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Is Coronavirus Scare Enough to Derail Diageo From Growth Path?

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Diageo plc DEO has also felt the jitters of the global coronavirus outbreak, which has not only harmed mankind but also plagued the economies of several countries. The outbreak of COVID-19 in China and other areas is therefore hurting the dynamics of the companies operating in the regions.

Having a meaningful presence in China and the Asia Pacific, the global beverage company Diageo is not shielded from the impacts of the deadly virus outbreak. This has resulted in restrictions on public gatherings, postponing events, and the closure of many hospitality and retail outlets in China. Several other countries and many businesses have also imposed restrictions on travel.

With the closure of bars and restaurants in China, there has been a significant decrease in dine-out, which is expected to hurt Diageo’s sales. Also, the company has witnessed significant trade disruptions since the end of January.

Consequently, it expects China operations to witness softness in the near term, which should have a pronounced impact on fiscal 2020 results. For fiscal 2020, it anticipates the coronavirus outbreak to have negative impacts of £225-£325 million on organic net sales and £140-£200 million on organic operating profit.

Other beverage companies that recently provided updates on the estimated impacts of the virus spread on their results are Coca-Cola KO and Anheuser-Busch BUD. Coca-Cola expects the COVID-19 outbreak to hurt its first-quarter 2020 organic revenues by 1-2 percentage points, unit case volume by 2-3 percentage points and earnings per share by 1-2 cents. Meanwhile, AB InBev stated that the outbreak has caused nearly $285 million of lost revenues and $170 million of lost EBITDA in the first two months of 2020. For the first quarter of 2020, AB InBev expects a 10% decline in EBITDA, driven by the impacts of the outbreak and tough comparisons in Brazil.

Unlike many peers, Constellation Brands (STZ - Free Report) stated that its business will not be affected by the coronavirus outbreak, as it derives most of its sales from the United States.

Coming back to Diageo, it continues to grapple with high commodity cost inflation and increased marketing expenses, which are offsetting gains from favorable price/mix and efficiencies from the productivity program. The company particularly witnesses inflationary pressures from commodity costs, including Agave and glass.

Though we cannot overlook the impacts of the deadly virus outbreak on its near-term results, we believe that the effects of the outbreak cannot be long-lived on the fundamentals of Diageo. The company’s well-knitted strategies and diversified global presence are well placed to instill growth once the effects of the COVID-19 fade away.

Growth Strategies to Support Fundamentals

The company is progressing well with its expansion and innovation strategy. It remains focused on expanding the fastest-growing premium spirits brands by resource optimization, which should drive growth and boost shareholder value.

The company explores opportunities to expand geographically through acquisitions to further strengthen its exposure in the fast-growing categories. In sync with the strategy, it acquired a number of companies and brands, including Don Julio, United Spirits and Casamigos, as well as increased shareholding in Shui Jing Fang. Additionally, the company has been divesting assets to enhance its portfolio — including the divestiture of 19 brands to Sazerac. The actions enable Diageo to focus on the premium and above-premium brands, with stronger growth and profit opportunities.

Moreover, the company is set to grab a share of the momentum in the fast-growing hard seltzer category by promoting the Smirnoff Seltzer with endorsements. Notably, seltzers are stealing a large share from beer, and wine & spirits categories, with a significant share sourced from the beer category.

The company’s strong fundamentals, continuous innovation and focus on expansion have been largely fueling its results in recent years. It reported strong results in fiscal 2019, wherein sales and earnings improved year over year. The company reported strong results for the first half of fiscal 2020, wherein sales and earnings improved year over year.

Conclusion

The near-term picture for Diageo’s growth may appear bleak on the concerns arising in China. However, the company remains confident about long-term growth opportunities in Greater China and the Asia Pacific business. Its diversified business and operating model in other key regions keep it well-placed to offset the impacts of the coronavirus outbreak. Management expects a gradual improvement toward the end of fiscal 2020, with consumption returning to normal levels.

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