Scotch Sales Drive Diageo plc's Growth

By Travis Hoium Markets Fool.com

The global spirits industry continues to be strong, driving results for Diageo plc (NYSE: DEO) higher in the first half of fiscal 2017, for which it reported results Thursday. Currency changes helped growth (and keep in mind that the numbers below are in Diageo's reported British pounds and pence), but organic trends for the business are strong nonetheless.

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Diageo results: The raw numbers

Metric 1H 2017 1H 2016 Year-Over-Year Change
Net sales 6.42 billion pounds 5.61 billion pounds 14.5%
Net income from continuing operations 1.58 billion pounds 1.49 billion pounds 6.4%
Adjusted earnings per share 60.0 pence 55.8 pence 7.5%

Data source: Diageo plc. 1H = first half.

What happened with Diageo this quarter?

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The spirits business continues steady growth around the world, and Diageo's key brands are well-positioned to take advantage. But keep in mind that the high growth numbers you see above take into account a big boost from exchange rates while organic growth in net sales, for instance, was a more modest 4%. Here's a little more context for what investors should be watching:

  • A positive change in exchange rates helped drive sales higher in pound-denominated terms. There was a net 815-million-pound increase in sales in the first half of fiscal 2017; 853 million pounds was due to exchange rates while 270 million pounds was due to organic movement. Looking at organic changes in volume and revenue gives a clearer explanation of the business than the top-line numbers do.
  • Overall, organic volume at Diageo was up 3% and organic net sales were up 6%.
  • If there's one spirit that drives Diageo's results, it's Johnnie Walker. The blended scotch is extremely popular in Latin America and the Asia Pacific region and it saw organic volume growth of 4% and organic net sales improvement of 5%.
  • The other two spirits performing extremely well are Crown Royal, which saw organic volume rise 15% and organic sales rise 17%, and Bulleit, which was up 27% in organic volume and 29% in organic sales.
  • Tequila volume overall was up 22% on an organic basis, and sales were up 18%, driven by Don Julio sales in the U.S. But at just 2% of sales, the impact on the business overall is fairly small.
  • While scotch sales improved (up 6%) and North American whiskey jumped (up 15%), vodka sales fell 2% in the period as demand for the spirit waned around the world. Smirnoff and Ketel One were the two brands that took the brunt of the decline, and right now there's no turnaround on the horizon.

What management had to say

The strategy of building and acquiring strong brands and then spreading them through Diageo's wide distribution network is working, which can be seen by a 28% increase in operating profit (to 2.07 billion pounds), compared to a 15% increase in net sales. And with scotch and American whiskey demand continuing to outpace supply, especially on the high end of the market, steady growth will likely continue.

Management continues to focus on building a positive brand experience and a more sustainable business. For investors considering this as a long-term investment, that's encouraging.

Looking forward

Management continues to expect mid-single-digit growth; a 100-basis-point organic operating margin improvement is possible between mid-2016 and mid-2019. In a business with the kind of staying power that spirits have, that kind of long-term focus is what investors should be looking for.

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Travis Hoium has no position in any stocks mentioned. The Motley Fool recommends Diageo. The Motley Fool has a disclosure policy.