Diageo Will Perform Well Because Of Its Emerging Market Performance

| About: Diageo plc (DEO)

Diageo (NYSE:DEO) is the world's largest drinks and spirits company with a collection of famous brands across spirits, beer and wine, and sells its products in over 180 countries globally. These well known brands include Johnnie Walker, Crown Royal, JeB, Windsor, Buchanan's and Bushmills whiskies, Smirnoff, Cîroc and Ketel One vodkas and Guinness beer.

The company's acquisitions

The company has completed the acquisition of a further 14.98% stake in the leading spirits company in India, United Spirits Limited, and is now the major shareholder with a stake of 25.02%. The consideration for the further acquisition was £344.0 million and has been funded from internal resources. The transaction is expected to be earnings accretive from the second year onwards. The company believes that its position in India will be completely changed in the market which represents one of the biggest growth opportunities in the world today. India will become one of its largest markets and a major catalyst for future growth. Diageo has been on an acquisition spree in emerging markets, having taken over the Chinese manufacturer of baijiu, Shui Jing Fang, the Turkish manufacturer of raki, Mey Icki, and the leading Brazilian cachaca brand Ypioca. These are highly localized products and brands catering to the total population of 1.6 billion people in these countries.

CEO Paul Walsh will shortly be leaving but, in his 13 years in the position, he has adopted an acquisition led strategy in creating the largest premium drinks company in the world and trebling the share price in the process. His successor, Ivan Menezes, takes over at a difficult time in which sales in Western Europe have declined by 4% though this has been offset by 6% growth in North America. Menezes intends to continue the emphasis on emerging markets and believes that the company can hit its objective of generating half its profits from there within three years compared to 40% today.

The brown spirits market

The United Spirits acquisition makes Diageo the largest whisky manufacturer in the world. Scotch is a major contributor to revenues as well as an engine for future growth. In the last year, Johnnie Walker had sales growth of 31% in Africa, 12% in Latin America and 18% in the Asia Pacific region. Clearly, the company has been successful in capitalizing on the increasing demand from the increasingly affluent middle class in the emerging markets. It will invest billions of dollars in new facilities to keep up with the growth in demand, especially since brown spirit consumption in the developing markets is less than the developed countries.

Naturally, the competition is not sitting on its hands. Beam (NYSE:BEAM) completed its acquisition of Irish whiskey producer Cooley Distillery in 2012 to add to its already successful brown spirit portfolio in which Maker's Mark and Jim Beam brands reported 2012 sales growth of 15% and 10% respectively. The more premium products, Basil Hayden's and Knob Creek, performed even better, by achieving 35% and 24% sales growth respectively in the same period. Brown-Forman (NYSE:BF.B) is convinced that strong consumer interest in bourbon will continue and is expanding capacity to meet demand. It has recently announced that it will invest $35 million in expanding production of its Woodford Reserve Kentucky Bourbon, which saw record volume, and growth in global sales of 28% in fiscal 2013. Since it was launched in 1996, the brand has seen annual double-digit growth rates.

The bottom line

I believe there are several reasons why the company will continue to do well. It has well diversified sources of revenue and profits. Spirits make up more than 70% of net sales and yet the biggest category scotch contributes no more than 29% of company sales. Aside from possessing a diverse portfolio of brands, seven of the top 20 premium spirits brands in the world including Smirnoff, the top brand by volume and Johnnie Walker, the top brand by value belong to the company. It also has an impressive geographical spread with 60% of its sales in developed markets and 40% in emerging markets. Emerging markets sales grew by 33% between 2010 and 2013. This puts the company in a strong position to generate growth from the emerging markets by continuing its dominant position in the developed world. If you have no reservations about "sin" stocks, DEO is definitely worth consideration.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.