Diageo PLC (DEO) 2004 Q2 法說會逐字稿

Good afternoon everyone and welcome to the Diageo conference call. I will now hand you over to Paul Walsh and Nick Rose.

Hello everybody and thank you for joining us today. Before I start a word about logistics. I understand a number of you have experienced some difficulty in accessing our announcements on the website. Our results have generated a huge amount of interest and our website has had an enormous number of hits. We've now reconfigured it, and therefore we hope to be able to cope with this additional volume. But I do apologize if any of you out there have been unable to access the announcements at this stage.

What I would like to do today is give a brief overview of Diageo's performance in the past six months, and then basically move into questions.

We are now a focused premium drinks business, and this is the first period and which premium drinks is the sole driver of Diageo's operating performance. Share gains in our most important markets, strong volume growth in our global priority brands, improved performance of our category brands and a good price mix improvement over the period I believe all demonstrate the strength of the business that we've worked hard to create in the last three years. Also in this period, we've delivered improved returns to our shareholders with a further 256 million pounds of on market share repurchases, and you will have noted a 7 percent increase in the interim dividend.

So with that introduction, what I think is most productive is now to turn it over to your questions.

(OPERATOR INSTRUCTIONS) Ricky Sandler (ph).

Can you guys just talk about based on where the equity markets are and your funded status on the pension is what the impact is likely to be in fiscal '05? I know I guess fiscal '04 is kind of set because it's based off the year-end balance sheet, but what are we looking at for next year?

I will ask Nick to take you through that, only to say that we have in these results adopted FRS 17 and we did have a schedule that articulated some of the impact on our results as a consequence of that. But let me hand over to Nick to take that question.

Let me try and do this in a way that doesn't take up the whole conference call. Clearly when we look at the effect of FRS 17, particularly through the P&L, there are two major elements that we will see -- a piece that goes through operating profit, and that largely reflects, if you like, the running costs of the scheme and I think we have signaled in the past the order of magnitude of that. In the full-year it's probably going to be about 110 million pounds. That should remain broadly constant as we go into '05. The second piece that goes through the P&L is obviously the piece that goes through finance charges. That will be more volatile and is made up really of two components -- one, effectively the expected return on our assets, offset by effectively the discount on the liabilities. And the return on our assets is very much governed by the value of the assets at the end of the previous year and the expected return on those assets. And effectively the discount on the liabilities is mostly governed by corporate bond yields, although it also governed by adding another year of liabilities as you progress. When you roll all that up, what that says is that depending on what your assumptions are for where the market will be as we progress through this year, depending on what your assumptions are for where corporate bond yields will be, for instance, that will be the biggest determinant of our charge through the P&L.

Clearly as we sit here today, we know we've had an improvement in the asset value in the pension fund that has effectively reduced the deficit. We know that under FRS 17 that does not come through during the year; it can only come through when you re-look at your balance sheet at the end of the year. So if all other things were to stay equal, we would see a benefit, i.e. a reduced financing charge because of the value of the assets in increasing. We also suspect that we are in an interest rate increasing environment. And again, that will help by applying a larger discount rate to the liabilities. That again will reduce the financing charge.

So as we go into '05 -- which was essentially your question -- we are expecting to see that component of the FRS 17 P&L charge decrease. How much by merely is a function of what assumptions you want to make there. At the moment we would probably say we could easily get 10 to 20 million back in those financing charges, just based on where the deficit is today and how far interest rates have moved today. If that continues along the same trend, it could be more than that. And it is very difficult for me to be more specific because it just depends on what assumptions you want to make around those two variables.

Thank you very much.

Before we move on to the next question, let me just add that in assessing the liabilities we have used a discount rate of just over five percent. Certainly our research shows that there are a number of companies, particularly companies in the US, that use a significantly higher discount rate, and therefore would carry liabilities at a much lower level as a consequence of that. So as Nick said, the underlying assumptions are all-important here, but we do have a very low assumption as it relates to the discount rate on liabilities.

Could we take the next question please?

Barbara Ambres (ph).

Hello. Calling from LDBW (ph). I have a question on restructuring charges. I think there restructuring charges within the operating profit before exceptional items. And additionally to that, in the first half there were exceptional restructuring charges that related to the Seagram acquisition. In the commentary you said that you expected total restructuring payments for the full-year of less than 120 million. Does this refer to the exceptional items or the total?

I will ask Nick to take that question.

Yes, you are essentially right. What we've tried to say is that exceptional charges, if you like, outside of the operating P&L going forward, in our view, should only relate to the tail-end of the Seagram acquisition because we started down a route with the Seagram acquisition of making it an exceptional transaction, and therefore with exceptional charges. Until that is complete, I'm afraid we will still see the tail-end of those kind of exceptional charges related to Seagram going through that exceptional column, if you like.

All others -- and the restructuring in Ireland is the first big example for us -- all others we're anticipating are going to go through the P&L. So the 19 million, if you like, in the operating profit relates to the Ireland restructuring. It is a little unfortunate that in the first half the Seagram amounts that went through the exceptional charges was also 19 million within that total 38 million. And obviously the larger number that you quoted is the piece that relates to Seagram and will go through exceptionals. But once Seagram is finished, this should become a lot clearer.

And Seagram's should be finished with this year's charges, is that right?

There could be a little residual I think into next year, in all honesty. But the bulk of it we are expecting to go through this year.

I think in the first half of the restructuring in Ireland you implied had a negative margin effect. Do you think in the future that any negative charges from restructuring will be countered by savings from former restructurings?

Yes, I think absolutely. This is the first-year where we will be putting I think a significant amount through our P&L and in the full-year we said something like 35 million pounds. In the case of Ireland specifically, it will be next year when we begin to see the cost savings coming through from that restructuring. And therefore as we get into this -- and we did say that we feel we have opportunities to make these cost improvements or efficiency year after year after year -- even though we may be spending thing that kind of amount of money per year, I think you're absolutely right, that we're going to see the savings catch up catch up with the upfront spending.

Now we did say they typically have a payback between eighteen months and two years, so whether by the second year, i.e. next year, we will have fully offset, I am not totally sure. But if you like, once this gets to be a running kind of piece of our business, absolutely we should see that margin dilution that we saw in this first half and we will see in the full-year. We should definitely see that margin dilution be taken away.

The market in Ireland was affected pretty strongly by the excise duty increases. Do you think the market will stabilize next year or what are your expectations for the Irish market? I think the second half you already said you expected to trend more or less to continue.

I think there have been a whole litany of issues which have conspired to force the market to contract at the rate it had in Ireland. Certainly duty is one of those issues. The general lethargy in the economy has also had a contribution. Hardening attitudes around the enforcement agencies towards closing times, etc. has also had a bearing.

And the unknown is the threat of a smoking ban in on premise accounts in Ireland. The introduction date has been delayed and we do not know when it is proposed to be put into place. And we don't know exactly what enforcement issues will be attached to that ban. But it's a variable that will have to get clarified before we can really predict what impact that will have on the marketplace.

I think that we should certainly see a slowing of the decline as we move into the next fiscal. But I suspect for it to fully stabilize, we will be looking at least a year out.

Thank you.

(OPERATOR INSTRUCTIONS) Tony Gleason (ph).

A couple of questions. Could you speak a little bit about Smirnoff? I was a little confused about whether the volume was up or down for starters.

First of all, spirits volume is up and RTD volume is down, which may be the source of your confusion. And let me just get the exact numbers. Smirnoff excluding ready-to-drink was up four percent; including ready-to-drink it was only up two percent. That's including ready-to-drink; four percent excluding ready to drink.

On the press release on page six it talks about Smirnoff volume excluding ready-to-drink was up four percent and on page eight it says Smirnoff volume excluding ready-to-drink was down one percent. Am I mixing something up there?

Yes, the one percent down is the US; the four percent up is global. And a word on the US -- we have taken a price increase. We've taken a price increase because we believe the brand health is strong; the credentials of the brand certainly warrant a price increase; the quality queues (ph) and recognition that the new pack is getting make this and opportune is an opportune time to put that through. When we moved similarly on price about three, three and a half years ago we did see a slowing of volume for about six to nine months and then we got back on the growth trajectory. So we are anticipating that this will take a few months to work through, but nevertheless we're confident that it was the right thing to do given the brand health measures as we are seeing them.

The numbers for the six months are really nice. Can you talk about the margin improvement potential here? Just remind me once again why the US margins are so much higher than the rest of your trading countries.

I'll ask Nick to talk you through the margin expansion. Specifically on the US, I think a lot of the issue is around duty.

I think you will have seen in the first half that we didn't get as much global margin expansion as we have been showing in our recent reporting periods, a little bit because of the one off costs certainly because we did spend eight percent marketing against six percent revenue growth. I don't think anything that we've seen in the first half daunts our expectation that we can get back on the margin expansion trail again, not least of all because one of the strongest components of our business is mix improvement. We continue to see the higher ends, the premium ends of our portfolio do better. And ultimately that is going to help drive margin expansion.

So going forward I think we still see real capability to expand margin. And I think as Paul said, in North America and we do enjoy the best of margin structure just about across the globe and that is because in terms of moving from turnover to net sales and then on down to operating margin, we've got one of the most favorable duty environments. If you contrast that with the market Paul was just talking about -- Ireland -- we've got essentially the worst operating margin structure in Ireland of all of our business, not least of all because of the very substantial tax and duties. So overall, though, we do need to get back and think we can get back on the margin expansion trail.

The other thing I would just add to Nick's point on the US is when you look at our performance in the US I feel very proud of what the team there have delivered. We have got share growth in volume terms, we have got clear volume increase, we have got clear sales increase and we have net sales volume per case increases. So this is a quality result on all counts and I believe we're the only major spirits player that can claim success on all of those four measures.

The 28 percent operating margin in the US, how much further do you think that can go?

We always try and target 50 basis points a year. It doesn't mean we always achieve it, but that's what we would target.

Regarding free cash flow, for the last six months you had 620 million pounds. Do you know off hand what that number would be for the trailing twelve-month period -- free cash flow?

In the same -- for six months a year ago?

That's fine; I could just add them up. I was looking for the trailing twelve-month free cash flow.

We would have to do to a quick sub for you there if you want -- the calendar year cash flow is what you're asking for, isn't it? For January '03 to December '03 -- the figure doesn't just tumble to my mind. What I would say is that if you look at the cash flow in the first half at 620, that was up about to 257 million pounds. Catherine is giving me a piece of paper suggesting that the twelve-month cash flow -- so the calendar year cash flow -- was 1466 million pounds.

Now, I think we have said today that we believe the first half performance puts us comfortably in a position to exceed our 1 billion pound cash flow target. Because we did have certain benefits coming through at the end of last fiscal, i.e. the end of June in '03, that may not be replicable into June '04, I'm not sure you should take 1466 and (indiscernible) based on first-half performance. And also, there will be a pension contribution. And we've said in the marketplace that that will be up to 100 million.

And just final question, can you talk about capital allocation thinking and any reason to stray from your premium drink focus that you've arrived at?

There is absolutely no reason to stray from that focus. We remain extremely disciplined around capital allocation. If you look at the results that we've been able to deliver and our wine business, we have Blossom Hill which is a wine brand we have created that is just become the number one wine brand in the UK off trade; we have Sterling and Beaulieu Vineyards which combined have grown twenty percent in the first half, which I believe is arguably the best performance in the US wine industry. I have no desire, nor does Nick, to invest and over-pay for wine assets. We will continue to look with interest, but we will remain extremely disciplined.

Thank you.

(OPERATOR INSTRUCTIONS) If there are no more questions, I will pass you back to Paul who will conclude the conference call.

Before closing the session, I would just like to make a few remarks.

Our goal is to build Diageo to be one of the world's most respected consumer goods companies. As I said this morning, our strength as an organization are our people, our brands and our performance. We have a leading array of brands in the industry -- nine of the world top twenty -- and we're building the positions of these brands, as evidenced by the share gains that we shared with you today. We have created a well-balanced platform for growth and our global reach is unique. It allows us to balance resources and investment against new opportunities and relative market performance. We are enhancing this platform further by improving our route to market, most notably in the United States, through our next generation growth program. We have created an advantaged capital structure through our focus on premium drinks. Return on invested capital is 17.6 percent, well above our weighted average cost of capital. As these results demonstrate, Diageo is able to consistently deliver shareholder value.

Thank you for your interest in Diageo. Good bye.