Diageo faces £150m hit to profits from strong pound

JOHNNIE Walker and Smirnoff owner Diageo yesterday warned that the strong pound will knock its profits by £150 million this year, £50m more than previously expected.

Ivan Menezes revealed that Diageo had been hit by the strong pound

The drinks giant, which operates in 180 countries and is also behind brands including Guinness and Captain Morgan, had warned over currency weakness in emerging markets earlier this year but yesterday raised its estimates of the cost.

Although the group – Scotland’s largest distiller – said sales in the new financial year had risen and overall performance is expected to be in line with forecasts, chief executive Ivan Menezes revealed the hit to operating profits in a trading update ahead of its AGM.

The FTSE 100 firm has pinned its growth on an expanding middle class in emerging markets in Latin America and Asia who could afford its premium brands. However, the global slowdown has pegged back the firm’s growth.

Menezes also said that he expected first-half sales in the US to fall by 2 per cent compared to a year ago, due to increased competition in the spirits market. The drinks maker’s boss added that volumes had grown by “mid-single digit” percentages, but that “price increases have been muted.”

Diageo said that while currencies were weaker in emerging markets it believed it would continue to grow volumes in these markets this year, which would lead to modest margin improvements.

Menezes added that he was confident Diageo’s strategy would pay long-term dividends.

“We are delivering the change which will further strengthen this business and deliver our performance ambition,” he said.

James Jones, an analyst at RBC Capital Markets, described the trading update as “mixed”. Although the currency impact will be higher than first thought Jones said it was not a “massive deterioration”.

“The news that currency is going to impact EBIT [earnings before interest and tax] by £150m in the year is unhelpful, though not surprising.”

But he retained his “outperform” recommendation and £20 price target on the shares.

“Our positive recommendation is based on the belief that Diageo has both the potential to extract significant cost from the business and that the wherewithal now exists to realise this potential.”

Shore Capital analyst Phil Carroll also highlighted the positives from the update.

“Volume growth seems to be particularly strong with it said to have grown mid-single digits, albeit against a weak comparative especially in US spirits.”

Nicolas Ziegelasch, head of equity research at Killik & Co, also noted that the group continues to achieve productivity gains which he said “support improved working capital management and drives continued strong free cash flow delivery”.

In its full-year results to 30 June, net sales had increased by 5 per cent to £10.8 billion, compared to £10.2bn with operating profits increasing marginally from £2.7bn to £2.79bn. Johnnie Walker’s reported net sales dropped a significant 12 per cent due to unfavourable comparisons and increased competition in China.

In July, Diageo sold Gleneagles Hotel in a deal thought to be worth up to £200m to a group of private investors led by London-based hospitality group Ennismore. Ennismore – owner of London’s Hoxton Hotel – said it would be retaining the management and 900-strong workforce at the venue, which hosted last year’s Ryder Cup.

Earlier this month, analysts at Nomura suggested a merger between Diageo and SABMiller would be a sound move and said such a deal would face few regulatory hurdles. “We would see this as a similar move to the creation of Diageo from the merger of Guinness and Grand Metropolitan in 1998,” Nomura said in a research note.