Diageo PLC

LSE:DGE

Earnings Call Transcript 2022-Q4

[Ivan Menezes, executive]

Good morning, everyone. I'm pleased to share our excellent results for fiscal '22. When we reported our interim results in January, we have delivered strong performance in the first half of the year while navigating a very dynamic environment. In the second half, the operating environment was even more challenging with stronger headwinds from inflation, supply chain disruptions, and geopolitical events. As Lavanya will discuss in further detail, our strong top line growth, gross margin expansion, and productivity savings have enabled continued reinvestment in our brands and strategic priorities. These results demonstrate that our growth algorithm is working even as the world around us is changing at base. Our strong performance is the result of consistent investment in our brands and our business to build a bigger, stronger, and more resilient organization.

Over the past 5 years, we have invested approximately GBP 3.7 billion in capital expenditures, including new investments in new sites in China, Mexico, and Kenya. We are increasing our capacity in key categories like scotch, tequila, baijiu, U.S. Whiskey, and beer. We have continued our strong track record of creating value for shareholders, and we're pleased to once again announce a dividend increase of 5%.

As of 30th of June 2022, we had completed GBP 3.6 billion of our GBP 4.5 billion return of capital program through share buybacks. We expect to complete the remainder of this program by the end of June 2023. Throughout the last 2 years, our business and our people have shown considerable resilience, and I want to thank my nearly 28,000 colleagues. We've become a stronger company that is advancing towards our ambition to be one of the best performing, most trusted, and respected consumer products companies in the world.

While Diageo is performing extremely well, we are restless and want to always do better. I want to highlight how we have continued to build Diageo into a stronger and more agile business. And I believe we are well positioned to navigate potential headwinds, including economic uncertainty, the possibility of consumer confidence weakening, and continuing impacts of the global pandemic. Let me start with why I believe Diageo has a long runway of exciting growth ahead.

Firstly, our categories remain very attractive. Total beverage alcohol, or TBA, has grown at a 4.1% compound growth rate since 2010. Within TBA, spirits has grown materially faster, gaining 9 points of share and continuing to premiumize during this period. Going forward, we expect spirits to continue to win share from beer and wine and for the premiumization trends to continue. We are well positioned to respond to these trends and to continue to grow our business and gain market share.

Last November, we set our ambition to reach 6% of TBA by 2030, up from 4% in 2020. Based on IWSR data, we increased our TBA share to 4.6% in 2021. And we gained more share than any of our peers and twice as much as our largest international spirits competitor. More than 1/3 of our share gains came from our Super Premium Plus portfolio, a reflection of the success of our premiumization strategy. We gained market share in all our regions and in global travel. And we gained category share in scotch, tequila, beer, vodka, gin, and Canadian whiskey.

There are 5 reasons that give us confidence in the resilience of our business. First, we have a diverse geographic footprint. This, combined with an advantaged portfolio with breadth and depth across categories, creates resilience. Second, we're doubling down on our focus on the consumer to ensure that we respond quickly and efficiently to shifts in consumer motivations, behaviors, and occasions. We believe our deep understanding of consumers and our use of data and technology are key competitive advantages. Third, our supply chain has been thoroughly tested in the last 2 years and has proven its resilience, agility, and strength.

Fourth, our leadership team has depth and experience. Our people are our strength and our success is underpinned by high levels of engagement and our advantaged culture. Finally, we are dedicated to doing business the right way and furthering our investment in people, sustainability, and long-term growth through our ambitious Society 2030 Spirit of progress ESG action plan. I believe this foundation will enable us to navigate volatility and will drive long-term sustainable growth.

In fiscal '22, we delivered double-digit growth in all regions across a range of developed and emerging markets, demonstrating consumers strong desire to find time for connection, socialization, and celebration. Our advantage portfolio meets a variety of consumer motivations and occasions with a wide range of categories, formats, and brands. Our world-class brand-building capabilities ensure that our brands are desirable and top of mind. I will share some recent examples of our brand equity scores in the U.S. In tequila, over the last 5 years, awareness of Casamigos more than tripled and, trial of Don Julio grew by over 50%. In American whiskey, trial of Bulleit grew by more than 60% in the same period. In China, where we have continued to build Johnnie Walker Blue Label through brand events and key influencers, awareness grew 70% versus the prior year in our most recent survey.

We continue to shape our portfolio towards the most attractive categories, which has been a key contributor to our strong market share gains. We use our insights to identify acquisition opportunities in fast-growing segments. Eight of the brands we've acquired since fiscal '17 are in the super-premium plus price tier. That includes our brand acquisitions in fast-growing categories like tequila, nonalcoholic spirits, and Japanese whiskey. And we're equally disciplined about disposing of assets that offer less attractive long-term growth potential. Most of the brands we have sold were in standard and value tiers as we continue to premiumize our portfolio.

We are driving sustainable growth and market share gains through our deep consumer insights, world-class brand building and commercial execution. In fiscal '22, we grew or held our off-trade market share for over 85% of our total net sales in measured markets. And we delivered growth across categories with scotch, beer, and tequila driving 2/3 of our organic net sales growth. Scotch was the biggest contributor to growth with a record year for our luxury Scotch portfolio and a record year for Johnnie Walker, which stopped 21 million cases for the first time.

Tequila had another breakout growth here, led by Casamigos and Don Julio, and we see significant headroom for future category growth. Tequila household penetration in the U.S. off-trade channel is only 15% today, significantly lower than 29% for total whiskey, demonstrating the runway for future growth. Beer grew 63% in Europe, driven by Guinness due to the on-trade recovery in Ireland and Great Britain. And we had terrific innovations, including Guinness Zero and the award-winning NITROSURGE.

In Africa, beer grew by 22%, and Guinness launched its first Pan African campaign in 5 years, Black shines brightest, which led to the recruitment of 1.5 million new Guinness drinkers across Africa. I couldn't be more excited about the health of the Guinness brand and its future growth potential. Finally, I'm pleased that last month, we captured 8 of the top 10 positions in the Drinks International, Millionaires Club, an annualist featuring the fastest-growing large spirits brands around the world. While we are delighted with these results, there is still more we can do across the portfolio. Smart investment in data and analytics and technology has strengthened our outstanding brand building, innovation, and commercial capabilities. Our digital transformation journey started with the launch of Catalyst in 2017, followed by Edge in 2019. Since then, we've continued to implement a suite of proprietary digital tools and data analytics.

We are using the data and insights we gather to get closer to the consumer. For example, to amplify our sponsorship of the NFL, we created several versions of Crown Royal video content using data and analytics to identify how to make our content more relevant. These videos were deployed to coincide with various consumer occasions, such as preparations for football parties. We also use geolocation data to ensure content was personalized and specifically targeted to consumers and cities where we have NFL team sponsorships. This contributed to a 17% improvement in return on investment in Crown Royal's digital media spend in the first half of fiscal '22.

We are continuously improving, and investing in our tools, capability, and talent. And as we improve, we are creating a virtual circle that brings us closer to consumers supports more efficient and effective engagement, and fuels incremental growth. We are integrating the digital touch points across Diageo's brands to provide a seamless experience from timely, relevant advertising to the many points of purchase, including third-party platforms and our own brand websites.

For example, Malts.com, the digital hub for our Scotland brand homes and distilleries offers consumers a premium destination for experiences, and exclusive and personalized products and connects them with our community of whiskey makers. This allows us to directly nurture relationships with our consumers and earn their loyalty. The global pandemic has demonstrated the agility and resilience of our supply chain.

In fiscal '22, our 3-year volume compound annual growth rate was 3%. However, there has been extreme volatility over the last 3 years with significant peaks and troughs in volume and switching between on and off trade, which impacted product mix. The volatility also impacted transportation and logistics providers, which lengthened shipping times. Our supply chain had to be extremely agile to meet fluctuating demand while still driving productivity savings. For example, our fiscal '22 production volumes were up 9% on fiscal '19. Our supply chain teams procured 10% more kilotons of glass in the same period, the equivalent of approximately 400 million additional glass bottles in spite of constrained industry capacity.

And while reducing shipping transit times with the introduction of rail, instead of ocean freight from Scotland. Our product portfolio has changed considerably over time. Significant volume growth, acquisitions, and disposals, shifts in category and market mix, and product innovation. To fulfill our share gaining growth ambition, we need an end-to-end supply chain that is fit for the future. It needs to be highly agile, efficient and configured for maximum sustainability impact to deliver our Society 2030 goals. Lavanya will discuss this in further detail.

Diageo's unique purpose-driven culture is a source of competitive advantage. Our people are passionate about our brands and Diageo's purpose, which creates an ownership mentality fueling better execution. In our most recent annual employee survey, 84% of respondents said they see a clear link between their work and our strategic priorities and performance ambition, 12 points higher than our external benchmark. Employee engagement overall is at 82%.

And -- we are hiring and developing the most talented people creating a culture where we execute with discipline and urgency while doing business the right way. This is reflected across the Diageo and in the depth and experience of our world-class leadership team. I am delighted with our recent announcement that Debra Crew will be taking on the role of Chief Operating Officer, and Claudia Schubert will be succeeding her to become President of North America. We made good progress against our Society 2030 Spirit of progress ESG action plan. Our brand campaigns to promote moderation reached 456 million people in fiscal '22. And DRINKiQ, our alcohol information platform, is now available in 73 and 23 languages. I am pleased that we have achieved this global roll out well ahead of plan.

At Diageo, we are committed to creating the most inclusive and diverse culture. Today, 44% of our leaders globally are female, up 2 points from last year, and 41% of our leaders are ethnically diverse, up 4 points from last year. On grain-to-glass sustainability, we continue to reduce our environmental impact on the world around us. We made progress on water stewardship, delivering a 3.7% improvement in water efficiency globally and generating the annual capacity to replenish more than 1 million cubic meters of water in water-stressed areas.

And we continued our efforts to become net zero carbon in our direct operations by 2030 with an absolute reduction of 5.3% in fiscal '22. Our use of total renewable energy increased to 41% this year, up 5% on last year. Increased production volumes and supply chain disruption have made it even more challenging to meet our absolute emissions targets. We remain committed to our ambitious 2030 goals, which will need government and industry engagement and technological innovation to achieve. Our clearly defined projects over the next 3 years are expected to meaningfully accelerate decarbonization in the second half of the decade.

Now I will hand over to Lavanya to take you through the details of our financial results.

[Lavanya Chandrashekar, executive]

Thank you, Ivan, and good morning, everyone. As Ivan shared, we delivered a strong set of results in fiscal '22. We have a resilient business with an increasingly advantaged footprint, strong brands, and the agility to adapt quickly in a volatile market environment. Organic sales grew 21.4% with volume growth of 10.3% and positive price mix. Spirits contributed 84% of total volume growth. Organic operating margin expanded 121 basis points. Growth in operating profit generated strong free cash flow of GBP 2.8 billion. Pre-exceptional earnings per share increased 29.3% and basic EPS increased 23.2%. And the recommended final dividend increase of 5% reflects our continued confidence in the long-term growth of the business and our commitment to a progressive dividend policy.

Return on invested capital was 16.8%, up 331 basis points and total shareholder return was 4% towards the top end of our peer group. As I shared with you at our Capital Markets Day last November, our profitable growth algorithm continues to deliver sustainable leverage growth. We are premiumizing our portfolio, increasing prices, and driving productivity, all of which enables us to invest smartly in long-term growth. We delivered 11 percentage points of top line growth from positive price mix. Price contributed mid-single digits growth, and the positive mix reflects the strong performance of our super-premium plus brands.

Our culture of everyday efficiency enabled us to unlock a further GBP 380 million of productivity savings across COGS, marketing, and overheads. Against the backdrop of significant cost inflation and supply chain disruptions, price increases and supply productivity savings more than offset the absolute impact of cost inflation and mostly offset the adverse impact on gross margin. We continue to reinvest in our brands and core capabilities, including a 25% increase in marketing investment ahead of net sales growth. Consistent investment in long-term growth has been a key enabler of quality market share gains across the majority of our markets and going forward, we will continue to invest strongly in marketing and innovation.

We delivered double-digit organic net sales growth across all regions, reflecting the continued recovery of the on-trade resilient consumer demand in the off-trade and market share gains. Our 3-year compound annual growth rate for net sales was 9%. And based on IWSR data, we are growing at almost double the rate of the industry. On a constant basis, our business today is 28% bigger than it was pre-COVID in fiscal '19.

Growth in North America reflects the strong performance of U.S. Spirits, up 17%. We drove particularly strong growth in our Super Premium Plus portfolio, and we increased prices. U.S. Spirit shipments were ahead of depletions with a benefit of approximately 3 percentage points from the replenishment of stock levels by distributors recovering from lower levels during COVID-19. It also reflects distributors increasing inventories of certain imported products due to longer product transit times in fiscal '22. In Europe, all markets grew double-digit as the on-trade recovered strongly, which particularly benefited Guinness in Ireland and Great Britain. Growth in Asia Pacific was driven by strong performance in India and China and the partial recovery of travel retail. And in Africa and Latin America, we built on our strong growth momentum and benefited from price increases. We have an advantaged portfolio across our key strategic categories supported by consistent investment in brand building and innovation.

In fiscal '22, we delivered growth across categories, led by scotch, tequila, and beer. Scotch grew 29% and contributed more than 30% of Diageo's net sales growth with double-digit growth across all regions. Premium plus scotch grew 34%, and Johnnie Walker also grew 34%. Tequila contributed 20% of Diageo's net sales growth and grew 55%. Beer grew 25% and Guinness was up 32%, driven by strong growth in Ireland, Great Britain and Africa.

Our Premium Plus brands continue to be a significant driver of performance, contributing over 70% of organic net sales growth. These brands now make up 57% of Diageo's net sales, up 10 percentage points from fiscal '17. Our super-premium plus brands, which contributed 27% of net sales, grew 31% and delivered around 1/3 of organic net sales growth. This reflects strong growth of our tequila brands, the higher marks of our scotch portfolio, and Chinese white spirits. Our premium brands grew 26%, reflecting the strong performance of Johnnie Walker Black Label and our premium beer Guinness.

As Ivan discussed earlier, our broad portfolio creates resilience, particularly in times of downward pressure on consumers' disposable income. Actions we have taken to strengthen our position in lower-priced tiers in emerging markets such as Latin America and the Caribbean and Africa enable us to keep our brands accessible to consumers. Our revenue growth management capabilities are a key enabler in driving positive price mix. In an environment of significant cost inflation and supported by strong marketing investment, we have taken targeted price increases. As an example, in Brazil, we increased prices across our scotch portfolio by an average of 7% in the first half, followed by an additional 10% in the second half. Johnnie Walker grew 52%, while delivering strong double-digit volume growth and the brand gained market share of both spirits and the scotch category. Price increases offset COGS inflation and contributed to a 350 basis point gross margin improvement for the brand.

Pricing is just one lever in our suite of RGM tools. I'll share an example of our broader capabilities. In Spain, we use data analytics to get more granular insights into the performance of Johnnie Walker Red Label. We measured the effectiveness of past promotional campaigns to understand the potential customer and consumer reaction to price increases and promotional activities. We increased the price of Johnnie Walker Red Label and reduced-price promotions at the point of sale while also increasing marketing spend to maintain strong brand equity. The variant gained 219 basis points of category market share in the 3 months following the price increase and has gained 167 basis points of share year-to-date.

Marketing investment grew 25% ahead of net sales growth and reflects increases across all regions, particularly the U.S. And our reinvestment rate increased to 17.6%, up 46 basis points from fiscal '21. Consistent strong investment in our brands has strengthened our brand equity and enabled us to grow volume, increase prices and gain market share.

We continue to drive marketing effectiveness through tools such as demand radar. Powered by AI, demand radar uses macroeconomic indicators and open source data such as Google search trends to model various demand scenarios. In Ireland, we use these insights to up weight our media investment on Guinness ahead of the on-trade restriction easing enabling us to outperform the competition and gain market share. Demand Radar is now deployed in 63 countries, covering more than 90% of our net sales value and marketing investment and giving us a competitive advantage in this dynamic environment.

Sensor is our proprietary tool that measures the relative effectiveness of our media spend across digital platforms. In the U.S., Sensor delivered a 30% improvement in return on investment on our media investment across our portfolio. We have just launched it in GB and expect to roll it out to other markets in fiscal '23. Everyday efficiency and our strong pipeline of productivity initiatives play an important role in offsetting cost inflation and reinvesting in our business. We delivered around GBP 380 million of productivity savings in fiscal '22. And as in previous years, the biggest drivers were COGS productivity and marketing effectiveness.

At our Capital Markets Day in November, I set out our target to deliver around GBP 1.2 billion of gross productivity savings over the 3-year period from fiscal '22 to fiscal '24. And we are on track to deliver this commitment. We delivered a strong increase in organic operating margin while continuing to invest in marketing ahead of net sales growth. Gross margin increased 112 basis points, reflecting a positive mix from premiumization, the recovery of the on-trade channel, and improved fixed cost absorption due to volume growth. Price increases and supply productivity savings more than offset the absolute impact of cost inflation.

The reported operating profit increased by 28% and the reported operating margin was up 162 basis points. The organic operating margin increased 121 basis points. We invest consistently and smartly to deliver sustainable long-term growth. In fiscal '22, this included over GBP 1 billion of CapEx investment to add production capacity and new consumer experiences, enhance our digital capabilities and deliver our sustainability agenda.

As Ivan mentioned, we are investing to build an end-to-end supply chain that is fit for the future to fulfill our share growth ambition. We have initiated a supply chain agility program spanning 5 years starting from fiscal '23. We expect this program to strengthen our supply chain, improve its resilience and agility, deliver additional productivity savings and make our supplier operations more sustainable. We expect the total implementation cost of the program to be up to GBP 500 million over 5 years starting in fiscal '23. This will comprise noncash items and one-off expenses, the majority of which are expected to be recognized as exceptional operating items also starting in fiscal '23. The savings from this program will be incremental to our ongoing everyday efficiency savings of around GBP 1.2 billion that I already mentioned.

The program is expected to have a 5-year payback period with the majority of savings delivered in fiscal '25 and beyond. We delivered strong free cash flow of GBP 2.8 billion due to growth in operating profit. The reduction of GBP 254 million compared to last year was largely due to the impact of lapping an exceptionally strong working capital benefit in fiscal '21, along with increased CapEx investments and higher cash tax paid. In fiscal '23, I expect CapEx to continue to be up-weighted in the range of GBP 1 billion to GBP 1.2 billion, including investment in production capacity for our strategic categories, our digital capabilities, our ambitious sustainability agenda, and our supply chain agility program.

We continue to benefit from our laser focus on debtor risk management and collections. Our days sales outstanding in debtors are lower than pre-COVID levels, and our overdue balances are at their lowest level in years. Our leverage ratio of 2.5x at year-end was at the low end of our target range. Closing net debt increased by GBP 2 billion, primarily due to an acceleration of our return of capital program in fiscal '22. However, average net debt and our net interest charges were broadly in line with fiscal '21. Net other finance charges increased GBP 44 million year-on-year primarily due to the hyperinflation adjustment for Turkey.

Our effective interest rate was 2.7%, in line with fiscal '21. In fiscal '23, I expect our effective interest rate to be around 3.5%. And we remain committed to a leverage ratio of 2.5x to 3x adjusted net debt to EBITDA. Our consistent and disciplined approach to capital allocation is unchanged. Our priority is to invest in sustainable organic growth and to acquire strategic brands that strengthen our exposure to fast-growing categories. Our recommended final dividend is [ GBP 46.82 ] per share, a 5% increase on our final dividend in fiscal '21. This results in a full year dividend of [ GBP 76.18 ] per share, up 5% on fiscal '21. Our dividend cover strengthened to 2x in fiscal '22.

Looking forward, we expect to maintain a mid-single-digit dividend growth, and we remain committed to staying within our target range of 1.8x to 2.2x. When we have excess cash, we expect to return it to shareholders. At 30th June 2022, we had completed GBP 3.6 billion of our GBP 4.5 billion return of capital program. We expect to complete the remaining GBP 0.9 billion of the program by the end of June 2023.

Moving on to foreign exchange, Unfavorable foreign exchange movements adversely impacted both net sales and operating profit in fiscal '22. This was mainly due to the weakening of the Turkish Lira and the Euro, partially offset by the strengthening of the U.S. Dollar. We are not able to provide specific guidance for foreign exchange in fiscal '23. However, using the exchange rates on the slide, I would expect a favorable impact on net sales and operating profit, primarily driven by the weakening of sterling against the U.S. dollar as well as some impact from other emerging market currencies. In addition, I expect an unfavorable impact related to hyper inflationary economies, primarily Turkey.

Earnings per share before exceptional items increased 29.3% from [ GBP 117.5 to GBP 151.9 ]. Our tax rate before exceptional items was 22.5%. This is within our guidance range of 22% to 24%, which we are maintaining for fiscal '23. I am encouraged by our strong performance in fiscal '22. We have demonstrated that our profitable growth algorithm delivers sustainable top-line growth, consistent productivity savings and enable smart reinvestment. And I am confident in our medium-term guidance on both the top and bottom line.

As Ivan highlighted, we expect the environment to be challenging in fiscal '23 with significant volatility and uncertainty. We will continue to closely monitor consumer trends across our markets to enable us to respond quickly to potential shifts from weakening consumer spending power. Across all regions, we expect organic net sales growth to moderate as we lap the strong recovery of the on-trade in fiscal '22. However, we expect to benefit from our advantaged portfolio, strong innovation, and effective marketing. We will focus on revenue growth management, including strategic pricing actions and everyday efficiency. A significant portion of the price increases this fiscal were in the second half, and the benefit will carry forward into fiscal '23. We continue to expect organic operating margin to benefit from premiumization trends and leverage on operating costs while investing strongly in marketing. We are confident in the resilience of our business and our ability to navigate headwinds.

And now back to you, Ivan.

[Ivan Menezes, executive]

Thank you, Lavanya. I'm very pleased with the strength and quality of our financial results and our strategic progress. I am optimistic about our opportunities for further growth, and we continue to invest for the long term. TBA is an attractive and growing category, and we have an advantaged portfolio, which we will continue to actively shape. We believe our core capabilities across brand building, supply chain, and culture are a competitive advantage, and we have a strong track record in ESG delivery. We are confident in our strategy and our ability to deliver sustainable long-term growth and shareholder value. Thank you.