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Diageo plc’s (DEO - Analyst Report) earnings in the first half of fiscal 2014 went up 4% y/y on a local currency to 62.6 pence (99.2 cents* per share) from 60.2 pence (95.9 cents** per share).

The increase in profit was the result of strong organic growth of Diageo’s strategic brands. Increasing reach to the burgeoning middle class coupled with fast penetration into emerging markets contributed to the positive results.

On a reported basis, net revenue (i.e. total revenue minus excise duties) slipped 1% on a local currency to £5.9 billion ($9.3 billion) in the first half of fiscal 2014 ending Dec 31, 2013. On an organic basis also, revenues increased 2%, while volume slipped 3% y/y.

Diageo increased its marketing spending by 3% organically in the first half of fiscal 2014. Operating profit before exceptional items (excluding acquisitions and disposals) went up 3% year over year on an organic basis.

Segment Details

Except Europe, all the regions have delivered positive organic sales growth.

In North America, Diageo’s organic sales increased 5% in the first half of fiscal 2014. Price/mix contributed 7 percentage points to organic sales growth backed by product launches and favorable mix in U.S. spirits. Marketing spending increased 5% in the region, primarily due to focuson key brands such as Guinness and Johnnie Walker and the reserve brands. Operating margin expanded 1.3 percentage points backed by positive price mix and lower overhead costs.

Among the strategic brands, Ciroc showed strong performance in the first half of the year. The lack of innovation in beers impacted the first-half performance.   

In Western Europe, organic sales fell 1% mainly due to tough economic environment in Southern Europe and Ireland along. Volume declined 2% mainly due to volume decline in all the categories. The company saw a decline in operating margin despite a 2% drop in marketing spending. The company is investing heavily on its premium core brands, innovation agenda and reserve portfolio.

The economy in Southern Europe remains challenging. While Diageo’s performance in Great Britain, Germany and France improved, sales in Ireland and Southern Europe declined during the reported quarter.

In Africa, Eastern Europe and Turkey, organic sales increased 2% backed by 15% year-over-year growth in the Meta brand. In West and Central Africa, Johnnie Walker and Guinness net sales grew 35% and 21%, respectively, on the back of strong brand execution and more consistent regional pricing.

Volume declined 4% in the region, particularly for the core beer brands and international spirits. Operating profit declined 12% due to a 8% rise in marketing spend.

The Latin America and Caribbean region delivered a strong performance in the year, with organic sales growth of 8% backed by strong sales growth in Brazil. However, volume declined 2% mainly due to 11% decline in the wine category. The company also increased its marketing spending by 8% to enhance the brand equities in scotch, increase the significance of vodka and support innovation. Operating margin inflated of 51 basis points driven by cost efficiencies.

In the Asia Pacific region, sales declined 6% mainly due to weakness in Chinese white spirits. Volume declined 4% mainly due to decline in Greater China which offset strong growth in India. Marketing spending declined 3% due to contracting whiskey market in Korea and market softness in Thailand. Operating margin improved as backed by cost efficiencies.

The company is increasing marketing investment in almost all the geographical segments, and is focusing more on its premium brands. The strategy of transitioning to high-margin, high-priced products is improving the company’s margins.

Currently, Diageo plc carries a Zacks Rank #3 (Hold). Some better ranked stocks in the consumer staples sector include Constellation Brands Inc. (STZ - Analyst Report), Green Mountain Coffee Roasters Inc. (GMCR - Analyst Report) and The Hain Celestial Group Inc. (HAIN - Analyst Report). All the stocks carry a Zacks Rank #1 (Strong Buy).

*£1=$1.58444 (average price of the half year ended December 31, 2013).

**£1=$1.59292 (average price of the half year ended Dec 31, 2012)

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