Why Diageo plc Shareholders May Face Years Of Stagnation

Diageo (LSE: DGE) (NYSE: DEO.US) is a great long-term investment. The company’s portfolio of world leading alcoholic beverage brands is one of the best around and the company would make a great addition to any portfolio, I feel. 

However, while Diageo is a great long-term play, in the short term the group could be facing years of stagnation as the group deals with issues at the recently acquired United Spirits, and growth of the global spirits market starts to slow. 

Slowing growth 

Between 2007 and 2012, the compound annual growth rate of total global spirits consumption stood at around 6%. But during 2013, global spirit sales only increased by a marginal 0.1%. 

This slowdown was driven by three mains factors, a slowing spirit market in China, a crack-down on alcohol consumption in Russia and increasing competition. 

Unfortunately, some forecasts predict that this glacial rate of growth is set to continue for the rest of the decade, which will crimp Diageo’s growth. 

What’s more, increasing competition is putting pressure on Diageo’s traditional product lines. For example, locally produced spirits and flavoured vodkas are starting to erode the company’s share within key markets like the US.

Indeed, figures show that during 2012 the global vodka market reportedly managed only 0.3% growth, although premium vodka sales jumped by 7.6%. Over the past decade, flavoured vodka has snapped up market share, from around 7% of the market during 2001 to 21% by 2013, disrupting Diageo’s traditional Smirnoff Vodka brand.

United Spirits 

As part of Diageo’s strategy to expand into new markets, the company recently acquired a majority share in India’s United Spirits, which is proving to be a trouble child.

India’s spirit market is growing rapidly, at a rate of 15% per annum and Diageo wants a slice. However, India’s alcohol market is tightly controlled and imported spirits face an import tax of 150%. 

To gain a foothold in the country, Diageo paid a total of £1.8bn to acquire its 54.8% stake in United and immediately discovered a toxic $225m loan to United’s parent company. This debt has now been written off. In addition, Diageo has been wrestling with United’s smaller shareholders, which were preventing United, now Diageo’s subsidiary, from making and selling its parent’s products. 

Still, this deal is not expected to be earnings accretive to Diageo for some years, as synergies will take time to flow through. For the time being, Untied will be a dead weight for Diageo. 

Predictions 

Despite negative headwinds, City analysts currently predict that Diageo will report sales of just under £11bn for the year ending 30 June 2015, up 6% year on year but still far below the £14.6bn in sales reported for 2012. The company is expected to report pre-tax profit for the same period of £3bn, once again, up year on year but down around 1% from the figure reported for 2013. 

Further, City analysts expect Diageo to report 5% sales and pre-tax profit growth for 2016. So according to City figures the company is set to grow steadily for the next two years, although Diageo’s sales are still far below the level reported several years ago. 

Nevertheless, Diageo’s defensive nature and dividend yield of 3% are two factors the make the company a great pick for any retirement portfolio.