Consolidation shows drinks industry on the defensive

Related tags Diageo Pernod ricard

Drinks industry consolidation aptly took on greater importance this
week as Diageo announced tough trading conditions in a sign that
cost-savings and pricing will be crucial, reports Chris
Mercer.

In its pre-results statement today, Diageo said that organic profit growth was likely to hit its six per cent target, but that turnover would be hit by a drop in ready-to-drink sales in the US as well as an overall decline in net sales across Europe.

The UK-based group said its beer brands had also suffered a slow-down at the hands of well-documented, tough Western beer markets.

The conditions have forced Diageo to increase its focus on cost reduction strategies and pricing in order to bolster profit margins, despite its US spirits brands still outperforming the market over the last year.

"Diageo will be looking to achieve a higher level of price increase in the coming year, and over the next few weeks price increases will be announced on a number of brands in North America,"​ the firm said.

The move should be helped by Pernod Ricard securing its takeover of Allied Domecq, according to a new report from financial advisors Goldman Sachs​, which said this deal would improve the climate for price increases has improved.

Goldman said larger competitors would have a vested interest in driving up brand equity and pricing power. "This is an industry that, for all its buoyant volume background, is lacking in pricing opportunities to deliver gross margin expansion."

The report also said the pace of drinks industry consolidation was creeping up. Diageo itself has spent £700m in acquisitions over the last six months, and would spend another £520m if it carries out a deal with Pernod to buy the Bushmills and Montana brands.

Goldman expressed concern about the financial strain these extra brands, especially Chalone and Montana wines, may put on Diageo. But, the rush of recent consolidation in the drinks industry also emphasises the growing importance of cost-savings on under-pressure margins.

Diageo said it had spent around £80m on cost-saving initiatives in the year up to 30 June, and expects restructuring costs to be £70m over the next year. The group said it benefited from a £22m reduction in cost in the year ended 30 June 2005 and expected to make another £50m by the same time next year.

Pernod also said it could save more than £200m (€300m) per year in costs across both it and Allied Domecq.

Philip Bowman, chief executive of Allied Domecq, said this would be important in the face of margin pressure: "Competitive and economic conditions in the first half of 2005 have been tough. Against this backdrop the need for further consolidation in the distilled spirits industry is increasingly apparent."

Wine may be the saviour product for a number of major drinks firms.

Diageo said its wine business had grown strongly in its key US and UK markets, where demand for new world varieties in particular is rising. The emerging demand for such wines was also cited by US-based Constellation Brands last week as the reason behind its 36 per cent increase in branded wine sales.

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