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Diageo faces struggle to make United Spirits pay: Analyst

By Ben Bouckley+

30-Jan-2013
Last updated the 31-Jan-2013 at 14:12 GMT

The potential upsides in Diageo’s potential acquisition of a majority stake in India's United Spirits (USL) are clear but achieving acceptable profitability from the business may be tricky, according to one analyst.

Diageo took a 27.4% stake in USL last November, and had planned to launch an open offer to shareholders to take a further 26% stake in the firm by January 18, where both transactions would total $2.1bn.

This last move is currently on ice due to Indian competition concerns, and Diageo is due to update shareholders on the situation when it releases its half-year results tomorrow.

But presuming that transaction does go through, Ross Colbert, an analyst on Rabobank’s Food & Agribusiness Research and Advisory Global Beverages Sector Team, said that Diageo’s acquisition was a clear example of “opportunities and challenges in emerging markets”.

Colbert made his comments in Rabobank's newly released 2013 Global Beverage Outlook report.

“The potential benefits of the acquisition are clear, in that USL gives the global spirits giant a dominant position in a market that consumes nearly 250m cases of spirits, and is registering heated growth as Indian spirits consumption grew nearly 80% in the five years from 2006 to 2011,” he said.

Profits lag other Indian spirits players…

But while the USL acquisition would help Diageo achieve its goal of generating 50% of revenues from emerging markets before 2015, Colbert said that making the business pay well was more of a challenge.

“USL has attained a dominant position in the Indian market, but has achieved its volumes mainly in the lower-priced segments of the market, and its profits lag the other major Indian spirits players,” Colbert said.

For instance, USL outstripped Pernod Ricard in Indian volume sales by three times, the analyst added, but the operating profits of the two were almost identical, since Pernod’s margins were nearly three times higher.

“Diageo appears willing to accept some volume declines in order to reposition the portfolio at higher price points, but this will not come easily as Pernod Ricard already holds a strong position in the more premium categories,” Colbert said.

Moving on to the US spirits market, Colbert discussed the possibility of a Beam Inc. takeover, given problems establishing short-term profitability in emerging markets.

“For improved profitability, spirits companies will continue to look at the US market, as it continues to generate the highest levels of profitability for major spirits companies,” he said.

The US spirits market continued to register healthy growth, the analyst said, but its principal appeal for multinational spirits companies was the fact that value growth was outpacing volume growth.

“The trend of consumers trading-up to better quality, higher-priced products has been well-entrenched in the US market, and though it saw a slight reversal during the recession, it has been making a clear comeback since 2010,” Colbert added.

Question of when, not if, Beam Inc. bought?

Yet the vodka category was one exception to this trend, Colbert said, since US growth here was based more on new mid-to-low priced brands and abundant new flavors.

Nonetheless, he added, brown spirits and bourbon in particular (dollar sales +12% in Nielsen tracked channels for the first eight months of 2012) continued to enjoy dynamic growth driven by premiumization.

Citing the two dominant US bourbon players, Beam and Brown Forman, Colbert noted that Beam the only US bourbon company not under family control.

“There is continued speculation that Beam could be acquired by competitors, though it appears unlikely to occur in 2013,” Colbert said.

“The acquisition of a company the size of Beam would likely have to be led by a larger competitor, such as Diageo or Pernod Ricard.”

Diageo’s emerging market focus and the USL transaction meant it was a less likely candidate, Colbert said, while Pernod’s leadership transition following the death of CEO Patrick Ricard “will make it a difficult time to consider an acquisition”.

But while any acquisition was unlikely in 2013, the strength of American whiskey would “keep the focus on the company as an attractive potential target for some time to come,” the analyst added.