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Diageo plc (NYSE:DEO)

Brunch time call with the Presidents Conference

March 06, 2013 8:00 am ET

Executives

Nicholas B. Blazquez - President of Africa, Turkey, Russia & Eastern Europe Operations

Analysts

Simon Hales - Barclays Capital, Research Division

James Isenwater - Deutsche Bank AG, Research Division

Trevor Stirling - Sanford C. Bernstein & Co., LLC., Research Division

Ian Shackleton - Nomura Securities Co. Ltd., Research Division

Melissa Earlam - UBS Investment Bank, Research Division

Christopher Wickham - Oriel Securities Ltd., Research Division

Jamie Norman

Alex Molloy - Crédit Suisse AG, Research Division

Operator

Hello, and welcome to the Brunch Time Call with the Presidents. [Operator Instructions] Just to remind you, the call is being recorded. I am now pleased to present Nick Blazquez. Please begin your meeting, sir.

Nicholas B. Blazquez

Thank you, and good afternoon, everyone. Thanks for taking the time to join us today. As is customary with these calls, I'll give you an overview of the business in Africa and touch upon the key strategic drivers that support growth now and into the future. And then I'll open up the call to questions.

Before I get into detail on Africa, let me say a few words on the inclusion of Turkey, Russia and Eastern Europe with Africa, which will be consolidated into the regional numbers at the year end. These are markets that share similarities with our African businesses in terms of growth profile and our strategic focus on the emerging middle-class consumer. Turkey, Russia and Eastern Europe will all continue to be managed by the same local management teams. And as we move forward, we will share insights and experiences across these businesses.

Turning now to Africa. I'd like to start by talking about our strategy. We've built superior routes to market in key protocols across Africa, and we have a compelling consumer proposition across categories and brands, which will deliver sustainable growth over the long term. For the past decade, Africa has emerged as a significant consumer opportunity. It boasts some of the fastest growing economies in the world, which together with infrastructural development and more business-friendly environments, will lead to a substantial increase in discretionary spending over the short to medium term. McKinsey estimates consumer spending on the African continent will grow to $1.4 trillion by 2020 from $860 billion in 2008. Opportunities for consumer goods companies with broad brand portfolios like Diageo will accelerate with population growth, urbanization and the adoption of new technologies. This supports premiumization across the consumer spectrum from informal consumers of home brews trading up to branded products due to the significant growth in a number of style outlets where super premium products are becoming ever more popular.

During this decade, we've built upon our strong position, invested in our brands, expanded production capacity, developed route to market and worked with governments and our business partners to enable our business to succeed. At this time, we've broadened our participation in total beverage alcohol in markets where we are already present in. We've achieved this through investing and refreshing our brands, innovating to capture emerging trends or seizing upon new opportunities and developing operational capacity. We've also taken back from third parties the marketing and distribution of our premium spirits brands in key markets, allowing us to make timely, targeted interventions to accelerate performance.

I refer you to the slide Paul presented at the half year results. This demonstrated the inflection point in the performance of Johnnie Walker business once distribution was brought back in-house. Growth went from flat between 2008 to 2011 and growing to over 1/3 in each of the last 2 years. In key markets in which we have no direct presence, acquired businesses and brands, that with the right investment, allow us to compete effectively. The Meta business in Ethiopia, which after a year is exceeding its business case, gives us a fantastic beer brand that has real providence with Ethiopian consumers. After investing in marketing and advertising and putting in the right sales organization, Meta has grown share in an increasingly competitive marketplace.

As I have said before, it is our intention to actively participate in both beer and spirits in the top 10 beverage alcohol markets in Africa, which represents approximately 80% of the total beverage alcohol pool. While competition is undoubtedly increasing in Africa, we are advantaged through our broad brand portfolio across both beer and spirits. We have a fantastic range of international and local brands that cater for every occasion and satisfy for different consumer motivations. Whether it's friends gathering to watch a football -- watch football match with Guinness or toast a celebratory event with a Johnnie Walker Black Label or relax after a hard day's work with a mug of Senator, our products are available at all key price points in a broad spread of locations.

At a market level, we manage the portfolio in different ways depending on the opportunity, the channels and the brand objectives. In Nigeria, we have separate sales and marketing organizations for beer and spirits who are sharing back-office functions. This is in contrast to Ghana and South Africa where we integrate beer and spirits organizations for our premium brands. In Kenya, we have separate sales teams dedicated to the lower-priced Senator Keg and Jebel gin, whereas we integrate premium beer and spirits. It's consistent across our businesses in Africa that we have local teams, which establish fit-for-purpose organizations that seeks to grow beer faster than the market and grow spirits even faster. This tailored approach, together with global standards, expertise and our continued focus on building our supply and commercial organizations with the best local talent mean we are as best placed as possible to win.

Now turning to our first half performance. Organic net sales increased 10% following price increases on key brands and another strong spirits performance. Efficiencies in both supply and demand contributed to an improvement in operating margin of over 180 basis points in the period. This was partly driven by the phasing of our promotional activity this year, but we will continue to grow operating margins in the second half.

Beer continued to benefit from a strong range of -- from a range of strong brands we have across price points, generating net sales growth of 5%. The providence and the strength of the Guinness brand supported price increases despite increased competition in key markets of Nigeria and Cameroon. Our regional beer brands had a mixed performance. Harp in Nigeria faced increased competition from lower-priced products, while Tusker benefited from high-profile sponsorships and innovation, and Senator grew sales through regional expansion.

Spirits delivered another great performance as we continue to invest in the category -- in the development of the category and benefit -- benefited from taking control of marketing and distribution of our key brands. Total net sales for the category grew some 20% during the period with superb performances from Johnnie Walker, which was up 38%, and Smirnoff, up 35%, both of these complemented by great growth in Baileys and in J&B. Developing sprits markets in West Africa have demonstrated very significant growth, and I'm very pleased at the considerable momentum generated behind scotch and vodka in East Africa and in South Africa. Growth in consumer spending and the development of high-end outlets in urban areas supported our focus on reserve brands, leading to a 32% increase in net sales.

While we have demonstrated great strength through our diversity in the half, the emphasis we have placed on world-class standards and controls has also delivered margin improvements. Our shared service center in Nairobi is now up and running, and we have made great progress across our supply sites and in the trade to improve costs, streamline processes and reinvest behind proven growth drivers. As we look to accelerate top line growth, we will continue to explore ways to further embed sustainable efficiencies to provide additional funds to invest behind our brands and support margin expansion.

As the modern African consumer evolves, we have been quick to capture emerging trends with our innovation pipeline. Dubic lager and [indiscernible] Gold have been developed and introduced to complement our consumer offerings in beer in Nigeria and Tanzania, respectively, while Snapp, our female oriented innovation, had been rolled out from Kenya and now is in Nigeria and performing ahead of expectations.

Of particular note have been Ruut Extra Premium, Diageo's first cassava beer launched in Ghana in January. Its introduction was made possible due to the Ghanaian government's progressive policy in local raw materials, which has resulted in concessions on products containing a majority of local ingredients. Ruut Extra is a high-standard clear beer that was developed from concept to launch in Ghana in just 8 weeks, a real testament to the insights we have and a great team we have delivering great teamwork.

I'm also delighted with the early performance of Jebel gin, a sprit innovation launched in Kenya in December at a recommended price of 100 shillings for a 25-centiliter pack. Jebel is an affordable quality spirit that is distributed through the Senator outlet network, leading to sales of 80,000 cases in its first 2 months.

Our commitment to developing our people remains a core driver for our future success. And during the half, we have reviewed our current programs to keep ahead of the curve in leadership development. As we have invested in production and distribution of our brands, so we have built operational capacity to drive growth. More recently, this has been focused on increasing the number of our sales organizations to support the investments we have made in our supply businesses. We've really focused on developing local talent. Whereas 5 years ago, more than 50% of our leadership community were expatriates, Africans now account for 2/3 of Diageo leaders in Africa. We have achieved all this while maintaining our focus on integrating -- we've achieved all these while maintaining our focus on integrating our business approach with the communities in which we operate. In our view, it is a critical license to operate in Africa. After all, the sustainable success of our business is dependent on a healthy and thriving economy.

Local sourcing is an essential part of this. We work with thousands of farmers to secure high-yielding crops for use in our production facilities. In Ethiopia, we've made good progress on turning our smallholder farmer pilot barley project into tangible high-quality input for Meta Brewery, and we have delivered more Water of Life projects in our quest to provide 1 million people with access to clean drinking water every year.

And I was delighted again we have been recognized for our leadership in broad-based development with the accolade of overall winner of the FT's Africa's Beyond Business awards, beating 1,200 other companies.

Now moving to performance at a market level. During the first 6 months, the beer market in Nigeria continued to be challenged as consumers were impacted by high staples inflation, following the removal of the fuel subsidy and the increased cost of energy. Despite the volumes increase -- decreasing by 3%, price increases on the Guinness and Harp brands, efficiencies in trade marketing spend and the excellent performance of spirits led to a net sales increase of 6%. We were also able to maintain share despite increased competition with the focus we are putting on building routes to market, ensuring quality through the supply in commercial organizations and increasing brand visibility in the market.

Spirits growth in Nigeria was very strong with net sales up 78%. Within spirits, Johnnie Walker sales doubled as the brand was supported by the launch of the Johnnie Walker Walk with Giants campaign, sponsorships and sampling events. Baileys also benefited from increased distribution and consumer visibility. The first phase of the capacity expansion project in Nigeria has now been completed, largely focused on our latest brewery, including new packaging capacity, reducing environmental impact and creating a world-class distribution facility. The majority of our Phase 2 of the project will be undertaken this year, totaling approximately GBP 70 million worth of spend. And we'll be focused on increasing packaging and finished goods capacity at the Benin brewery. The project will culminate in a 50% increase in our capacity in Nigeria and some of the most advanced brewing and warehousing sites in Africa.

Elsewhere, we are reshaping A&P spend to remove inefficiencies and focus on our key brands. We're also intending to enhance our competitiveness of our route to market with distributor incentives, rural distribution, continued increase in sales force and reinvestment in trade marketing.

Whilst we expect softness in the beer market to continue into H2 this fiscal, we remain confident in the medium- to long-term prospects in Nigeria, and following our investments in capacity, are dedicating resources in increasing quality and coverage.

In East Africa, the strong performance in beer offset a short-term decline in local spirits to deliver double-digit net sales growth. Beer grew 11%, growth as a result of good performance of bottled beer brands in Kenya and market share gains in Tanzania as well as the geographic expansion of Senator. Spirits also performed well with international spirits serving double-digit net sales growth, led by Johnnie Walker up 38% and Smirnoff up 24%. Last year, Kenya Cane in glass bottles gained significant share when plastic bottles abound in Kenya. However, we are lapping tough prior year comparatives in which Diageo was the only national supplier able to supply glass, which has resulted in a relative decline of 30% in local mainstream spirit brands. Net sales of ready-to-drink brands increased over 50% with the excellent growth of Smirnoff Ice augmented by Snapp following its launch last year.

While we enjoy a healthy position in beer, we have still less than 50% share of the recorded total beverage alcohol market across East Africa. With the informal sector estimated to be about 1/2 of all alcohol consumption, our total portfolio and great geographic distribution approach means we are well positioned to win share and deliver sustainable growth from East Africa.

South Africa was a star performer in the period. Strong growth of Johnnie Walker and Smirnoff, which were up 33% and 36%, respectively, drove 16% net sales growth. Johnnie Walker Red Label performance was driven further by distribution gains of the 20-centiliter bottle and the continued success of the Step Up campaign. Continued investment in customer development and establishment of a dedicated reserve sales force have led to further share gains in the market. Our share of total beverage alcohol now stands at over 20%, making Brandhouse the distinct #2 in the beverage alcohol market in South Africa. The promotional activity on Smirnoff 1818, which led to a 38% growth in the first half will not continue in H2. However, we were encouraged by the government's decision to take a considered approach to excise tax increases in last week's budget with duty -- spirits duty increasing by only 10%.

The good performance in the African regional markets was driven by excellent growth in spirits and solid growth in beer. In beer, net sales growth of Guinness in Cameroon and Ghana was complemented by the November launch of the 33-centiliter bottle of Malta Guinness in Ghana. In spirits, excellent growth of Johnnie Walker in Angola, Cameroon and Ghana drove increased net sales of 26%. Marketing reinvestment increased by 30 basis points, [indiscernible] the expansion in route to market and the growth of our strategic brands.

Overall, this is a strong holistic performance reflecting the market opportunity, a well-positioned business and our targeted investments ahead of specific growth opportunities. We do expect some headwinds in H2, most notably a continued softness in the Nigerian beer market.

As we look out over the remainder of the year, our focus will be on delivering top line growth while expanding margins. You will see an increase in marketing spend as above the line and promotional activity on key brands was phased into the second half. Capital investment will be focused on broadening our routes to market, building spirits and building high-quality execution in beer as capacity comes onstream. We will continue to seek efficiencies in trade marketing and reduced overheads, which we expect to partially offset inflation of raw material inputs.

Before I hand over to the operator, I want you -- to remind you of the reasons why we continue to deliver consistent growth now and we will do so for the long term. Diageo has an unrivaled range of brands. We put the talent, experience and know-how to build and manage brand portfolios to win across beverage alcohol. In Africa, we operate in both beer and spirits. Within each of these categories, we have products in premium, mainstream and value segments. These outstanding brands satisfy all consumer motivations and cater for every occasion. We choose to participate in markets where there is a significant profit pool and where we can sustainably grow our brands and our business.

With that, I will now hand over to our operator. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of Simon Hales at Barclays.

Simon Hales - Barclays Capital, Research Division

A couple questions, if I can. Just firstly, on Nigeria, I appreciate that H2 is going to remain mostly challenged, but we're starting now to lap last year's fuel subsidy removal. I was just wondering if you can give us any color at all on recent trading trends in that market? Secondly, you talked about the introduction of the cassava beer in the beginning of January. Are there any other plans to roll out local brands in other local markets that you can talk about in the near term? And finally, just with your Eastern European hat on, I wondered if you could just mention any thoughts on Turkey where I think [indiscernible] currently being investigated by the Competition Authorities, any update around what's going on there would be much appreciated.

Nicholas B. Blazquez

Okay, you're right. The fuel subsidy was removed in Nigeria last January and we saw a downturn in January, February and March. And we expect actually there to be an increase in the beer market in the first quarter this calendar year. That's actually not occurred as much as we can -- as far as we can see. The trading through December and January continued to be soft and Nielsen still had the market -- it projects the market was down about 4%, 5% in the first half and they're reporting the same in -- for the January period as well. So we continue to see a soft market in Nigeria. Now I expect it will come back and the long-term prospects are quite attractive, although it will take a little bit longer than we were originally expecting. With respect to the cassava beer in Ghana, we're delighted with that. What the government did was encouraged manufacturers like ourselves if we used local raw materials, it would apply a lower duty rate that allows us to launch a brand at a lower price and still make the appropriate margins and capture our sales through that mechanism. We've got quite a good split between international brands like the Guinness and Johnnie Walkers of this world and local brands, Tusker, Bell in Uganda, Serengeti in Tanzania and now Ruut in Ghana. We will launch local brands where there is the opportunity; the recent launch of Jebel gin in Kenya is an example of that. And we've got quite active innovation plans. Senator Keg is a fantastic example of a local brand developed for a specific market. And so we'll continue with innovation program that looks at both international brands and local brands. On Turkey, as you would expect, I can't really comment when there is a current investigation except to say that we are cooperating with the authorities and we do not expect that we would have acted in any way inappropriately.

Operator

The next question is from the line of Jamie Isenwater at Deutsche Bank.

James Isenwater - Deutsche Bank AG, Research Division

Just a quick question really on the spirit side. I'm just wondering if there's any markets where the international spirits portfolio isn't doing well and whether there's still third-party distribution that you got out there that you could possibly take in-house over the next couple of years, say?

Nicholas B. Blazquez

Our international portfolio is doing well everywhere, Jamie, I think, either driven by increased penetration of digital satellite TV, mobile phones, companies -- ourselves driving awareness. And so whether it be Johnnie Walker or Smirnoff or Baileys, these brands are resonating with people, we've broadened their distribution, and as we're doing that, in their markets where we build our brands and distribute our brands ourselves, we're seeing growth, but we're also seeing growth in markets where we don’t distribute our brands. We currently are going through third parties in Angola and in Mozambique and we're seeing some good growth there with those third parties. We've recently established our own in-market company, registered a company in Mozambique. We'll be looking to do the same in Angola to put our own feet on the street. Working with distributors might continue to be a really good way to leverage their broader distribution, to grow those brands. So it's a possibility we'll take those in-house. Equally if the distributors continue to grow the brands at the rate they're growing them and we can join them in that by having greater proximity to the market by our local companies, we will do that, too. At the moment, the growth we're seeing is encouraging and we expect that to continue, Jamie.

James Isenwater - Deutsche Bank AG, Research Division

Great. Just whilst I've got the line, given the elections going on at Kenya at the moment, should we expect softness in that market in the current quarter? I know it's obviously a big market for your region.

Nicholas B. Blazquez

Well, it depends on how things evolve. If -- as everybody hopes, it goes smoothly, then there might be no impact. We'll just have to wait and see. They're still in the process of counting the votes and I think things will become a little bit clearer over the next few days.

Operator

The next question is from the line of Trevor Stirling at Sanford Bernstein.

Trevor Stirling - Sanford C. Bernstein & Co., LLC., Research Division

One question from my side, Nick. I mean, I've seen the huge progress of the international spirits brands all around Africa. But to what extent is South Africa still the big engine and broadly what proportion of spirits in Africa comes out of South Africa?

Nicholas B. Blazquez

In South Africa, our spirits grew really well. I think the total number of -- let me have a look -- of the growth in South Africa, Trevor, is something in the order of, hold on one second, about 20-odd -- something like 14%, I think, they grew in South Africa. Across the patch, however, we grew by some 20-odd percent. And our premium international spirits brands in West Africa grew around 60 or 70-odd percent in different of the markets and between about 30-odd percent in Kenya. So for sure, the South African market accounts for a significant proportion of our international premium spirits brand, but with the rate of growth of the other markets, they're catching up quite significantly. We can provide you subsequently the detail. I think, Johnnie Walker, for example, I know that Johnnie Walker probably at 1/2 of that is in South Africa where they further -- slightly less than 1/2, about 40% in South Africa, with the balance outside of South Africa. So more Johnnie Walker sold outside of Johnnie Walker in Africa than it is in South Africa. Smirnoff, on the other hand, it's somewhat different. About 80% of Smirnoff is sold in South Africa, less outside, again the rate of growth of Smirnoff outside is growing significantly. And we certainly sell more Baileys outside of South Africa than we do inside South Africa. So the Smirnoff brand is over 2 million cases now in South Africa is really huge. It grew very well in the first half, assisted by our promotional activities and our introduction of a 20-centiliter pack, which is going extremely well. So that accounts for the vast majority of Smirnoff in Africa. If you look at other brands that is more distributed into other parts outside of South Africa.

Operator

The next question is from the line of Ian Shackleton at Nomura.

Ian Shackleton - Nomura Securities Co. Ltd., Research Division

Question I have was really -- obviously, you've got the new territories coming into your region. And I know it's very early days, but are there any sort of learnings that you're already making and it's not just in Turkey you're quite big in local spirit. Is that something you can learn -- perhaps make more of that in Africa. I don't know. Are there any sort of learnings, are there any sort of cross-fertilizations you can see across the wider territory now?

Nicholas B. Blazquez

Ian, it's early days, but the way in which Diageo operates is that there's a fairly high degree of connectivity between all of our top 21 markets. And so, this searching and spinning of ideas, learning best practices is something that we do as a matter of course. So there will be a degree of, call it, a proximity between certainly me and these markets. But in terms of sharing a best practice, we have long had a sort of mechanism in place to enable that. That said, there are a lot of similarities. I mean, all of these markets together have similar characteristics in terms of high growth, emerging middle-class consumers, premium international spirits brands resonating. And interestingly, as the May business took over the distribution of the Johnnie Walker brand, since that has occurred, leveraging May's scale we've seen really significant growth with Johnnie Walker in Turkey, which is somewhat similar to us leveraging our beer distribution for Johnnie Walker across Africa. So there are some similarities, but in terms of sharing best practice, fertilize -- cross-fertilizing ideas, we've got mechanisms in place that have been doing that in any event and those will continue.

Ian Shackleton - Nomura Securities Co. Ltd., Research Division

Just as a follow-up. I mean, obviously we've seen some of your competitors now ramping up their spirit business in across Africa. Do you still feel you're outperforming? I know market share is probably very difficult to get in the region. But I mean, are you confident you're outperforming the sort of international spirits category across Africa?

Nicholas B. Blazquez

Yes. If I look at some of our competitors published growth data -- it's supposed to be available to you, too, and then you'll see that our posted growths are higher from what I can see than their posted growth. So from that perspective, I am confident that we are outperforming our competitors. I feel really, and I've said it before but I'll say it again, I really welcome the competition from these international premium spirits brands. What they're doing are kind of [indiscernible] good competitors, they're investing to build the category. And that's driving understanding, distribution, better [indiscernible] quality and so on and so forth. That's the benefit, I think, of the overall spirits category. So that's good and I think that we are well positioned getting our historic footprint of our brands and the scale that we have through our beer distribution units. So I think that beer and spirits, that combination that we have, benefits us. And with the industry investing in a category that'll accelerate as natural growth as the economies develop and more people come into the category, but the increased investment will help grow the category. And as I say, I think our footprint gives us an advantage there. So outside of South Africa, we're using our spirits -- our beer platform to grow spirits. And in South Africa, we're now using our broader beer distribution footprint to help grow spirits. So it's quite a nice combination.

Operator

The next question is from the line of Melissa Earlam at UBS.

Melissa Earlam - UBS Investment Bank, Research Division

Just a couple of questions for me. You mentioned the 10% organic sales growth from Africa in the first half. Should we be expecting that rate of growth to accelerate in the second half and going forward? And then a couple of questions. You mentioned Angola and Mozambique as markets that you're entering in terms of direct participation. Are you going into those 2 markets with a TBA offering or are you going first with beer or first with spirits? And then could you also talk a little bit about DRC. I believe that's a market that you don't, to date, have a direct participation?

Nicholas B. Blazquez

Thanks, Melissa. On the 10% growth, I expect that to continue, have some minor acceleration. I think it depends very much on how the Nigerian beer market evolves and with consumer spending power there and also somewhat in relation to the Kenyan elections. I think that these 2 factors will have a significant impact on our performance. But I would expect, at a minimum, to deliver the 10%, if not a little bit more in the second half. In regard of the market, our game is to increase our share. I think our spirits growth, given the significant headroom and simple distribution gains we have, we'll see spirits continue to grow well across the continent of South Africa and the other markets, and I expect this to continue to gain market share across all our categories as a consequence of our investments in route to market. And indeed, it [indiscernible] of innovations that we will continue to roll out. With respect to Mozambique and Angola, these are -- now that we've got Ethiopia up and running and we've kind of integrated our third-party distribution on spirits in these other markets, our attention really is now on Angola and Mozambique. As I said, we've registered the company in Mozambique. We're seeking to do the same in Angola. We've got some good third-party distributors there and we'll be looking to work with them to see how we can accelerate our performance. Our participation, I think, in the first instance will absolutely be with spirits, building off that sort of strength that we have there. And in due course, if we see a profitable opportunity to get into beer, then we would look at that. But I think our first focus is on spirits and on international premium spirits. With respect to DRC, our Guinness brand is distributed by the BGI group there. And we're enjoying some modest growth there. Our spirits business through a third party actually is growing quite well. I think that in due course we'll focus our attentions on DRC, but we've got our focus priority at the moment really to mostly Mozambique and Angola in terms of expansion and then really start attending to DRC once we've made sufficient progress on the other 2 markets.

Operator

The next question is from the line of Chris Wickham at Oriel.

Christopher Wickham - Oriel Securities Ltd., Research Division

I was just wondering if you can give us what your current estimate is for total spirits consumption in the continent by volume and then what portion of that would be international spirits? And what's the sort of sense of all assumptions you make about the sort of the sweep -- or the share of international spirits within that?

Nicholas B. Blazquez

They're just somewhat difficult to get hold of. And certainly, it depends very much by market. So in Ghana, you've got the spirits in terms of servings, very similar size to beer. In Kenya, it's about 40% the size of beer. So it varies by market. And within total spirits consumption, I think the premium and international spirits, I think, is somewhat less than 10% outside of South Africa. And in South Africa, it's very much largely in our premium international spirits with Bell's being the #1 whiskey, #2 J&B -- Johnnie Walker and J&B. Smirnoff being the #1 white spirit there. So it varies very much by market, both in terms of the size of spirits relative to beer and in the percentage of premium international spirits, that is local spirits.

Christopher Wickham - Oriel Securities Ltd., Research Division

And just a couple of follow-ups. I mean, in terms of infrastructure and doing business, I mean how much improvement are you seeing at the moment? I mean, are we moving at a rapid pace there? And then also what about spirits sort of outside scotch and outside vodka, I mean what scope is still there?

Nicholas B. Blazquez

In terms of the infrastructure -- if you just -- I've been traveling to Nairobi, Lagos [indiscernible] I've been there in the last few weeks, I've been at those countries, most of those cities. And just going around the cities, the transformation in the road infrastructure is very significant. And you see that quite broadly across the continent. And so whilst there's a long way to go for sure and the cost of logistics and distribution are relatively high, it's very visible to see the change. So I think about Internet connectivity, there has been a recent big cable -- probably cable, along the eastern seaboard of Africa that's materially accelerating access rates and the bandwidth in a number of countries. And as a consequence of that, we were able to set up a finance shared service center in Nairobi. So all of our back-office processing now occurs in Nairobi. This was enabled by the improved communications links as a consequence of improved Internet access and so on and so forth. So we're seeing very quick and very rapid infrastructural changes. Now there still is a lot more to do. But the rate of change, I think, is going to accelerate. One of the big issues that still is to be resolved is power in Nigeria. However, the Nigerian governments, recent statements on increasing the power generation and distribution within Nigeria are very encouraging. So I think that we will see quite a transformation in terms of the infrastructure as that will drive down costs and increase access across the continent. Sorry, what was your final question?

Christopher Wickham - Oriel Securities Ltd., Research Division

Just thinking about spirits outside vodka and scotch, I mean...

Nicholas B. Blazquez

Yes, so the growth in Baileys is off a small base, but the brand has doubled in, I think, 2 or 3 years, and it resonates extremely well. So Baileys clearly can resonate. Cîroc vodka, I was in Addis Ababa not too long ago. And Cîroc vodka is selling more in Addis than in many other cities in Africa and quite a material amount. So I think these premium international brands, they resonate as well with African consumers as they do elsewhere around the world. And I think that the penalization that we're seeing occurring throughout beverage alcohol is occurring at the top end as well. We saw our reserve portfolio, reserves comprised of Johnnie Walker Blue Label, Cîroc, Zacapa and higher-priced brands, they grew by some 38% in the first half. And I expect that growth rate to accelerate. So the growth in premium international spirits is across not just scotch or indeed vodka, but across, say, Baileys, but also on other reserve brands. And I think that's good for the category because that halo effect on the top end will benefit the premium brands.

Operator

The next question is from the line of Jamie Norman at Societe Generale.

Jamie Norman

Just firstly to follow up Simon's question, if I may, to press you a little on why you think the Nigerian beer market hasn't recovered in recent weeks as you might have hoped. Is it possibly down to other things on consumer income, like higher food costs? And the second question is a broad one about your addressable markets and that is your estimate of mobile telephone ownership and the extent to which that really does provide a platform for you to advertise your brands, perhaps even more than in other emerging markets?

Nicholas B. Blazquez

Okay, on Nigeria, there've been a number of things that have occurred to suck money, disposable income into other areas. So I've mentioned fuel price subsidy that was reduced by 50%. Electricity prices were increased. Also, recently, there's been some legislation a few months ago which required landlords to rather than having 2 years upfront deposit before you could get rented property, only to have 1 year. As a consequence of that, rents have been put up. That has also really consumed quite a bit of disposable consumer income. So that's just another example of -- the other one, of course, is the amount of spending by regional government -- governors has also been reduced. In fact, the spending is somewhat below the expectations there. And given the importance of this regional spending, that does have a significant impact. So for the short term, for sure, I think that those are some of the factors that are depressing the market. However, you need to -- we look at [indiscernible] concern and we need to deal with that and look to compensate for -- and what are the mechanisms to gain share and certainly accelerate spirits growth, I think a more medium- to long-term view, then this will undoubtedly come back. If you look at the history of the beer market over the last 10 or 20 years, even my short period of time of 8 years I've seen some -- Nigeria goes through peaks and troughs. But if you look at the overall trends, the trend is upwards. And the size of the beer market, I think, when you look at per capita has still got some considerable way to grow, and I think that is evidenced by ourselves and indeed our competitors investing for the future. To us, I think, right now, things have slowed down. We've seen it before. One of the benefits of Diageo has is we've operated in the continent over a long period of time and we're able to absorb this sort of slowdown with accelerations elsewhere like in South Africa and I'm sure we'll be able to do this longer term. With respect to the mobile, the impact of mobile as a potential communication vehicle, you're absolutely right. The incredible growth and penetration of mobile phones and how those phones are being used does provide us with a super platform to grow our brands. So in Nigeria, for example, going back to Nigeria, we have a Guinness VIP program, where as Guinness is the sponsor of the English Premiership feed into Africa, we're able to provide consumers with updates on what's going on in the English football premiership, and provide them the opportunity to text the network with their friends at no cost and bring the Guinness brand closer to them. In Kenya in East Africa, we developed a -- in conjunction with a partner, a TV program that tested people's knowledge and skills in football and then we followed that up by a text engagement with consumers and we got something like 5 million text responses over a few-week period. That told people where they can either access Guinness promotions or win some prizes and so we're using that mechanism in East Africa as a direct way to communicate with consumers. I think that the mobile telephony has leapfrogged fixed-line technology in the so-called developed markets, and likewise, I think the opportunity for us to lead and leapfrog in terms of digital marketing in Africa is very significant and it's something that's very much on our radar.

Operator

The next question is from the line of Alex Molloy at Credit Suisse.

Alex Molloy - Crédit Suisse AG, Research Division

SABMiller talk a lot about trading people up from the informal sector. You seem to talk less about that. Is this less of a focus for you?

Nicholas B. Blazquez

That's a great question. Okay, so let me tell you the Senator Keg story and the scale of that business. And we might talk less about it, but I think we're no less focused on it and I think we've had some considerable success. So in Kenya, we had a significant share of the beer market and a significant share of the spirits market, so where are we going to go for growth? Price up, do whatever. And then we recognized that more than 1/2 of the alcohol consumed was in the illicit sector, which is very oftentimes injurious to health. So we developed a product in the form of Senator Keg, so it came in a keg format. The government reduced the duty on that, initially reduced it and then they eliminated all duty on that, which allows us to sell a mug of Senator at -- it's now 20 shillings versus a bottle of Tusker for 100 shillings. This year, we'll sell more than -- and we launched that about 5 years ago. This year, we'll sell more than 2 million hectoliters of that product. It provided very, very, very significant growth at very acceptable margins given that there's no duty on the product. And it's a really quadruple win. Consumers are able to access a product that's not injurious to health when consumed responsibly where beforehand, their stuff -- the concoctions they were drinking oftentimes resulted in deaths and other illnesses. We train informal outlet bar owners to become formal bar owners, so we're developing the trade. The government's pleased they're getting more corporation tax from us and we're paying far more farmers and we've generated well over an additional $300 million with the sales of this product. So we absolutely have focused our innovation program on accessing the informal occasion. We've been hugely successful and I don't think there's any product from SAB or anybody else, in fact, that's been anywhere near as successful as Senator Keg in doing that. This continues to be a focus for us. And it kind of goes to, what I mentioned earlier, the premiumization that's going across all the beverage alcohol categories. So we're seeing from informal to formal, and with informal people trading up into more premium brands. Our Jebel gin product is also operating at similar sort of levels we've innovated in that space. And the Ruut Extra Beer, because of our discussions with government around the learnings we've got from Uganda and Kenya and Nigeria on local sourcing and growing and using local agricultural products, have encouraged them to follow the same sort of approach. And so we'll be able to afford -- sell Ruut Extra at a more affordable price. So yes, I think some of our competitors talk a lot about these things. I think with Senator Keg, we've got, I think, the clear winner and great example in accessing that market and providing that, as I say, the quadruple benefit.

Operator

The next question is from the line of Andy Boca [ph] at Exotics [ph].

Unknown Analyst

I have 3 main questions regarding your East African operations, more specifically your various African breweries. First, is it possible to get your current operating margin levels in Kenya and Uganda, but also when do you expect Tanzania to break even? My second question is on your spirits activity. Is it possible to know how much of your total volumes sold in East Africa the spirits business currently represents? And the last question is about the intercompany loan granted to EABL. When do you expect the capital to be entirely reimbursed? I'm raising these points as EABL reduced its [indiscernible] dividend in the first of 2013. And I was wondering whether we should assume the company would pay back this loan sooner than later.

Nicholas B. Blazquez

Thanks, Andy. Some very specific detailed questions there. I think some of them I can provide insights into, some of them I can't or won't. In terms of the operating margins, I think you'll get the operating margin details from the annual reports in terms of -- for EABL and we don't provide those margins below that level of detail. However, we are seeing -- we've been in a bit of an investment phase in East Africa more recently. That will continue to -- we'll continue to invest in East Africa and growing our capacity both in beer and indeed in spirits. And as additional capacity comes onstream and then we fill that up, I expect our margins in East Africa, like elsewhere across Africa and indeed the Diageo group, to continue to improve. In terms of total spirits, I think they account for about -- let me just look out, probably about 20% of our business, I can provide you more detail of that later. And in Tanzania, we really are very much in investment growth in Tanzania. I'm really pleased with the share gains we're getting in Tanzania. As with all of these investments, we take both the medium- and longer-term view and we're building our position there to win in the long term. I think our position in East Africa with the manufacturing footprints in all the key markets of Kenya, Tanzania and Uganda, really gives us a super advantage there. With respect to intercompany loans, as and when it makes sense to pay off those intercompany loans, we'll do that. It's quite normal for us across the group to optimize our structure -- our financing structure, and when it makes sense to change that, we'll change that in due course.

Operator

The next question is from the line of Julian Verne [ph] at Investec.

Unknown Analyst

I've got one question on Nigeria again. I can't help being a bit more cynical about the performance of Guinness Nigeria in that period in the light of what we've seen coming from [indiscernible], Nigeria or even the Nigerian breweries even after adjusting Nigerian breweries' performance for the acquisitions you've made there, there seems to be some growth of sorts there as well. So I was wondering why one shouldn't maybe think about issues which has some [indiscernible] having defaulted to other brewers because you've been in a prolonged period without adequate capacity on issues related to that. That would explain why the performance, especially in the first quarter, was very disappointing. I have a question about the model of Diageo in Africa when it comes to selling spirits alongside beer. So I understand that, for instance, [indiscernible] you do sell spirit and beer in the same business unit, and in Nigeria it is not the case. So I was wondering whether it's going to be some rotation as far as Guinness Nigeria is concerned where we'll see the 2 legs of the business in that [indiscernible] or will you keep them separate. And then the last question is about the development of Diageo's business in East Africa. So I know that, for instance, if you look at Ethiopia, EABL was not involved while in Serengeti acquisition EABL was involved. When I look at new pastures such as Southern Sudan, Burundi or Rwanda, maybe, I don't know, whether you will go with the EABL or without the EABL or will you go directly alone without involving the EABL?

Nicholas B. Blazquez

Okay. Good questions. On Nigeria, I think without question, we were capacity constrained up until about, I think, 9 months ago. Prior to that period, we'd gained about 3 market share points as a consequence of our relaunch of Harp, Harp going very well. And then we hit the buffers. We actually grew ahead of our expectations. The capacity we had planned came on therefore a little bit late. The Harp story is another good story. I think 6 or 7 years ago, that brand was 147,000 hectoliters in terms of annual sales. This year, I think we'll do well over 1.5 million, 1.6 million hectoliters, showing the great innovative skills that we've got. However, the reality is it grew faster than our expectations. As a consequence, the capacity we had planned came in a bit later. And without question, that sort of flat share was given in part by not having the capacity. We've now got that capacity, and therefore, I anticipate us to grow share going forward. Do I think that the -- that has had any long-term effect? No, I don't think so. For sure, at the time, it was not ideal, but I think we'll kind of absolutely recover from that. And I think we are recovering from that. If I look at the Nielsen data -- and again, Nielsen data is not -- one needs to look at it knowing that the absolute market size of Nielsen is not sometimes very accurate in some of these markets, I don't think. But the share trends are relatively accurate. If I look at the share trends, then more recently we'd been holding share flat. And in fact, in the last period we've gained a modest amount of share, which is encouraging. So I think that will come back. With respect to is Nestle's performance better than ours, and actually is our statement around consumer disposable income is that consistent with what you're seeing elsewhere. If I look at the other beverage alcohol players and indeed other consumer goods companies, both in the beverage space and in the foods space, which is something that we do to see how we're doing, I'm confident that we're not lagging the mark in terms of our overall consumer market in terms of our performance. With respect to beer and spirits, you rightly said that in Kenya for our premium international spirits, the sales force carries them together. And in fact, they go on the same trucks together where our distributors carry them the same. In Nigeria, we've kept the sales organization separate at this stage, sales and marketing organizations separate. And the reason for that is that there's -- one needs to get the balance between -- one needs to look at the channels of trades to see whether there's much overlap there and need to get the balance of focus versus a broader portfolio. And at this stage in evolution of that business, with the spirits business, and indeed, the beer business, there's plenty of share gain opportunities for us in Nigeria on beer. And we really do need to build a bar-by-bar [indiscernible] that spirits business. And therefore I'm very keen to paying the focus and nurture this -- it's quite a big business, I think it will be about 300,000, 400,000 cases, a little bit more this year on Nigeria. I want to nurture that at this stage. And then, once you've got it more broadly established, then to integrate it, I think, there are certain channels into beer. So it is a channel dependent question, a state of market evolution question and really are we best focusing or using the breadth of our portfolio. In Ghana, as I mentioned, we have an integrated beer and spirits sales organization and that really works well. So it really is dependent on the brand, the category development channels and the organizational capacity. With respect to East Africa, you're right, that Diageo acquired the Meta breweries in Ethiopia directly whereas EABL acquired 51% of Serengeti breweries. Why was that? And the simple answer is if you look at the broad -- the brand distribution, in East Africa -- in Eastern African community, which comprises Tanzania, Uganda, Kenya, Rwanda and Burundi, the Tusker brand, mostly that's a single trading market and we're moving towards the premium of service and goods across that single market. And that really does provide opportunities. It is why I think that we're well positioned when you look at our brand, our breweries, our distribution locations. The Tusker brand really is a very successful Pan-East African brand, it was already doing extremely well in Tanzania. We terminated the contract with SAB and we brought that into the Serengeti breweries business. A lot like pilsner, it used to be very significant in Tanzania, it will be again. And Guinness had been in Tanzania and doing very well in Uganda and Kenya and it will do well in Tanzania. So because of EABL brands' footprint, it made sense that EABL participated directly in Serengeti. Were we to expand and we are expanding into Rwanda and Burundi, we've got our own salespeople now in Rwanda and Burundi. That's an EABL-led thing because it's the EABL brands that are driving that. Ethiopia is quite different. They were no EABL brands in that marketplace. The brands that we're selling there were our spirits brands and therefore it made sense that Diageo participated directly into that market. The Ethiopian authorities were very pleased and keen to have a British company participate directly in that regard. And therefore, it made sense that Diageo participate directly. With respect to Southern Sudan, the Bell brand is doing well there. That's an EABL brand and EABL has set up a company in Southern Sudan and we will continue -- I think we've got 56% market share. We've chosen to go down the export model for a variety of different reasons, enjoying that market. If and when the time is right, we will consider investing in capacity there and that will be an EABL business.

Operator

And there are no further questions at this time. I return the conference to you, Nick.

Nicholas B. Blazquez

Okay. Well, that was a good set of questions. I hope you found it interesting. I certainly did. And just to summarize, I think that Diageo is well placed in Africa. It is a very attractive continent. We've got a very broad distribution, a broad set of beer and spirits brands at different price points, making available for different consumer motivations and all occasions. We take a very much a beverage alcohol perspective and target where we can best meet consumer needs, and indeed, win. And we have delivered sustainable growth over the last few periods, and I'm fully expecting that to continue going forward. So with that, I'll say thank you for joining the call, and don't hesitate to contact us if you require further information. Thank you.

Operator

Ladies and gentlemen, this now concludes our call. Thank you all for attending. Participants, you may disconnect your lines now.

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