Stock in Focus: How long will Diageo's troubles persist?

The conclusion of ‘Dry January’ will no doubt have come as a relief to many of its participants. One in five Brits gave up booze this month, according to a survey from the British Beer and Pub Association (although it’s unclear whether this accounts for those of us who said we were doing Dry January, but caved in the first weekend).

The increasing popularity of alcohol abstinence in the first week of the year (a tradition that was introduced in the UK in 2013) is a growing concern for companies in both the hospitality and drinks industries and highlights a wider trend among Brits whose penchant for booze is diminishing. Many of those who have participated in Dry January this year may have realised that abstinence is not as difficult as they previously feared.

Despite my failed attempt this time around, I did give up drinking for five months last year. And until a weekend in Munich during Oktoberfest put paid to my resolution, I found it surprisingly easy. That’s not because I am not an enthusiastic drinker (I love a beer), but because alcohol-free alternatives to booze are both increasingly available and comparable to the real thing.

It’s a trend that drinks companies like Diageo are keen (or perhaps desperate) to exploit. Last year the company, added an alcohol free version of its spiced rum, Captain Morgan’s, to its growing list of drinks for those who abstain. That list already includes 0.0% versions of Guinness, Johnnie Walker, and Tanqueray and the exclusively non-alcoholic gin brand, Seedlip (which, alongside Lucky Saint 0.5% beer, got me through my abstinence last year).

On top of product innovation, Diageo’s marketing team have been keen to leap aboard the non-drinking bandwagon. But this has resulted in some weird messaging. In December, the company launched a campaign called ‘The Magic of Moderate Drinking’ which aimed to educate people about “pacing your drinks with water or food, having a non-alcoholic option, or measuring your units to help you keep an eye on how much you drink.” When companies are having to having to run advertising campaigns encouraging customers to consume less of their product, it feels like the market in which they operate may not be functioning that well.

Indeed, these efforts to promote sensible drinking with the help of non-alcoholic alternatives have not helped to plug the gap left by what Diageo’s chief executive Debra Crew generously describes as an “uneven global consumer environment.” Sales fell 1% in the six months to December 2023 owing to a 9% decline in volumes.

And this disparity speaks to one of the more fundamental challenges facing Diageo, its peers in the drinks market, and the pub companies that rely on punters. A decline in customer numbers will leave those left paying more and companies operating in the space are turning to ‘premiumisation’ to lift average selling prices.

But during a period of economic turmoil, when many are being forced to cut down on spending, the premiumisation of drinking is an additional deterrent to consumers. In 2024, the average pint in Britain costs £4.70 (a statistic which will probably come as a surprise to those who live in London, where pints have not been purchased for less than £5 for many years), compared to £1.95 at the turn of the Millennium. Higher prices have also spread to the non-alcoholic segment of the market. A 500ml bottle of Erdinger Alkoholfrei Wheat Beer now costs £1.75 in most supermarkets, up from £1 this time last year, making it more expensive than many of its alcoholic counterparts. And there is an alcohol free bar which recently popped up in London selling cocktails for £9 - a price that the bar’s owner justifies as “paying to not have a hangover”.

Is Diageo going flat?

The challenges of the alcohol market added to a bleak year for Diageo in 2023, which had already been clouded by the sudden death of its chief executive Ivan Menezes, who joined Diageo at its creation in 1997 and led it successfully for almost a decade.

The company’s shares ended the year down 20% - a movement that was somewhat justified by this week’s interim earnings announcement. A decline in the volume of sales (especially in the Latin America region, which has been badly affected by by economic troubles), an increase in average selling prices and higher spend on marketing sent like-for-like operating profits down 5%. The company was also forced to stomach a $54m impairment on the declining value of its brands and an $86m increase in finance charges following a new bond issuance. Earnings were down 17%.

On other traditional measures of quality, Diageo continues to look resilient. Operating cash inflows were higher than this time last year thanks to more disciplined management of working capital. And management plans to tighten this up even more in the rest of the year by bringing stock inventory “in line with current demand” (read: lower).

Capital expenditure rose to $69m in the period in line with the company’s “commitment to investments for long-term sustainable growth” and additional cash is being used to support the well and buy back stock with its additional cash.

But companies of Diageo’s ilk (high quality and expensive) are likely to continue to be punished for missing expectations. And with the end market in its current state, it seems unlikely that the company is going to be able to pull growth out of the bag. Certainly not enough to justify a price to earnings ratio of 17 times.