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Diageo - issues profit warning due to weak Latin America outlook

Diageo issued an unexpected trading statement to warn that this year's revenue and profit will both be lower than the group had previously expected.

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Diageo issued an unexpected trading statement to warn that this year's revenue and profit will both be lower than the group had previously expected.

This is due to a "materially weaker" performance outlook in its Latin America and Caribbean (LAC) region, which accounted for nearly 11% of group sales last year. Macroeconomic headwinds here are leading to lower consumption and consumer downtrading.

Organic net sales in this region are now expected to fall by more than 20% in the first half, compared to market forecasts of 2% growth. It's worth noting that LAC is lapping a very strong comparable period last year, which saw organic net sales growth of 20%.

First-half operating profit growth is now expected to decline compared to last year, primarily due to the adverse impact of LAC. Positive momentum has continued in the group's other regions.

Over the medium term, organic net sales guidance has been maintained at 5-7% growth. However, operating profit is now expected to grow in line with sales, down from 6-9% previously.

The shares fell 12.7% following the announcement.

View the latest Diageo share price and how to deal

Our view

Diageo has served up an unexpected profit warning. The underperformance stems from its Latin American and Caribbean (LAC) region, where growth was very positive in the past. The region only accounted for around 11% of group sales last year but because of the magnitude of the sales decline there - expecting a 20% decline vs. previous market forecasts of 2% growth - it was enough to move the dial on the group's full-year outlook.

As a result, first-half operating profits are set to fall year-on-year, as customers in LAC have been consuming less and downtrading to cheaper alternatives. Given that LAC is one of its higher-margin territories, it's having an exaggerated impact on the bottom line. The outlook here remains murky, so medium-term operating profit guidance has also been wound back slightly from 6-9% to 5-7% growth. However, Diageo has stuck with medium-term sales guidance, with the group expecting 5-7% growth on this front. And trading across the group's other four regions has remained positive.

In today's inflationary times, Diageo's been leaning on its brand power to help push through price hikes. Last year, the 7.3% higher average prices only led to a small drop in volumes - testament to the impressive catalogue of brands like Guinness, Tanqueray, Don Julio tequila and many more.

Whisky is also in the portfolio and is an especially attractive market because it takes a lot of up-front investment and time for a newcomer to compete. Good whisky needs to be aged, so a new competitor would need to be comfortable waiting for their investment to pay off. Alternatively, they could buy existing distilleries and spend heavily on marketing, but scaling up would be difficult and expensive. Strong brands and barriers to entry have meant attractive margins in normal times.

Diageo's current focus is to premiumise its portfolio, offloading a selection of smaller brands to shift the dial towards sales of more lucrative products. That's served the group well in the past, as consumers willing to spend money on premium brands have tended to be more resilient to cost-of-living pressures. But with volumes beginning to stutter, we could potentially see the rate of price hikes eased this year.

Looking at the balance sheet, inventory levels climbed last year as the group aims to avoid future supply chain disruptions. This has significantly dented free cash flow, as did payments to creditors after higher-than-normal lines of credit last year.

Improvements in the LAC market will be key to future margin expansion but to a large extent, that's outside of Diageo's control. And we can't rule out consumer weakness in other regions while economic conditions remain challenging. The group has a world-class stable of brands to fall back on, but investors will need patience to ride out the uncertainty and there are no guarantees.

Diageo key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 10th November 2023