our position in these emerging economies for long term future growth, while delivering good growth today in many of them.
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• So, let’s start with those markets that have been a bit more challenged and look at some of them individually.
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• In South East Asia, our focus in the half has been on driving sell out and the depletions from wholesale channels were up double digit, with particularly strong growth of Johnnie Walker premium and above variants. However last year stock rose in the wholesale channel and in this half we have reduced stock
which resulted in net sales down over 80%. We plan to reduce inventories further in the second half although the rate at which we can do that will depend on depletion levels. Performance in South East Asia was also impacted by the political unrest and a slowdown in consumer demand in Thailand.
• In the border zones of West LAC, the strong US dollar had an impact on underlying demand and currency devaluation led to inventory reductions of about 300,000 cases. A good performance in the domestic business in West LAC, where net sales were up 4% helped mitigate the impact of the challenges we faced in the border zones.
• Reducing stocks in these two big, profitable markets is definitely causing us pain and we estimate that this, and inventory reductions in Nigeria and Russia, impacted net sales growth by about 1.5 percentage points. But it will benefit us in the future as we will have greater visibility of the stock in trade, which will bring us closer to our consumers, allowing us to better understand the marketing and trade executions that really resonate with them.
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• In Venezuela, trading has been severely impacted by the devaluation of the bolivar as the import of finished goods has been restricted and we have seen very high inflation. Inevitably we have had to increase prices and scotch volumes have been impacted. • But we have also seen good growth of the strong local brands we have in Venezuela. We leveraged the leadership position of Cacique, increasing prices and launched a super premium variant Cacique Leyenda, and we invested in the growth of Gordon’s vodka, recruiting consumers from the imported vodka segment. Together with strong growth of Smirnoff Ice this led to a 6% increase in total net sales, a very creditable performance in a challenging environment.
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• The political and economic situation in Russia has had a considerable impact on the consumer environment there, leading to trading down within spirits. The strength of Diageo’s scotch portfolio –
which accounts for nearly 60% of our business there – and the introduction of locally produced whiskey and rum spirit brands, Rowson’s Reserve and Shark Tooth, meant we were able to gain share in a tough environment. A great example of acting quickly to optimise sales in a difficult situation.
• The impact of the anti‐extravagance measures in China is well documented. The baijiu market has been fundamentally reshaped and the modern on trade outlets where so much of our Johnnie Walker was sold have become intensely competitive. This means how we reach our consumers by channel and outlet has had to change.
• So what have we done? We’ve innovated. We’ve innovated in product, and we’ve innovated in the way we connect with our consumers. • Haig Club was launched in China in November with the support of our partners, David Beckham and Simon Fuller. It is targeted at new consumers and a new occasion, and we’re piloting a new distribution approach selling through the Shuijingfang salesforce. It is very early days and the brand is performing well, but in building this brand to its full potential we aim to go slowly and build a sustainable platform for long term growth. • We’ve also innovated in baijiu to extend our participation at lower price points and Master Distiller’s No.8, which competes in the premium baijiu segment, was a contributor to an improved performance of Shuijingfang, with net sales up 25%.
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• In Nigeria the beer market has shifted and our reactions as I have said before have not been fast enough. • We now have a new management team, new packaging and new promotional programmes on Guinness,
a refocused value beer portfolio, introducing Satzenbrau and repositioning Dubic and we reduced trade inventory for Harp and our premium spirits to improve visibility on consumption patterns.
• This is work in progress and the results will be ongoing. But we have already seen share improvements of
Guinness and we have grown overall share in beer in the last four months following the launch of Orijin,
an innovation at a mainstream beer price point. Orijin is giving us the performance headroom we need as we make these changes. • Route to consumer is central to this plan. During the half we continued to make distribution gains through the successful programme we are piloting in Lagos. The insights we gained from this are driving more effective coverage throughout Lagos and beyond. Together with investment in our core brands in beer and premium spirits, and the reshaping of the Nigeria leadership team, I am confident we are competing more effectively and we will return this business to good growth.
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• Moving on to developed markets.
• These markets have seen some headwinds on industry growth from uneven economic recovery and weak consumer confidence. But Diageo is delivering some good share growth as we focus on our strategic priorities – building our route to consumer, innovating at scale and winning with our reserve brands portfolio. 14
• The beverage alcohol market in North America is a competitive place.
• Millenial consumers are looking for brands which are new, interesting and authentic. They are a multicultural group, internet savvy, less category loyal and they are one third of the US population. Similarly, the attractiveness of this industry makes it one others want to enter, so there has been a lot of brand proliferation in most categories.
• How are we tackling this challenge?
• In Canada our new distributor model was fully operational at the start of F15 and gives us stronger sales
execution: more feet on the street representing our brands every day.
• We’re also leveraging our strength in innovation. In the last quarter Ciroc Pineapple was the #3 spirits innovation and Crown Royal Regal Apple, launched in October to recruit new fans to Crown Royal,
claimed the number 1 spot for Year 1 Innovations in December according to Nielsen.
• Our first innovation in the Discovery Series, Guinness Blonde American Lager has had a great reception. We’ve also complemented the brand credentials of Guinness with another offering, Guinness 1759 which is focused on the fine dining and gifting opportunity.
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• And we’re also leveraging our marketing capability.
• Smirnoff is starting to benefit from the new campaign, ‘Exclusively for Everybody’, new retail programming and new packaging. Brand equity is strengthening and consumer pull is picking up which together with more competitive pricing activity, is resulting in an improving share position.
• On Ciroc, we’re augmenting our Pineapple launch with a new ‘Blue Dot Focus’. Following on from the successful ‘Luck be a Lady’ campaign, ‘Step Into the Circle’ captures scenes of celebration amongst everyday consumers who enjoy Ciroc as a centrepiece of their special occasions. Increasingly we are using fully integrated campaigns such as this one that span broadcast, print, out‐of‐home, digital, on and off premise and experiential events.
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• And with Buchanan’s we’re really connecting with a growing consumer group. Buchanan’s is now the second largest super premium blended scotch to Johnnie Walker’s number 1 position. It is strongly positioned for the demographic trends in the US, as it plays well with the hispanic community, a group that accounts for over 20% of scotch consumers. Many of these consumers know the brand from their home countries and now seek it out in the US. • Rooted in the consumer insight that Buchanan’s makes any celebration bigger, we have continued to support our campaign ‘A lo Grande’, which encourages men to choose Buchanan’s as a symbol that they’ve ‘made it’. This year we we’ve built upon our successful on trade activations and expanded beyond Mexican American markets to connect with the growing number of Dominican, Colombian and Venezuelan communities on the east coast with activations such as sponsoring the Latin GRAMMY’s.
• Bulleit goes from strength to strength in the North America, growing net sales 59%. It is now the number one rye whiskey in the US and Bulleit Bourbon is no longer a small brand and is likely to reach over 750,000 cases this year. That said, it still maintains its craft image. Like other reserve brands, Bulleit
consumers are looking to discover brands and don’t respond positively to overt marketing. Therefore we continue to focus on recruiting influencers with events as well as cultivating ambassadors in the trade. 17
• After a few difficult years, we have stabilised Western Europe and in this half net sales were again broadly flat.
• GB delivered good results driven by innovation and the solid performances of Captain Morgan and Baileys. While the decline in spirits hampered Ireland’s topline, I am pleased that we have returned Guinness to growth through good execution in the on trade. • While there was continued weakness in Spain, there are some encouraging signs. We’ve made headway in our route to consumer programme and seen some restocking in the on trade after stabilising prices. The other Southern European markets improved with Italy and Greece in growth. We are well positioned to lead the way should these markets come back to growth. • In Germany, we are implementing a revised commercial investment strategy and we are focused on making sure our improved execution is consistent with other countries in Western Europe. • Our leadership in luxury really stood out in the performance of Western Europe. Strong net sales growth in vodka, gin and scotch where our scotch malts and the launch of Haig Club in GB contributed to 18% of growth in reserve brands.
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• Moving on now to those emerging markets that are delivering growth.
• Again there are a couple of broad themes we see when looking at these markets.
• We’re seeing our investments in leading local brands and an outstanding distribution network pay off in Turkey, India and Brazil.
• In others, we’ve focused on clear priorities – either by category, segment or channel to capture the biggest opportunities.
• And in others, the key driver is really the strength of our portfolio, our unrivalled ability to provide customers with the price and category breadth they require for consumers to access our brands. In many cases, local production helps us to move quickly and cost effectively to meet these needs while also mitigating against foreign exchange volatility. • Let me talk to a few examples now.
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• The consumer dynamics in Turkey, with a growing, LDA+ population that is increasingly wealthy, make it an incredibly attractive market over both the short and long term.
• Despite restrictive regulation around advertising, our business is performing very well as our international spirits benefit from the Mey Icki footprint. • Diageo’s expertise in building premium brands has supported the premiumisation of our raki portfolio with super premium variants driving a 14% increase in raki net sales. • The broad network and customer relationships we acquired through Mey Icki together with increased investment in off trade activations has helped our international spirits brands gain share. Our reserve brands have also been a strong contributor to Turkey’s performance with net sales up 35%. • And this type of synergistic relationship is also working in Brazil…
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• As we mentioned in our route to consumer webcast in September, Brazil is one of our Wave 1 markets for route to consumer work. And while net sales for the first half were flat, I feel good about the performance there. Let me explain.
• We have expanded coverage increasing the number of smaller retail and mainstream on‐trade outlets we cover by 12,000 in the half. In addition, we are investing in a new distribution partnership that will deliver 10,000 more outlets. We have also made significant changes to our trade terms, put mechanisms in place to avoid price disparity and introduced incentive schemes to focus distributors on the right behaviours to build our brands. • As part of this work we have adjusted our pricing in the first quarter to take into account tax variations by state. This together with the reduction of commercial discounts led to distributors reducing inventories during the half, impacting Johnnie Walker net sales in particular. In the second half shipments should be more in line with consumption trends.
• Now fully integrated the acquisition of Ypioca has transformed our route to consumer. It has given our brands access to outlets alongside Ypioca where we weren’t previously present, and it is already benefitting our international brands. • This year the Ypioca brand, while still strong in its core region of the North East, didn’t perform as well as we would have liked elsewhere. Last year we expanded the brand into new regions, but the execution of sales activities was not consistent or good enough. We have since changed distribution partners and believe this, coupled with expanded coverage, will drive share gains and net sales growth in the second half.
• The decisions we’re making now in route to consumer are giving us a competitively advantaged platform to win in both international and local brands in Brazil.
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• Mexico is a great example of where we have used our broad portfolio to optimise category participation. • As the slowdown in the economy translated to weaker consumer spending, our participation in standard scotch in Mexico has enabled us to retain consumers within Diageo brands. Broad distribution along with the media campaign ‘Keep Walking Mexico’ drove Johnnie Walker Red Label’s 40% contribution to total net sales growth in Mexico. We also introduced Black & White to participate in the standard segment and the brand has gained share from competition. • Within premium scotch, Mexico’s leading brand, Buchanan’s 12 year old Deluxe, increased net sales 9% driven by strong above and below the line execution. There is also growing demand for super premium scotch in Mexico, and the growth of Johnnie Walker Platinum and Gold Reserve was strong enough to offset the mix impact of our Red Label success, resulting in 8% net sales growth for the brand. 22
• Africa is another great example of how our local teams execute strategies that leverage the strength of our global giants and drive performance of local stars.
• In East Africa this enabled us to deliver 11% top line growth. In beer, double digit growth in both Tusker and Guinness was driven by football related activations and trade investment, and new‐to‐market innovations in lower priced beer and spirits including Senator Dark, Kibo Gold and Jebel Gold and Coconut contributed to 6% growth in beer and 26% growth in spirits. East Africa’s strong route to consumer and its drive to increase mainstream coverage together with local production capacity allowed us to get product into the market quickly and cost effectively.
• It is a similar story in our Africa Regional Markets where the variety of consumer occasions means our brand range delivers real advantage. Performance here benefitted from a more than threefold increase in spirits in Angola as we improved our route to consumer by appointing a new distributor and implementing a new route to consumer strategy. • In Ghana, the transformation we have made to our route to consumer is driving performance as increased sales coverage and more efficient sales calls are giving us greater visibility of Diageo’s brands in a fragmented trade environment. During the half we expanded our sales force and introduced a new incentive scheme. We established a network of 50 new micro‐distributors in the off trade who sell to 3,000 new smaller outlets we weren’t covering before. Outlet coverage has increased 20% and net sales in Ghana are up 28%.
• The performance in Africa during the half really demonstrates the power of our platform. Beer was up 5% and spirits 19% on double digit growth in every market. It was a great result and there is still more to play for.
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• While focused on delivering on our strategic priorities, we have captured inorganic opportunities as well. • In November we announced the acquisition of the remaining 50% we did not already own of Tequila Don Julio. In gaining full global ownership and management control of the brand and its supply assets, we will enhance our position in the high growth segments of super and ultra‐premium tequila. • With this deal we are also repatriating the Smirnoff brand into our in‐market company which will allow us to extend our leading position in spirits in Mexico – a market with huge potential. • This opportunity was realised through the sale of Bushmills to Casa Cuervo. Bushmills is a good brand however this was the right strategic decision for Diageo as we build our presence in the world’s fastest growing markets and invest behind the biggest growth opportunities.
• And none come as big as India…
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• India, and our acquisition of USL, is an important and unique opportunity for Diageo.
• The demographic in India is very positive with a forecast increase in the working age population of 270 million by 2030. This translates into an increase each year of 4 million consumers of legal drinking age who are open to alcohol consumption. • In addition, western style spirits is the biggest category, accounting for over half of all beverage alcohol consumption in India. However, despite spirits being a high proportion of total consumption, per capita consumption is low. • These positive macroeconomic and demographic trends will lead to a rapidly growing middle class, which given low per capita consumption of spirits, gives Diageo, as the leader in spirits in India through our new subsidiary, a unique opportunity. • Not only will these factors drive growth in spirits, they will also drive a shift with growth in higher margin more premium brands likely to exceed that of low margin popular brands. This is the premiumisation of the Indian spirits market. • Our focus now is on integration to capture this opportunity though the creation of an iconic business. Continued
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• When we completed the share purchase agreement in July 2013, integration was focused on governance. We are now moving to the changes we want to make in the wider business starting with the portfolio to ensure we have the leading brands in the fastest growing profit pools in Indian spirits. • These are: luxury, where we now have a full offering following the distribution agreement; premium, where our strategy is to drive growth and leadership in scotch and vodka; and prestige, which is already 50% of USL’s gross profit and the category is projected to grow high teens over the next few years. In the popular segment we will be selective as to which brands to prioritise and our strategy is to grow our popular brands in those markets which offer opportunities to drive value. • This participation strategy will lead to a tailored portfolio approach focused on around 12 USL brands and 5 Diageo brands. • We are also looking at how the already advantaged point of sale coverage which USL’s sales team has can be augmented by Diageo’s route to consumer work and the team is in place to deliver this. • In addition USL now has an enhanced innovation capability. • Our focus on the brands which contribute around 75% of USL’s net sales will, over time, remove complexity allowing margin to benefit from the scale USL has. • There is a lot of work to do as you can see but the strategy is now clear and the opportunity is huge.
• Which seems a good place to pause and I’ll now hand over to Deirdre, who will take us through the results we reported earlier today.
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• Thank you Ivan and good morning.
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• Ivan has outlined the actions we have taken to deliver our performance ambition and he has also told you how we are managing macro and specific market challenges. Now I am going to take you through how this is reflected in our results for the half.
• Our net sales were broadly flat, overall and in developed markets and emerging markets. In developed markets, we have seen a slow down in the US spirits market as the economic recovery remains uneven and in Western Europe continued softness drove a modest decline. Our results in emerging markets reflect the market challenges that Ivan has mentioned.
• Pressure on household incomes has impacted our ability to take price, yet we have delivered overall positive price mix, with growth of reserve and improved mix in beer.
• We have maintained our focus on cost across all lines of the P&L. Our global efficiency programme is on track and the savings generated from this programme in the first half delivered an improvement in operating margin. • We have driven efficiencies in all areas of spend including commodity prices and media fees and we’ve rationalised service providers. We have reinvested these benefits into our brands and into extending our influence and coverage through route to consumer initiatives, prioritising spend toward our long term growth drivers. • And I am pleased our cash delivery has improved. However, there is more we are doing here to drive sustained improvement in our working capital.
• Let’s now go through the results in more detail. 28
• Reported net sales were down 0.5% and I want to highlight some of the drivers of this before we look in more detail at our organic performance.
• USL was fully consolidated for the first time this half, accounting for the majority of the movement in acquisitions and disposals. It will contribute to our organic performance next year and as Ivan has mentioned this business presents a great opportunity for Diageo in an attractive market.
• Last year in the first half we used a rate of 9 Venezuelan bolivar to the US dollar to consolidate our Venezuelan business. In March 2014 we took the decision to change the rate to Sicad II when we consolidated our results for the full year and have continued to use this rate. This reduced reported H1 fiscal 14 net sales by £237m.
• Other negative FX movements reflects the strengthening of the pound against many currencies. This includes developed market currencies, in particular the Euro and the Canadian dollar, and also emerging market currencies, such as the Russian rouble and the Turkish lira.
• Organic net sales were broadly flat with volume decline largely offset by positive price mix.
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• Volume was down 2% driven by our decision to reduce trade inventory levels in certain markets, a challenging environment in Venezuela and Eastern Europe, and lower shipments of standard brands in the US. • In South East Asia, volume was impacted by the comparison with last year when shipments were ahead of depletions for the first half and by the impact of our decision to reduce high inventory levels. The same decision to reduce inventories led to volume decline in West LAC.
• Increased prices, due to high inflation and limited availability of imports significantly impacted volume in Venezuela. • Volume in Eastern Europe fell, as we lap the pre excise duty buy‐in in Poland in the comparable period, and volume in our Eastern Europe partner markets was impacted by the prolonged crisis in Ukraine and a change in distributor in Kazakhstan.
• US spirits volume declined 3%, largely driven by Smirnoff, given comparison again high shipments in the prior period, and Captain Morgan which was impacted by a more price competitive spiced rum category
as well as lapping the launch of Captain Morgan White Rum. While shipments were lower in the half, Captain Morgan White Rum is performing well and was the number 1 innovation in the US in the latest 12 month data and driving share gains for Captain Morgan.
• In Brazil, as part of our route to consumer work, as Ivan described, we have developed stronger commercial partnerships with our distributors to support long term growth. This has reduced the number of intermediary customers, leading to lower inventory levels which impacted volume performance.
• In Africa, spirits now represents 30% of net sales and we are driving real momentum with volume up 25%, and each market in the region is contributing to this. This growth is coming from consumers trading up to Diageo international brands such as Johnnie Walker. Smirnoff grew in South Africa on the back of new packaging, sampling programmes and in store promotions. The success of local spirits, such as Jebel in Kenya and Orijin spirit in Nigeria, which provide a value offering for consumers, also contributed to this growth.
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• Positive price mix generated £98 million of net sales growth. This is net of a £15m negative market mix impact from the volume decline of South East Asia and West LAC.
• The impact of foreign exchange volatility on discretionary incomes in emerging markets and a low inflation, low wage rise environment in developed markets makes it much harder to take price on our brands and we have to be selective.
• Therefore, I don’t expect price to be an important lever of growth this year. Across the majority of our markets, mix is the biggest component of the positive price mix we have delivered. • Looking at the individual drivers, the continued growth of our reserve brands contributed positive price mix.
• US Spirits, including the contribution from reserve, delivered a third of our positive price mix, with declining volume of standard priced brands, such as Smirnoff and Captain Morgan, the other key driver.
• Pricing in Venezuela contributed to positive price mix but as I will come on to higher cogs in Venezuela and negative product mix meant this did not drive gross margin improvement.
• We have seen positive mix from our beer portfolio in Africa, largely due to lower volume of Senator in Kenya and the successful launch of Orijin in Nigeria.
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• The decline in net sales of our global giants is largely driven by Johnnie Walker which was the brand most impacted from the volume declines in South East Asia and West LAC. Lower volume of Smirnoff in the US and Baileys in the US and Europe, as we lap the successful sell in of prior year innovations, also contributed.
• As you would expect, local stars have been more protected from the impact of global events and so have performed better.
• 10% growth in net sales for reserve brands was a significant contributor to our net sales performance with the economic slowdown having a more moderate impact on wealthier consumers. Cîroc innovation, strong growth of scotch malts, Don Julio, and Bulleit, up 57%, led this growth.
• Beer was up 2%, led by Africa where Orijin performance drove a mid single digit increase in net sales. Guinness was down 4% largely due to performance in Nigeria. Following the relaunch of the brand in Nigeria in December 2014 we have seen improvements in brand equity, however the pressure on discretionary income continues to drive a shift towards the value segment, impacting the brand’s performance. We have upweighted our investment behind the brand in the half, focusing on promotions and activations in the trade to drive depletions. Elsewhere in Africa, in Ghana, Cameroon and East Africa, Guinness improved, and while the brand is slightly down in Western Europe this reflects category performance as Guinness maintained share in Great Britain. In Ireland, net sales for the brand were up
and we gained share.
• Ready to drink was down 1%. In Latin America and the Caribbean, the segment grew double digit across every market, allowing our brands to access more consumer occasions, and in Australia, innovation targeted at wine occasions and a price increase delivered net sales growth. In South Africa we lapped the high production of Smirnoff Ice Double Black & Guarana for DHN last year.
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• Looking at our growth across the half, we saw improvement in the second quarter, with net sales up 0.7%. This improvement was driven by the comparatives as we began to lap a number of challenges we faced last year, and by the accelerated performance of innovation in the second quarter, mainly Crown Royal Regal Apple in the US, Orijin in Nigeria and Haig Club in a number of markets. • The biggest driver of improvement in the second quarter was Africa which grew 9%, driven by performance in Nigeria, led by innovation, and by performance in East Africa where the duty change on Senator has now been annualised. Asia Pacific also contributed as trends improved due to the performance of our baijiu business, which was up nearly 80% in the second quarter.
• Quarterly trends were relatively stable in North America. DGUSA performance was stronger in the second quarter following the launch of Guinness Blonde American Lager. However, US spirits declined 1% as we lapped high shipments last year going into the holiday period. The second quarter was also impacted by phasing of scotch shipments last year which were weighted to the first half.
• A stronger second quarter for Europe was driven by Russia and Eastern Europe, given negative price mix in the first quarter as a result of higher trade spend.
• In Latin America and the Caribbean there was a modest improvement in net sales performance in the second quarter. This was largely as a result of Brazil where, as we mentioned in our first quarter IMS, net sales performance was impacted when we realigned pricing across states and net sales were down in the first quarter but up in the second.
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• Marketing spend as a percentage of net sales increased across all regions except Asia Pacific. And while the total movement in marketing spend was in line with Diageo’s net sales growth, we generated procurement efficiencies worth 3 percentage points of marketing spend, hence increasing our effective marketing investment.
• In North America, we upweighted investment behind priority areas, building Smirnoff’s credentials with the new ‘Exclusively for Everybody’ campaign, growing our presence in tequila, and supporting our innovation agenda.
• In Western Europe incremental investment was focused on innovation and reserve, the future growth drivers for this market.
• A double digit increase in marketing spend in Africa supported the strong growth we have seen across the spirits portfolio in the first half and additional spend on Guinness to drive recruitment of the next generation of consumers, with spend focussed on the ‘Made of More’ platform.
• In Latin America and the Caribbean marketing spend increased 3% with Smirnoff in Brazil benefitting the most from this increase. Spend more than doubled to support the national roll out of the Smirnoff global platform via the ‘Cheers to Real Life’ campaign and we have seen good improvements in brand equity in the half. • In Asia Pacific, we took the decision to reduce our spend in China and South East Asia where difficult market conditions and competitive dynamics meant we were not confident that we would drive good returns on investment. In these markets we have reprioritised spend behind long term growth drivers such as the premiumisation of scotch through Johnnie Walker Blue Label mentoring and media campaigns in China and in Thailand. Another important growth driver that we are investing behind is expanding scotch into new consumer occasions, for example, testing new campaigns for Johnnie Walker Black Label in the off trade in China, upweighted investment behind Johnnie Walker Red label in Thailand to encourage consumers to step up to international brands and the successful launch of Haig Club. 34
• Organic operating margin improvement was 28bps in the half, leading to 1% organic profit growth.
• Gross margin declined slightly. Price increases in Brazil did lead to gross margin improvement for the market but at a Diageo level this was offset by negative price movements in other markets, such as chinese white spirits with a reduction in pricing on Shui Jing Fang and pricing adjustments on Harp in Nigeria. In Venezuela where we did have significant price increases, gross margin declined slightly as this was offset by higher cogs and negative mix. Mix benefits from the growth of reserve were offset by some negative market mix and the impact of lower volumes.
• As I have mentioned, we increased our marketing spend across a number of different areas of our business but the significant procurement efficiencies that we delivered funded this increase, hence marketing spend had little impact on operating margin.
• Other operating expenses were lower this half and were the main driver of the 28bps operating margin improvement. Our global efficiency programme delivered £53m of the £110m we plan to deliver this fiscal. This was partially offset by spend on route to consumer initiatives and foreign exchange differences arising in the half.
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• While operating profit was up on an organic basis, reported profit was down 11%, impacted by £268m of adverse foreign exchange. Almost 70% of the negative foreign exchange relates to our business in Venezuela given our decision in March 2014 to change the FX rate we used to consolidate this business. • Based on current spot rates we expect foreign exchange to reduce operating profit by £85m in the full year, primarily driven by currency weakness in emerging markets.
• Associate income, largely Moet Hennessy was down £68m.
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• Average net debt increased by £1.5bn, principally as a result of the acquisition of the controlling interest in USL and the consolidation of its debt.
• While net debt increased, our effective interest rate reduced and therefore, net interest charges were broadly in line with last year. Lower interest rates achieved on new term debt and an increase in the proportion of floating rate debt through the use of fixed to floating interest rate swaps were the main drivers of the lower effective interest rate and this more than offset the 0.5 percentage points negative impact of consolidating USL’s debt for the first time. • The increase in other finance charges largely reflects our updated projections for Zacapa that resulted in an increase in the estimate of dividends payable to ILG.
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• Eps was down 8.9 pence or 14%, mainly as a result of the impact of negative foreign exchange on operating profit and lower income from associates. • Our tax rate pre exceptionals reduced from 19.4% last year to 18.3% this fiscal. The higher tax rate last year was a result of the relative weighting of profit from our Venezuelan business given the consolidation exchange rate. The 18.3% tax rate for this half is in line with our full year rate for fiscal 14. 38
• I expect our cash conversion performance to improve this fiscal and we have seen that in the first half. The executive team and our 21 market GMs are all incentivised on this measure. And across markets we are making changes.
• For example, in July, we completed the roll out of our global sales and operations planning process to all 21 markets and 60 individual business units. All markets are now using one common process. The impact is two‐fold. First we improve our sales forecasting accuracy to that of a top quartile FMCG and second, we link this with disciplined inventory management to drive an improvement in working capital. Around half of our 21 markets have improved their forecasting accuracy in the last 6 months and this has enabled us drive inventory reductions across a number of markets. • Australia is a good example of a market which is closely managing their overdue debt. One way in which they are doing this is by carrying out forward looking reconciliations with our customers to resolve payment issues before they become overdue.
• As many of the changes that we are making are about improving our business processes, I don’t expect the impact of these changes to be felt overnight, but I am tracking our progress. More than two thirds of our 21 markets over delivered their cash conversion target for the half, a clear step in the right direction.
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• Looking at our performance this half our free cash flow increased by £373m. • Working capital improved £454m compared to last year. In fiscal 14, early phasing of marketing spend impacted our cash delivery. This year our marketing spend was more in line with normal patterns with a 7% increase in the second quarter. This phasing and more efficient management of our payables resulted in higher creditors at the end of the half. • Net capex in the half was lower than last year as the new brewhouse in Ireland has been completed and with lower spend on scotch capacity and on beer in Africa. For the full year I expect net capex to be around £650 to £700 million, somewhat dependent on spend relating to USL. • Lower tax payments were largely as a result of the timing of tax audit payments last year and lower taxable profits in fiscal 14. Our net interest payments reduced significantly in the half as we benefitted from our recent refinancing of debt and the timing of payments. The favourable cash movement on pension payments is largely driven by the one off payment made into the Irish pension scheme last year.
• The Interim dividend is 21.5p which is a 9% increase on last year. Diageo's dividend philosophy has been a consistent increase in the annual dividend payable while maintaining dividend cover between 1.8 and 2.2 times relatives to eps. In recent years that has allowed us to increase our dividend by 9% a year. Given the economic slowdown in emerging markets, and the associated currency weakness we continue to see and which had such a significant impact on our reported results in fiscal 14, our dividend coverage ratio is now below the lower end of the range we set. However cash flow is improving as these results show and the strength of the dollar is providing some offset to emerging market currency weakness. Therefore we have maintained interim dividend growth at 9% but we will review this for the full year results and if necessary vary the rate of increase of the final dividend to manage our coverage ratio albeit at the lower end of the range.
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• In the half we incurred exceptional operating charges of £171m. This includes £145m in respect of the expected settlement of the dispute with the Korean customs authorities. It also includes £26m relating to business restructuring, largely the global efficiency programme that we announced in January 2014 and the supply excellence programme. In the second half of the year we expect to incur an operating charge of £83m in relation to these programmes.
• Exceptional non operating items in the half is mainly a gain of £103m which resulted from the recognition of the market value of the shares we acquired in USL in fiscal 14. This arose following our acquisition of our controlling interest in USL in July 2014. There was a similar step up gain last year when we moved from investment accounting to associate accounting for USL. • In the first half of fiscal 15 we made cash payments of £62 million in respect of exceptional restructuring items and I expect to incur around a further £120m in the second half relating to the global programmes. 41
• So let me sum up my view of how we have started this fiscal year and what we expect to see in the second half.
• Our top line performance in the half reflects the current weakness in emerging markets, slowdown in US and some specific challenges in a small number of emerging markets. However we have managed this environment well, we are making the right investments in our markets and brands and maintaining our focus on costs to deliver improved margin.
• I expect macro trends will be broadly unchanged for the remainder of the fiscal year, however, I also expect Diageo’s performance to improve in the second half as we lap some of the challenges that we faced in fiscal 14. • For the full year, as our investments in growth drivers continue we expect to grow our share and with continued management of costs will deliver margin improvement.
• Let me now hand back to Ivan.
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• Thank you Deirdre. • So, bringing it all together. • This is a strong business and this half demonstrated that. We have delivered share gains in many markets and categories, growth through innovation, growth in many emerging markets and continued growth in our reserve business. • It is a strong business we can make stronger. And we have continued to strengthen it in the half with the acquisition of control of USL; the agreement to acquire the half of Don Julio we did not have; investment in route to consumer and delivery of the global efficiency programme and the savings which we identified. • And this half we have also demonstrated that when we see areas we can improve we identify the action and implement it. In the half for example, we have seen our performance in Nigeria improve as a result of the changes we have made; Smirnoff in the US is stronger and our cash performance is stronger. Good progress but more we can do. • And there are some areas where we have taken the right actions but the impact on results will take longer to come through. Guinness for example is already stronger in Ireland, Ghana and East Africa as a result of the changes we have made in marketing and packaging and route to consumer. However the steps we have taken in other markets to grow Guinness will take longer to come through. Similarly our focus on sell out in place of sell in will drive better visibility of market trends and through that growth. But in the half it has had a negative impact on sales as we reduced inventory in 5 markets. • Delivering this performance in a consumer and economic environment which gives us mostly headwinds is a testament to the platform we have. • We have momentum in the business which will drive performance improvement in the second half and for the longer term the quality of these results reinforces my confidence that Diageo has enviable potential and we can deliver it. • Thank you for your time.
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