Diageo Indicates Worsening Profit on ‘Murky’ Economy (Update2)

Aug. 27 (Bloomberg) -- Diageo Plc, the maker of Johnnie Walker whisky and Guinness stout, indicated a worsening profit outlook for the coming year on concern over the speed and sustainability of an economic recovery.

Operating profit in fiscal 2010 will rise at a “low single digit” pace, excluding currency swings and takeovers, London- based Diageo said today. Earnings on that basis rose 4 percent in the year ended June 30, according to the company, which in February lowered its growth forecast to 4 to 6 percent.

Diageo fell 4.1 percent in London trading, the steepest drop since March 19. The forecast is “appropriate” given the “murky” outlook for the drinks industry, Chief Executive Officer Paul Walsh told Bloomberg Television today. The distiller’s global volumes declined 4 percent last year, with consumption declining in every region except North America.

The “opaque” profit outlook is “disappointing,” Simon Hales, a London-based analyst at Evolution Securities Ltd., said in a note today. “The market hoped to see a repeat of the 4 to 6 percent.” He rates the stock “neutral.”

Diageo shares slid 40.5 pence, or 4.1 percent, to 956 pence in London, erasing this year’s gain. Rival Pernod Ricard SA fell 3.9 percent in Paris.

‘Worst is Over’

“We feel that the worst is over, but were not shouting about green shoots,” Chief Financial Officer Nick Rose said on a conference call today. Rose said he would prefer to provide a lower profit forecast now to avoid a repeat of last year, when the distiller cut its forecast halfway through the year.

Diageo’s net income rose to 1.62 billion pounds ($2.63 billion) in the year through June from 1.52 billion pounds a year earlier, the company said today. That beat the 1.58 billion-pound average estimate of 11 analysts surveyed by Bloomberg News.

“While the economic downturn has affected all markets, the response of customers and consumers has not been uniform and therefore the impact on our business has been varied,” Walsh said in the statement.

In the U.S., where Diageo generates almost 40 percent of earnings, volumes and operating profit were unchanged as distributors began to re-order stock and the company introduced products such as ready-to-pour Smirnoff cocktails. The distiller, which sponsors the New York Yankees with Johnnie Walker and Ketel One vodka, said U.S. distributors and wholesalers cut inventory levels by 1 million cases at the end of the third quarter.

Job Cuts

In Europe, Diageo’s second-largest market, volumes fell 6 percent and profit declined 1 percent, hurt by the weaker Irish and Spanish economies. Diageo’s international unit increased earnings by 10 percent, led by sales of Guinness in Africa.

The Smirnoff vodka maker shed staff in the U.S. and has announced distillery and packaging plant closures at the cost of 900 jobs in Scotland to save 120 million pounds annually by the end of the year and an additional 40 million pounds by 2012.

This year’s planned savings will boost organic operating profit by 4.6 percent, according to UBS AG analyst Melissa Earlam. Diageo’s guidance implies that operating profit excluding the savings “is flat or declines,” she said. Earlam has a “neutral” rating on the stock.

Net sales, which exclude excise duties, rose 15 percent to 9.31 billion pounds last year, helped by 1.1 billion pounds of positive exchange rate movements.

Operating Costs

The gross margin, a gauge of profitability, narrowed 1.5 percentage points due to “the negative mix effect of consumers trading down within brands and the volume decline of higher gross margin segments,” such as Scotch whisky, the company said. Volume sales of Johnnie Walker whisky declined 11 percent.

Operating costs increased by 912 million pounds, mostly due to higher costs for promoting and discounting o make sure drinkers didn’t stray to cheaper brands. The liquor maker increased advertising in the U.S. and slowed activity in weaker markets including Spain, leading to a 9 percent reduction in marketing expenditure, excluding currency swings.

Marketing spending fell to 14.1 percent of net sales from 15.3 percent in the year-earlier period.

Diageo will be “very cautious” about raising prices this year, with any increases in the U.S. likely to be selective, Rose said. Prices are more likely to rise in Latin America, he said.