Term Paper on "Diageo (NYSE: Deo, Lse: DGE) Was Created"

Term Paper 14 pages (3683 words) Sources: 6 Style: MLA

[EXCERPT] . . . .

Diageo (NYSE: DEO, LSE: DGE) was created in 1997 with the merger of brewer Guinness and spirits-maker Grand Metropolitan. The company's major brands include Guinness, Johnnie Walker, Lagavulin, Captain Morgan, Tanqueray, Bushmills, Crown Royal, Baileys, Smirnoff and a number of other beer, wine and spirit properties (Diageo.com, 2011). When Diageo was formed, it had inherited a number of food interests from Grand Met including Burger King and Pillsbury, but in the early 2000s it divested its food businesses to focus strictly on alcoholic beverages (Ibid). The history of many of the companies and brands within the Diageo family dates to the 18th and 19th centuries. Diageo has roughly a 29% share of the premium spirits market. It competes in beer as a differentiated provider and its share of the heavily-fragmented global beer market is considerably smaller as a result.

Diageo is structured on the basis of geographic units. The four main units are Asia Pacific, Europe, North America and International (2010 Annual Report). Within each geographic area, individual nations and brands have their own companies. Within each nation/product company (e.g. Guinness Anchor Berhad for beer in Malaysia) there are units for individual products, and there are divisions that separate the production and marketing functions. Diageo markets in far more locations than it produces. For example its scotch business has production in dozens of sites throughout Scotland, but the marketing of the product is conducted nationally around the world. Key production/marketing units are Diageo Ireland, Great Britain, Scotland, Diageo Brands NV in Europe and Diageo North America. In addition, there are several sub-units dedicated to financing, located in Europe, Britain and the United States (2010 Annual Report).

The board of Diageo is comprised of 11 individuals, seven of whom are non-executive (external) directors and the remainder coming from within the company. Strategic lead is taken by the Executive Committee, which is comprised of a mix of functional managers and regional managers, including executives for marketing, procurement, Asia Pacific, Africa, HR and finance. This team is responsible for steering global strategy for Diageo, with sub-units taking direction from this overall strategy.

There is no "Letter to the Stockholders" section of the 2010 Annual Report, but rather a "Chairman's Statement." In this, the chairman notes that the current operating environment is characterized by volatility. The company responded by making significantly changes to its business, including organizational restructuring and taking steps to reduce the cost base. The Chairman reports that the strategies outlined the previous year were implemented, resulting in "greater efficiencies and stronger performance." He concludes by mentioning that the company increased its dividend to the stockholders.

The audit of the financial statements was conducted by KPMG. It was "audited to the extent required by the regulations." The report was approved by the Board of Directors and complies with applicable UK regulations on governance. The auditor's report is clean -- there are no matters on which to report with respect to the Companies Act of 2006, the IASB and the director's report. The statements are deemed to "give a true and fair view of the state of the group's affairs as at 30 June 2010 and its profit for the year ended," that they have "been properly prepared in accordance with IFRS" and have been "prepared in accordance with the requirements of the Companies Act of 2006 and Article 4 of the IAS regulation" (p.105).

The section concerning management discussion and analysis outlines the performance of many of Diageo's star brands. The company saw the scotch category grow 5% with Johnnie Walker experiencing double digit growth spurred by improvements in the Middle East, Latin America, South-East Asia and the Global Travel segment. Smirnoff, the company's flagship vodka brand, saw declining performance in fiscal 2010, but ultra-premium vodkas improved significantly. Captain Morgan growth was mixed, with weak sales in North America and strong sales in Europe and International. The company distributes Jose Cuervo and saw decline in this brand in North America, a region that experienced weakness overall. Guinness was flat as strong growth in South-East Asia offset declines in Europe. The company struggled with sales declines in Africa as the recession caused consumers to "trade down" from the premium stout segment. Share for Guinness in the core UK and Ireland markets was up, but volumes for industrial beer were down in general.

Regionally, Europe saw a slight increase in volume (1%) but declines in sales as margins were squeezed. This hurt operating profit, despite declines in marketing spending. North America was the weakest market of the year, posting a 2% decline in volume and a 3% decline in sales despite increased marketing efforts. International posted strong gains, with an 8% increase in volume, a 13% increase in sales, all supported with a strong increase in marketing expenditure. Asia-Pacific saw a slight increase in volume (2%), profit (1%) and marketing expense. Overall, North America is the largest region with 34% of total sales; Europe had 28.4% of sales; International 27% and Asia Pacific was the smallest segment with 10.5% of global sales.

The company's strong geographic diversification saw is able to offset weakness in recession-hit countries like Spain and Ireland with strong growth from other regions. The company's product diversification has allowed it to enjoy steady growth even downturns in a number of key regions and products. Lager spurred 10% growth in Africa, for example, and Latin America and the Caribbean both experienced 15% sales growth. Whiskey spurred growth in Taiwan, offsetting rum declines in Australia. Overall, the company's diversified, global approach should be expected to stabilize the business and in 2010 it appears that this was the case.

Going forward, Diageo expects to continue with its broad strategy of providing a range of alcoholic beverages to consumers and continuing with a global focus. The company expects to continue to face challenges in North America and Europe, and has adjusted its marketing expenditures accordingly. Diageo expects to continue as the leading producer of premium spirits, a position it currently occupies with 29% global market share. Its focus will remain in scotch, beer and vodka, but it is expected that Diageo will continue to focus growth on other product lines. The company is focusing its growth strategy on continued marketing efforts, leveraging its distribution capabilities and on new product introductions. Specific markets targeted for their high growth potential are South Africa, China, Vietnam and India.

Part Two:

Diageo's income statement shows improvements in sales in each of the last two years. The company's turnover was £12.958 billion in 2010, up 5.5% from 2009 levels. The company earned £1.743 billion in profit, up 2.2% from the year previous. This translates to earnings per share of 66.3p, compared with 64.5p in 2009 and 58p in 2008. The common size income statement highlights some of the underlying causes of the decline in net profit margin, which fell from 13.89% in 2009 to 13.45% in 2010. The common size income statement can be found in Appendix a.

The common size analysis reveals little change in the company's operations year over year. Diageo saw its excise increase slightly year over year, which is not surprising given that many governments are turning to increased taxation on price inelastic products as a means of balancing their budgets. It is surprising that the increase in excise was not greater. Diageo saw a slight reduction in its cost of goods sold over the past year. There were slight increases in marketing expense, primarily in North America to help overcome slumping sales, but also in Asia Pacific and Africa to support rapidly growing markets. The company's moves in 2009 to reduce operating expenses paid off in fiscal 2010, with operating expenses declining from 13.62% of sales to 13.03% of sales. As a result of these changes, Diageo saw its operating profit as a percentage of sales improve in fiscal 2010. This implies that the reduction in net income was the result of non-operating factors. Tax as a percentage of sales rose from 2.33% to 3.68% in 2010, a jump of 73% in real sterling. As with excise, this increase in taxation was not unexpected as governments seek to increase taxes in order to make up for their budget shortfalls.

The income statement shows that Diageo has increased in size over the past couple of years by 21.7%. This growth has been matched by increases in profit over that same time period. The growth in most expense categories has been more or less in line with revenue growth. The income statement therefore tells the tale of a company in a relatively mature industry that is finding some growth in some markets, but has also maintained its strategic focus on its core businesses. With no major acquisitions or divestitures over this period, Diageo has been able to focus on the steady growth of its core business.

The common size balance sheet reveals a slight improvement in the company's financial situation. The common size balance sheet can be found in Appendix B. Diageo has seen its equity improve… READ MORE

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