Diageo plc’s Chinese Mistake

Diageo’s (LSE: DGE) (NYSE: DEO.US) expansion into China was part of the group’s much celebrated international expansion and drive into emerging markets. 

However, just two years later, after a change in Chinese government policy, Diageo is being forced to take a multi-million pound write-down on the value of its Chinese brand. 

Slumping sales

Diageo took control of Shui Jing Fang, a 600-year-old Chinese super premium wine spirit brand during 2012. At the time, Diageo was predicting that sales of the spirit would expand at 10% per annum until 2015. 

Unfortunately, Diageo’s forecasts could not have been further from the truth. 

As a result of the anti-extravagance drive of President Xi Jinping, the Chinese premier elected just after Diageo’s acquisition of Shui Jing Fang, the sales of luxury items have slumped across China. The premium spirits sector has been no different.

Sales of Shui Jing Fang crashed 66% during the first half of this year. What’s more, the Chinese spirits group expects to report a loss for the first half of the year and its chairman has resigned.

The problem is that due to the anti-extravagance drive, premium spirit makers have become locked in an aggressive price war, in an attempt to maintain sales growth. It would appear that Shui Jing Fang has failed to attract customers. 

Millions at stake

Diageo paid around £250m for control of Shui Jing Fang originally, the company then booked a gain of £124m when it revalued its stake. Writing down this stake as sales collapse could cost Diageo hundreds of millions.

The Shui Jing Fang losses are just one of the many problems Diageo is struggling with in emerging markets. According to Diageo’s management, the biggest impact to group performance this year will be the economic weakness in the emerging markets.

Still, Diageo has used emerging market weakness to increase its presence within India, where the group recently took control of United Spirits. 

Huge potential 

India holds huge potential for Diageo as the country is the world’s largest whiskey market in terms of volume. However, most whiskey sold within India is locally made. This local whiskey market is dominated by United Spirits and the company’s profits have soared, as India’s whiskey consumption doubled during the period 2005 to 2010.

Not only did the deal to acquire a majority share in United Spirits give Diageo access to the local Indian market, but is also gave the company s access to United’s extensive distribution network. The network will allow Diageo to distribute its own beverages, as well as United’s existing offering.