Diageo leads Pernod in race into emerging markets

LONDON Sun Jun 10, 2012 10:40am EDT

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LONDON (Reuters) - British drinks giant Diageo (DGE.L) is leading the race into emerging markets ahead of French rival Pernod Ricard (PERP.PA) and looks set to be first to get half its sales from these growth areas as it serves drinkers from Moscow to Mumbai.

While Diageo has been snapping up producers of baijiu, cachaca and raki in China, Brazil and Turkey to drive sales in the world's fastest growing economies, Pernod is hamstrung by massive debts taken on four years ago to buy Absolut vodka.

Diageo's next goal is a firmer grip on the world's biggest tequila producer, Jose Cuervo, which would provide important access to the emerging Mexican spirits market and a stronger offering there to go with its Johnnie Walker whisky and Smirnoff vodka brands.

Both rivals make around 40 percent of their sales in emerging markets and analysts expect Diageo to be first to hit the 50 percent mark boosted by recent deals, while Pernod admits it is some time away from joining the serious acquisition trail.

Diageo Chief Executive Paul Walsh says he is seeing faster growth in emerging markets than his rivals driven by buoyant Scotch whisky sales and expects to meet his target to get half group sales from these fast growing markets by 2015.

"We are absolutely on track. I will be personally disappointed if we do not get there earlier," he said, stressing growth was coming from a wide range of emerging markets, giving him confidence that this performance was set to continue.

The London-based group is tapping into the strong growth in local spirits sold for under $10 a bottle which make up 80 percent of the worldwide spirits market, and which also gives it a distribution base to introduce its top international brands.

Diageo's sales grew in the last half of 2011 by 8 percent while those in emerging markets were up 18 percent and set to be boosted further as it bought Turkey's Mey Icki for 1.3 billion pounds ($2 billion) and a stake in China's Sichuan Shuijingfang (600779.SS) last year, and Brazil's Ypioca earlier this year.

"Diageo is in an aggressive acquisition mode as it sees the growth to be had from these local brands and we would expect it to get to the 50 percent level before Pernod," said one investment banker who has knowledge of both firms.

Diageo is looking at a potential listing of its shares on the Hong Kong stock exchange to help boost its expansion plans in Asia, a company spokesman said.

HIGH DEBTS AT PERNOD

Pernod's Chief Executive Pierre Pringuet has ruled out big acquisitions over the next year as the company cuts debts after buying Absolut owner Vin & Sprit in 2008 for 5.7 billion euros ($7.2 billion), but expects to hit the 50 percent mark in 2-3 years.

He says its debt/EBITDA profit ratio at end-June 2012 should fall to 3.9 times but it will need to get to 3 times for him to consider big acquisitions, while Diageo has more flexibility for deals as its debt/EBITDA ratio stands around 2 times.

Pernod's 9 billion euros ($11 billion) debt at end-June 2011 and hefty interest bill limited its free cash flow to 910.6 million euros ($1.1 billion), while Diageo with 6.5 billion pounds ($10 billion) of debt had over twice the cash flow at 1.7 billion pounds ($2.6 billion).

While Diageo spends its cash in the emerging world, it is also tapping into the trend for affluent young professionals in Asia, Latin America, Africa and eastern Europe to get a taste for international spirits such as Scotch whisky.

Analyst Chris Pitcher at brokers Redburn said Diageo is entering a new era of sustained growth helped by its global leadership of the fast-growing Scotch market and expects half of Scotch industry sales this year to come from emerging markets in what he sees as a third golden age for Scotch whisky.

"After late-Victorian Britain and the U.S. post World War Two, there are solid foundations for the current super-cycle," Pitcher said.

Scotch is the world's biggest international spirits category and business is booming, especially in the BRIC nations of Brazil, Russia, India and China where drinking whisky has become a status symbol among the growing middle classes.

These affluent young professionals are developing a taste for Scotch and quickly moving upmarket to the more expensive single malt and luxury blends, driving Scotch industry sales up 14 percent in the last six months of 2011.

Both Diageo and Pernod, who control over half the industry, are investing heavily in production back in Scotland to meet the expected strong demand. L5E8H60YK

What could push Diageo further ahead in the race for emerging market sales is a deal to take a minority stake in $3-billion-plus Jose Cuervo tequila, which would lead to it taking control eventually from the Mexican Beckmann family.

Diageo distributes Cuervo in most markets outside Mexico in a deal which ends in June 2013 and Diageo's Walsh is determined to get a better deal for Diageo, while the Beckmanns need Diageo's global distribution. Sources close to the situation say a deal is expected between the two groups during July.

"Diageo needs Cuervo and Beckmann needs Diageo," concludes analyst Pablo Zuanic at brokers Liberum Capital.

(Reporting by David Jones; Editing by Giles Elgood)

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