Diageo plc (DEO - Free Report) reported interim results for the first half of fiscal 2020, ended Dec 31, 2019, wherein pre-exceptional earnings per share improved 4.2% year over year to 80.2 pence (in local currency). This was backed by higher operating profits and the capital return program.
Diageo’s stock dipped 1.5% yesterday after it cut the net sales view for fiscal 2020 on the ongoing trade conflicts in key markets and the spread of Coronavirus in China. The company expects the persistence of increased levels of volatility in India, Latin America and the Caribbean, and Travel Retail to hurt sales for fiscal 2020.
For fiscal 2020, it now expects net sales at the lower end of 4-6% growth mentioned earlier. The company had earlier expected sales growth at the mid-point of the aforementioned range. However, it continues to anticipate organic operating profit growth of about 1% ahead of organic net sales. This is consistent with its medium-term target stated earlier. Based on current rates, the company now expects foreign exchange to hurt net sales by £110 million and operating profit by £40 million in fiscal 2020.
Though shares of the Zacks Rank #4 (Sell) company have moved down 6.1% in the past three months, it fared better than the industry’s decline of 10.1%. The alcohol giant is gaining from the focus on innovations, achieving growth through buyouts and penetration in emerging markets.
First-Half Fiscal 2020 Highlights
On a reported basis, net sales and operating profit moved up 4.2% and 0.5%, respectively, owing to organic growth. Top-line growth also included slight negative impacts of the sale of a portfolio of 19 brands to Sazerac in December 2018.
Organic sales also rose 4.2%, benefiting from broad-based sales growth across all regions and categories, as well as rise in organic volume. This was, however, offset by challenges in India, Latin America and the Caribbean, and weak Travel Retail. Notably, organic volume was up 0.2% and price/mix grew 4%. Organic sales growth was above the company’s medium-term target of mid-single digits.
Volume growth was mainly attributed to rapid growth in tequila, Canadian whiskey and Chinese white spirits. Price/mix was particularly aided by premiumization, improved revenue-management capabilities and sustained innovation, with the launch of Crown Royal Regal Apple and Tanqueray Flor de Sevilla in the prior years.
Gross margin contracted 65 basis points (bps) in the first half, hurt by inflation in cost of goods sold (COGS) and nearly flat volumes. This was partly negated by favorable price/mix. During the first half, the company witnessed inflationary pressures from commodity costs, including Agave and glass.
Improved price/mix and productivity benefits from everyday cost efficiencies aided organic operating profit, which grew 4.6%, higher than organic net sales growth. Further, organic operating margin expanded 13 bps, driven by the focus on productivity, revenue-management initiatives and the mitigation of cost inflation.
In the first half of fiscal 2020, Diageo delivered net cash from operating activities of £1.3 billion, marking a decline of £0.3 billion year over year. Furthermore, the company reported strong free cash flow of £966 million, down from the last year due to one-time tax payments.
Diageo remains committed to its disciplined approach to capital allocation primarily to enhance shareholder value. In sync with that, it returned £1.1 billion to shareholders in the first half of fiscal 2020 through share repurchases.
The company earlier announced plans to repurchase shares worth up to £3 billion for the year ending on 30 Jun, 2019. It now increased the interim dividend by 5%.
For fiscal 2020, the company now expects net capital expenditure of £700-£750 million as it is ahead of the plan, with the implementation of some IT projects. This reflects a modest increase from the previous guidance.
Medium-Term View Intact
Diageo reiterated its growth targets for the medium-term between fiscal 2020 and 2022, which was initially announced in May 2019. The company continues to expect organic net sales growth in mid-single digits for the period. Further, it expects organic operating profit to sustainably grow by 1% ahead of net sales to 5-7%.
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