Diageo PLC (DEO) 2016 Q4 法說會逐字稿

Good morning, and welcome to the Diageo Preliminary Results Call with Ivan Menezes, Chief Executive; and Kathryn Mikells, Chief Financial Officer. (Operator Instructions).

I will now hand over to Ivan to introduce today's call.

Hello, everyone, and welcome to the call. I'm sure by now you've had a chance to look at our press release and the webcast that Kathy and I did earlier this morning. We're both in London and ready to take your questions.

So with that, operator, let's take the first one.

Olivier Nicolai, Morgan Stanley.

I've got a couple of questions, please. First of all, your margin in Africa was down, particularly in H2, affected by negative mix. How should we think about margins in 2017 in Africa, and particularly what could be the impact from the sharp depreciation of the euro?

And just regarding your FX guidance of GBP370 million impact on EBIT for 2017, could you give us an idea of how much is coming from transactional versus translational?

Thank you.

Hi, Olivier. I'll take the first one then ask Kathy to jump in on the second.

On Africa margin, yes, we were impacted by Nigeria in particular on the margin and in this year's organic. But going forward to your question, I do expect Africa to expand margins going forward and getting operating margin up again. So that's very much in our plans.

And then your question with regard to the impact on operating profit coming from FX benefit, about 70% is translation relative to transaction.

Okay. Thank you very much. And just to follow up on the FX, concerning your hedging profile on FX, should we expect further positive transaction again in full-year 2018; or in other words, issue enough hedge on your transactional -- should we have expected more than GBP370 million for this year?

Yes. Our hedging profile generally, we're at any point in time out about 18 to 24 months, and so that diminishes the immediate impact either positive or negative with regard to transaction, and so we'll still have that ruling off in FY18.

Very clear. Thank you very much.

Sanjeet Aujla, Credit Suisse.

Just a few questions on the US, please. Can you give us a little bit more color on the new agreements you have with your distributors there? What's actually changing?

Also, can you try and help us quantify the price adjustment on Smirnoff? And are you adjusting price anywhere else in the portfolio?

And thirdly, you're talking more positively about margins in the US. I think the message at the Investor Day was not to expect much margin expansion out of that business in the foreseeable future. So what's really changed in there to give you more optimism on expanding margins in the US?

Thanks.

The distributor agreements are basically focused on strengthening our sales executional capabilities. So things like we run the activation armies in the top 40 cities; how we support behind the activation army. Things like more focus on multicultural and a non-premise; more focus on reserve brands.

We're at a point now where our distributor partnerships are strong. We are getting better real-time data on performance. We are aligning supply chains closer so we can really get efficiency in working capital, both for our distributors and for ourselves.

So I'd say it's just raising the game to the next level of execution, and just to me, the key is widening our advantage relative to competition.

On the price adjustments on Smirnoff, I would say we've had to make [back] and state-[wise] adjustments on the [175s] and the [750s]. We've done most of it. There's a little more to do. As you know, Vodka is very competitive.

But the way I would characterize pricing in the US is in FY16, we virtually got no price, but under the surface, we took price on brands like Crown Royal and Bulleit and Don Julio, and we've had to make adjustments on brands like Smirnoff and Captain Morgan.

In FY17, I don't expect us to get much price. Mix is very positive; mix is driving a couple of points of improvement. That should continue. And we will stay on the premium core brands, particularly on Smirnoff and Captain Morgan just to ensure our price premiums are not too high. So I'm not expecting price in the next year as well.

On margins, we have a strong productivity program in North America. There's still -- as you know this is a scale business. It is very efficient, but we see room for more. Supply chains can be run more efficiently. We will be taking tramlining through our product lines, working with distributors more closely. And we're looking at our back office activities, on driving more efficiency there.

The margin picture in North America, from FY12 to FY14, we grew 100 basis points in margin a lot. Last year, we dropped because our volumes were down. In FY16, we grew 40 basis points. I would say the underlying business algorithm should drive some small margin expansion, not as big as it's been in the past years, but at the same time, I would say we are -- this is the market I'm looking to invest.

And you know, in our global productivity program, we talk about two-thirds coming back into reinvestment. North America is going to be high on our priorities to reinvest in marketing once we are confident we can get the returns.

So that's how I would characterize margins going forward.

Many thanks.

Chris Pitcher, Redburn Partners.

A couple of questions. You mentioned how much you'd increased your European sales force by. I was wondering if you could give us some similar statistics on your US business.

And then, you singled out in the presentation scotch; India and the United States as central to your medium-term guidance. Could you give us an idea of what you think the growth ranges are for those three different parts of the business?

Thanks very much.

Hi, Chris. On the distributors' sales force in the US, we've made adjustments. As you know, we got out of the wine business, and so we've had to resize a bit on that. But I'd say it's more than the sheer numbers; it's the redeployment. We've got a 3,000-plus sales force in the US but we're putting more focus on multicultural segments and more focus on the on-premise and on-reserve; and activating in the on-trade and in 3rd space and in the communities in the big cities.

I'd say it's more that; and better data, more disciplined execution, where we've released a lot of capacity by getting out of wine, and we're redirecting that against spirits execution.

The three priorities -- go ahead.

On that, sorry. If I understand how your sales force go to the market, how many of your sales people now would be going and selling the whole Diageo portfolio versus more specialist teams going in and focusing on reserve or whisky and the like? Is that the way it's going? It's become much less of a portfolio approach?

No. I'd say the vast majority in the US are selling the full portfolio. So we do have specialist resources that focus on, say, African American and Asian accounts, or the Korean clubs in California. We've got a very tailored sales force against the opportunities. So it's tailored by channel, by type of outlet, but the vast majority is selling the full portfolio.

Okay. Thank you.

On the three priorities, scotch, as you know, we got it back to flat this year from the decline in the last couple of years. I would expect us to improve that this year. I'm not going to give you a scotch forecast, but you can expect momentum to continue and build.

India, we grew 5% this year. I would expect that to improve. You know our medium-term goal in India is to get to double-digit growth on USL.

And the third was?

The US.

Oh, the US. Next year, we'll grow in line with the market. That's the goal.

When do you think the market will grow?

Sorry?

When do you think the market will grow?

Well, it grew this year at about 4% on spirits in FY16.

Thank you very much.

Yes.

Trevor Stirling, Bernstein.

Three questions from my side, please, Ivan. The first one, concerning the top-line aspiration of mid single digits FY17 to FY19, is that an average across the three years, or such that by the end of FY19 you'll be up at a mid single digit growth?

Second question maybe for Kathy, the overhead drag is of the -- so a good performance on gross margin expansion on the market and savings, but about 110 bps of drag from overhead. Is that something that we can expect to go forward, at least the inflationary element of that?

And the third question my side, Ivan, coming back to US scotch strategy, you mentioned Buchanan's and Johnnie Walker, but single malt seems to be the fastest-growing bit of the US scotch category. What are your plans in malt in the US?

Sure. Why don't I take the first?

The growth rate is the average over the three years, mid single digit.

On scotch malt, we absolutely see this as the vibrant end of the whisky market. We do have stepped-up plans on growing our malt business through -- we're up-weighting our reserve focus in the US significantly. And it's not just malts, it's also super deluxe Johnnie Walker blends as well where brands like Blue Label are doing very well in the US, and I want to really accelerate that momentum as well.

So going into FY17, the team has, I think, quite robust plans against scotch in total, Johnnie Walker in particular, malt strong. And super deluxe scotch I expect to continue to accelerate because that's the very vibrant end of the marketplace.

And I'll now take the question with respect to overhead.

So as you looked at the overhead impact to our margin, about 50 basis points of that was as the result of a bigger bonus accrual effectively this fiscal relative to last fiscal. Last fiscal, it would have been artificially (inaudible) off of what wasn't a great year for Diageo overall.

When you think about the inflationary impact, I'd say overall, we'll continue to have an inflationary impact, but we will be looking to address that in part by getting more productive overall within our workforce. So that impact is going to continue to be there. We'd at least be looking to get partial offsets against that impact.

Thank you very much, Ivan and Kathy.

Thanks, Trevor.

Nik Oliver, UBS.

Two from my side, firstly, on the marketing spend. Another year of good efficiencies there. How should we think about that line going forward? Is there more scope for efficiency, or should we think about marketing spend gradually increasing as a percent of sales in FY17 and FY18?

And secondly, Ivan, just coming back on to your comment on the US market growth. In terms of growing in line with the market, was that a commitment for the full year on average, or by the year end? And if it is the full year on average, just a sense of what are the key building blocks getting us from that 3% depletion rate this year and up to circa 4% next year.

Thank you.

On the second one, I'm not going to give you a decimal point forecast for the US spirit business. We grew 3% this year. It will improve.

Let's face it, we are underperforming the market right now because of the drag of Smirnoff and Captain Morgan. Both of them grew 2% this year. We expect improvement, but it will be gradual. It will be through the course of the year.

The thing I would point to is I have confidence in the momentum in the US which is really coming through stronger execution. Our marketing has significantly stepped up. I spent a week in the US a few weeks back and just went through all the brands and our marketing programs. Very, very strong. The commercial execution, we talked -- I talked about it earlier. It's also stronger. And the distributor alignment against what we want to get done in the on and off trade, in the multicultural segments, etc., is good.

So that's why I feel confident we'll get improvement, but it will be gradual. This is a super tanker, and we will steadily get it better.

Okay. Thanks. And I think in the past, you talked about stabilizing some of the low-end brands as being part of that driver of the sequential improvement. Is that still part of the strategy as well?

That is part of the strategy. So we are -- there's still a drag, the low-end brands. And so Deirdre and the team have plans underway to improve our competitiveness at that end of the market as well.

And then your last question with regard to marketing spend, I thought I'd go ahead and address.

If you look at how we've basically lowered our overall marketing spend most recently, it's come from really getting efficiency out of our marketing spend; so consolidating our vendors, benchmarking our contracts, negotiating better deals using our agencies; you know, more smart ways. That has given us a lot of benefit in the US as well as Europe. We're concentrating that program on Rest of the World, but obviously, we have a disproportionate amount of our marketing spend in Europe, in the US, and so I'd expect we'll continue to get more from that but not to the same degree that we have seen over the last couple of years.

But the place that we're really looking to step up then across the board is I'd say marketing effectiveness. Right? And that's really a set of better tools and data so that we can really use that spend in a more effective manner and therefore get more pounds of revenue for our money.

But overall, I think it is fair to say that given we want to really invest in growth, and two-thirds of our overall productivity savings we're looking to target to invest in growth, that we're not looking to get a lot of incremental benefit on marketing as a percent of sales.

Okay. Thanks a lot.

Thanks, Oliver.

Simon Hales, Barclays.

Two or three questions, please. Ivan, you mentioned earlier you expected African margins to increase in 2017. Does that also apply specifically to the Nigerian market? And I'd just be grateful if you could give us a little bit more detail as to perhaps how you're thinking of dealing with the naira devaluation there. Is there cost savings you can take out of that business? Are you aiming to pass on some of those FX moves in terms of pricing?

And then secondly, not wanting to get bedded down in quarterly trends, but I was just struck by some of the change in trends in Q4 versus Q3 in terms of your sales growth rates getting much better in Africa and much worse in Latin America. Is there anything specific or changes happening in those markets we should be aware of, or is it just comp issues on that?

And then just finally on the US, good to see Captain Morgan back in growth. That 2% growth for the full year, how much of a contribution was Cannon Blast to that?

Let me -- hi, Simon. Africa margins, yes, Nigeria is a big piece of the improvement. We are taking a very aggressive approach in terms of how we manage in the volatility and the challenges in Nigeria; managing our cost base very tightly. We've gone through quite a significant change in that business and organization to get our cost base down. We're managing mix, pricing, local sourcing of materials. So Nigeria will be a contributor, and I am expecting margin expansion out of them for next year.

On the Q4/Q3 trends, I wouldn't read too much. There's some specific things in the phasing of Brazil, etc. Underlying trends in Latin America are good in terms of market share performance; very broad based. Our scotch business is doing well. And in Africa, you've seen our overall beer business is doing well.

Captain Morgan, we had -- OSR was up nicely. Cannon Blast did contribute, but overall, we had, I'd say, a broad-based recovery in Captain Morgan. We were cycling some stuff in Captain Morgan White, etc., but overall, the Captain momentum has improved.

I would not declare victory yet because this is a slight improvement, but our marketing programs, both on the -- we've up-weighted on-premise activities is a lot, and we're seeing in -- the activation army is in the 40 cities where we're back in the on-premise. You can see the uplift coming through on brands like Captain Morgan from the activation army.

So we will continue to work at that. We still need some pricing adjustments relative to the key rum competitor, and most of them were made this year in FY16. We have some more to make as we go into FY17.

So that's how I would characterize Captain Morgan. Encouraging, but not yet where we want it.

Perfect. Thank you.

Andrea Pistacchi, Citigroup.

I have three questions, please, the first one on Ciroc in the US which had a more difficult year. I think part of the problem were the technical issues related to the timing of the launches in H1. But more broadly, if you could give us more color on what you think the problem is for Ciroc and what you're planning to do to address it. You referred to some more seasonal flavors.

Second question, where, please, is the main focus for your innovation this FY17 in terms of brands or categories?

And thirdly, on emerging markets, 3% organic growth about in FY16. There were some technical factors there, some destocking still holding you back in H1. So do you think the underlying performance is a little better than that? And given the macro outlook with some countries probably -- some macro bottoming out in Brazil, Russia, do you expect a -- what do you expect for EMs in FY17?

Thank you.

On Ciroc, you're right. There are -- it was a tale of two halves in the US where in the first half with the shift in the innovation replenishment model we had a big decline. The second half actually had a big increase. Overall for the year we were down 7% in the US.

But the key issue for Ciroc in the US, and it's US specific, is to really stabilize the core and get less dependent on big flavors needing to continuously recruit back the same consumers.

So we're out to build, broaden the franchise beyond the urban market, get the core variant more stable. We have got good plans on the marketing front. We will be taking a differentiated approach from what we've done before on how we broaden and strengthen the franchise. I expect in FY17, we will do better overall on Ciroc in the US.

Outside the US, Ciroc is in an amazing place. You will have seen in our presentation, in the UK for example, we've overtaken the other French vodka competitor who long dominated this market. We are building it in reserve very nicely around the world. So I see Ciroc growing really nicely there.

In the US, we've got to get more resilience and less dependence on big flavors every year, and that's the direction we're taking in our marketing.

On innovation, it's -- I'd say the core direction on innovation is less straight line extension; more innovation that recruits new consumers to a franchise and is more disruptive. So we are redirecting our resources to build more sustainable innovation and less from what we would just call recruiting existing consumers with line extensions.

And it's hard to give you market by market. We've got a pipeline. I'm very confident we will have a strong year in innovation. And the quality of sustainability will also improve because we are putting our resources behind things that will really drive incremental growth and bring new consumers to our brands and less on straight line extensions.

Emerging markets, there is -- underlying business is better, and as we point out, we did have parts of the world where we had -- like in South East Asia where we had taken stock levels down. So the underlying momentum is slightly better than what you see.

And for next year, FY17, what [broadly] would you expect?

Yes. I would say it's -- in total, I would expect to see better, but again, I come back to the strength of Diageo right now is --

You saw 70% of our growth came from North America and Europe last year. So I think the world is volatile. It's hard to predict the pace at which Brazil changes or comes back, or what happens in Russia, parts of -- the pace of recovery in China and international spirits.

So we've got some degree of volatility still out there, but overall, I feel a good ability to drive some degree of improvement. India will be a big factor. India only grew 5% this year. We expect, certainly expect it to do better going into next year, and that will be a big piece of it as well.

Thank you.

Anthony Bucalo, HSBC.

Ivan, just two questions. One, in Africa, are you having the same hard currency shortage problems as everyone else? And what kind of mitigating strategies in the market if you do?

And the second question is a bit more I guess existential in that the US election cycle is usually a rather stressful time. This election cycle seems to be more stressful than any in recent memory. Do you see anything in your US consumer feedback or chatter that indicates that maybe US consumers are feeling a little bit anxious into the election in November? And are you seeing any impact maybe in the on-trade or possibly at the local off-trade level?

I'm happy to take the first question.

We would see the same kind of currency constraints as other companies would see in Africa, but we have, I'd say, gotten much better at getting out in front of these issues. And some of the big actions that we take is to get maximum local sourcing for products.

We actually have introduced a number of new products that are made in country, getting more into mainstream spirits and basically distilling and bottling in country. And so the more of our cost footprint that we can put into those countries, the less issue that we have associated with some of the hard currency constraints that we see. And I'd say that's one of the places that we've gotten much better at getting out in front of and so it hasn't been that big of an issue for us overall.

And is that why you're confident that Africa margins can pick up again next year? Is that part of the positive story there?

A big part of that positive story is what's gone on underneath Nigeria. Within Nigeria, beer actually grew 8% this year. What's gone on in Nigeria has a lot to do with just Orijin.

And if you look at what went on in Orijin, we basically did something very disruptive; we created a new category. A lot of people came into the category initially. We left peak Orijin sales in Nigeria in June, and the decline that we saw year over year in Orijin is really what stressed our margins.

We've seen a little bit of a move towards value brands throughout Africa as well, and so we have a little bit of negative mix, I would say, across the board generally. But it's really the story of Orijin and the fact that Orijin has now stabilized in Nigeria. That gives us very good confidence in terms of improved margins in Africa next year.

Great. Thank you.

Then on the US, Anthony, I'd say the trends we're seeing right now we don't see much change. The spirits category continues to be very healthy.

I think one of the factors, to your point, the on-trade is not as robust as we would like. At-home consumption is still stronger than the on-trade. You've seen it in some of the recent restaurant data coming out of the US.

And that's a good indicator of people's levels of, let's say confidence. But as it relates to the spirits category overall, and including the trends we've seen in July, we feel confident that what's driving the growth there is much more demographics than taste changes than response to consumer confidence, and that's quite a secular trend which will underpin solid growth for spirits. And so we feel confident about the spirits side continuing good growth.

Okay. Thank you.

Stephanie D'Ath, Bank of America.

My first question concerns organic sales growth and your goal to grow mid single digit. Could you maybe speak or develop the trajectory? We have gone from flat to 2%. Consensus for next year is at 4%. Can you maybe comment on that?

My second question is regarding developed markets versus emerging markets. So you were mentioning that EM underlying is actually slightly ahead. Do you expect that to continue to be the case or not? And more particularly maybe on Brazil, Nigeria and Middle East which were driving the performance down.

And then finally, can you maybe develop a little bit on reserve? It has been taking -- driving a lot of growth in your portfolio. How accretive is it on the margin, and where do you see it going forward?

Thank you.

Okay. Maybe I'll take the first couple and throw the third one to Ivan.

With regard to the trajectory in terms of how we see our sales, this year, we had 2.8% organic sales growth, and earlier in the call Ivan said over the next three years we'd expect to average mid single digit.

We consider that to be at the low end 4%, at the high end 6%. You look at where consensus is for FY17 for us and I think it takes that appropriately into consideration.

When we look at emerging markets, a couple of things. So Ivan mentioned earlier that depletions are actually a little bit ahead of where our sales growth was in emerging markets. We did have some destocking in places like South East Asia; also in free trade zones. Specifically within West LAC we would have had some destocking. And so the strength underlying the business in emerging markets is a little bit better than the net sales organic growth that we had this year.

I talked a little bit about Nigeria already. It was down [15%] NSV this year, and that's really attributable to Orijin. Orijin has really settled out. In the last couple of months, we've introduced new products there, Orijin Zero more recently, and we've lapped the most difficult high peaking sales period. And so that will help Nigeria in terms of having an easier comp year over year and an easier comp as the year progresses.

In Brazil, we did see the impact of a big tax increase there effectively in the middle of this last fiscal year. Ahead of that tax increase, there was quite a lot of advance buying. So Brazil was actually up 9% NSV in the first half; obviously down significantly in the second half.

So Brazil's pattern as we look next year will be weaker first half relative to second half as a result of some of the changes that have occurred there in terms of tax. And, obviously, the economy has been weak there as well, but we would expect to see positive progression over the course of the year in 2017.

So that underpins some of our confidence in terms of emerging market overall improvement next year, and India, obviously, is a big market for us, and we'd expect India growth to move up next year relative to the 5% it had this year.

Great. On reserve, Stephanie, the gross margins in reserve are higher, the marketing investment is higher, but the overall contribution is also higher. So this, the reserve business, is accretive from a margin standpoint and, clearly, growing faster is very good for Diageo's margin development.

As you know, in the last four/five years we've doubled this business. It's now about 14%/15% of Diageo. I do see it remaining the fastest growing part of our business. We are investing heavily behind it. Just in the course of the last few years, if you take the top 100 cities in the world, we've doubled the number of outlets in which we're activating reserve. We've put a huge number of reserve brand ambassadors around the globe on our portfolio.

You would have seen in my presentation on the webcast we are segmenting the reserve business into three distinct segments and taking more tailored approaches here. I expect reserve to be a fast-growing business for Diageo and very helpful in the mix impacts on our margins.

It's really a consumer trend that is strong and sustained, not just in the developed world but as much in the emerging world. In Africa, a small base, but we were up 30% on our reserve business. And so you're seeing it really take hold everywhere and I'm really pleased with Diageo's approach and [we are at] advantage in building this business.

Thank you. And maybe following up on that. Could you specify maybe you are taking share in reserve and how you are doing at Group level? I think you were more flat year on year and so it's really (multiple speakers) offsetting --

This year, we didn't, and some of it was driven by Ciroc in the US because of what we talked about earlier. But if you look at us over a sustained period, we have grown share steadily and I certainly expect us to grow share going forward.

So I'd say this year reserve only grew at 7% and it was held back a bit by the US performance and some of the corrections we took on super deluxe scotch in parts of Asia and Latin America. But underlying, I expect us to absolutely grow share.

Okay. And on Scotch, you mentioned about a year ago your inventory, or your production being slowed down a bit. Can you maybe comment on where production inventories and levels are, please?

So we continue to grow maturing whiskies overall and Scotch. We had some adjustments, I would say, within some of our distilleries this year. We had a project with regard to environmental recycling at one of our distilleries that caused the distillery to be taken out of production for a period of time. But overall, our expectation is we're going to continue to grow our maturing whisky stocks against a long-term average, so roughly in a 2% to 3% range, pretty steadily.

Laurence Whyatt, Societe Generale.

A couple on your US spirits division. Can you just explain to us the numbers on Smirnoff? You've taken the prices down as I understand, yet your price mix has increased. Could you just run through how that works on the -- presumably on the mix side?

And secondly, could you give us a bit more detail on Crown Royal and where the growth is coming from? How much is growing in the core and how much is it from the flavor and line extensions? And how many line extensions do you expect that product to be able to do?

Sure, Laurence. Overall, on Smirnoff itself, yes, we have had to sharpen pricing to be more competitive. But the advantage of our portfolio in North America is the overall portfolio has a very strong mix in its favor. So when Bulleit grows 33% and Don Julio grows high single digits and super deluxe scotch is growing fast and Crown Royal is growing fast, all of that is mix benefit while we sharpen our competitiveness on Smirnoff and Captain Morgan.

Sorry. I probably wasn't specific enough on the question. On the -- you've got 1% volume movement for Smirnoff but you've got 2% net sales movement on Smirnoff in North America? Just wondering on that precise price mix and how that works on Smirnoff on its own, not including the other brands.

Yes. We also have -- we've -- it's the mix within Smirnoff. So some of the flavors which we had grown over the last few years, those have -- we've lost some of the cheaper flavors. We've introduced some higher price mixed innovation like Smirnoff Sourced, etc. So it's the mix within Smirnoff that is helping that.

You also have pack size mix that's changing. The 750s in general in the US are much more appealing to millennials than the 175s of old where the growth used to happen a lot more on the 175s. So you've got some of that dynamic.

On Crown Royal, total Crown Royal, I'm pleased to say the base is also strong growing mid single digit, and Crown Royal Apple grew about 15% in the year.

To your point on flavors, we are going to be very careful about how we look at flavor extension on Crown Royal. I certainly don't see this as one where we will keep introducing flavors. We did a limited time offer in the summer for Honey with a limited quantity, but that's to keep news in the category. We will probably do one more flavor.

But what we measure when we introduce a new flavor in Crown is is it bringing new consumers to the franchise, and our innovation approach is really targeted at recruiting more into the franchise and not cannibalizing existing consumers. But it's an area of high watch out and whisky flavor proliferation is not something we believe in.

And Regal Apple, I think, is such a great example of bringing new consumers to the brand because it's brought more women to the brand and it's brought the shot occasion to the brand where it wasn't necessarily participating as richly in that occasion. So it's a great example of bringing new consumers to a brand through an innovation.

And just to follow up on that then, could you give us any more detail on the percentage of women consumers using -- drinking Crown Royal or Apple in particular?

I don't have the percentage off the top of my head but it's a significant movement relative to the [baseline].

Okay. Thank you very much.

Alex Smith, Investec.

I had a follow-up question on FX transaction from earlier; the benefits you expect to see coming through this year and into full-year 2018. How should we think about these benefits playing out? Do we expect them or should we expect them to all fall through to the bottom line, or are there other means that you can benefit from this?

I guess I'm thinking about your competitor positioning in scotch in emerging markets where over the last few years you've been hurt by quite significant local currency devaluations.

And then I had a second question which is a follow-up on Simon's question. And without wishing to be overly obsessed in terms of quarterly sales trends, but I was struck in the US that sales in Q3 were significantly stronger than Q4, whereas last year, it was Q4 that was particularly weak. So I'm just wondering if there's anything we need to be aware of in terms of shipments as we look to H1 this year in North America.

Thanks.

I'll take the first question on FX. Because we hedge our major currencies, when currencies move, either positively or negatively, the transaction effect, it dampens. Right? So it rolls into our P&L over a period of time, and I said we're typically hedging over an 18 to 14-month period.

So if spot rates stayed right where they are today and stayed in that place for the next 24 months, eventually, we would end up at the spot rate. But what happens is we end up moving towards the spot rate more slowly through the transaction impact on FX. And that's why we would expect to see some benefit continue into FY18, but at this point we would not be at all close to fully hedged for FY18.

You then came back to talk a little bit about the scotch portfolio. One of the things I would just mention is overall, whilst Diageo has had the impact of FX over the last couple of years, other competitors have as well with regard to their imported products into emerging markets.

So we always look first and foremost at making sure that our products are priced competitively. While FX moves and that puts pressure on us to raise price, we've got to be competitive in the markets. And so those decisions are really made on a market-by-market level, and we're obviously looking at things like demand elasticity relative to price as we make those decisions as well.

So we'll continue to monitor that situation. If we feel like there is a good trade for us to make with regard to price and volume and how that will impact our profit, we'll make those trades. But we do that in a very detailed basis market by market.

Alex, on the phasing in the US, I wouldn't read -- there's not -- Q3/Q4 is not the issue. There were some comps in Q3. I think what I would look at, and actually all I look at is depletions and what's happening every month, every week, every quarter.

The depletion momentum is improving. We had H2 depletions ahead of H1. And as we finish FY17, we had a tale of two halves in terms of our shipment performance but we're now on a more sustained shipments in line with depletions profile. So underlying business momentum I expect to hold and improve slightly from where we are.

And H2 depletions ahead of H1, would you say your market share trends within that was also better in H2 versus H1?

Market share trends get a little messy, because if you look at NABCA and Nielsen, that's not quite the case. If you look overall, NABCA and Nielsen is about one-third, or a little more than one-third of the market. If you look at independents and on-trade, we're doing better. So H2 depletions were running about [3.1%]. And as I said, we estimate a market at [4%] and we were under [3%] in H1.

So I am encouraged by the momentum but we still lost share in NABCA and Nielsen in H2; more in Nielsen, than in NABCA. And some of that relates back to getting our Smirnoff and Captain Morgan momentum improving; Smirnoff in particular in the Nielsen markets.

Thanks.

Edward Mundy, Jefferies.

Three questions, please. The first is on slide 66 of the presentation pack where you show your ZBB processes by cost line and benchmarking versus other [CPG]. Once you've put through your GBP500 million of cost savings, which quartile would you be in for each of these sub-categories? Would you expect to be in the top quartile, or is getting into the top quartile more than GBP500 million of cost savings?

Secondly, in terms of stock levels, you've taken a lot of pain in the last couple of years from destocking in emerging markets. As you see some growth from new and emerging markets, is there potential for shipments to run ahead of depletions?

And the third question is on Seedlip; clearly very attractive margins given the high price and no excise. How do you think about the prospects of zero alcohol as a sub-category? How big could it be?

Okay. So I'll take the ZBB question. I'd say two things.

So first, clearly, as we target savings over this next three-year period of time, our desire is to move towards the top quartile. That said, ZBB and some of the other things that we're doing are really just about creating a culture of everyday efficiency and effectiveness across every aspect of the business and every line item of expense in the business. And it's really getting that embedded in the culture that will continue to give Diageo benefits, I would say, far beyond FY19.

Benchmarking is a pretty helpful tool in trying to think about costs or an approach in a different way, and I'd expect, three years from now the benchmark will have moved. So this is really about continuous improvement and continuing to look across every aspect of our business to get more efficient and more effective.

On the stock question, there are some technical factors, which you'll see a bounce-back where we had reduced stock levels.

But on an ongoing basis to your question about as the emerging markets come back or scotch gets stronger, we are very focused on really having everyone's eye and measurement and incentives and data around what's selling out and depleting, and really managing the stock levels and distributors very tightly as a result.

So I don't expect us to get back into a position of having stock levels out of line in distributors. We've got rigor, we've got data now, and the measurement systems in the organization are very focused on sell out and depletions, and that's how we incent our people.

On Seedlip, as you know, Seedlip is one of our 10 investments in Distill Ventures where we're backing entrepreneurs who have new interesting ideas. Most of these we don't disclose. So we've got a pipeline of exciting stuff there.

We are interested in this space, and clearly, that is part of why we have made this investment. But to your question on non-alcohol in general, Diageo, we do have plays. Right? We have Guinness Malta in Africa is a big play. We've done Guinness Zero into Indonesia. And in non-alcoholic adult beverages, we will continue to test and expand our opportunities as we see them.

And the Seedlip opportunity attracted us because we do keep a track of what's trending, what's interesting. Today in London's hot restaurants, Seedlip is on the cocktail menu. It's doing pretty well. It's selling for GBP30 in Selfridges; selling very well there. And we intend to be at the forefront of new consumer trends.

And that's all I would say is what we're doing right now. We're experimenting, we're learning, and we're backing new developments in this space, as we are with our other investments in Distill Ventures.

Great. Thank you.

Mitch Collett, Goldman Sachs.

I wanted to come back to FX, and I wondered if the current spot rate remains, by the time your hedges are fully rolled off, how much would the cumulative benefit be.

And then secondly, I wondered, going back to scotch, you've obviously had a difficult couple of years of having to take up pricing in certain markets because of FX. How do you expect that to play out now that isn't a drag?

And then finally, a question I think I asked at the first-half stage. You've obviously had some good savings on marketing. At the first-half stage, I thought the message was that you would step it up in the second half, and it looks like that hasn't really happened. Was there a temptation, perhaps, to reinvest some of the benefit of your savings to try and get your share in the US in particular back to stable?

Thank you.

Okay. I'll start with the FX question. So I mentioned that transaction FX within the GBP370 million was about -- call it 30%, so a little over GBP110 million of transaction benefit. We would get some incremental benefit in FY18 because we have some hedges on right now for FY18 that would roll off, but that is relatively small compared to what we would have on hedges on right now for FY17.

So I'm not going to give very specific FX guidance out a year plus into the future, but that's how I would think about it. So we get some incremental benefit in FY18 but it will be a fraction of what we would have in FY17.

Mitch, on scotch pricing, we're going to manage this very, very closely, and it's very market specific. But the broad principles I would say generally in deluxe scotch and above, I don't see us rolling back price. In standard and primary scotches in certain markets where, if we've got currency benefits and we're uncompetitive, we will make adjustments. But then on the other hand, in so-called hard currency markets, like the US, I expect our scotch margins to really improve.

So we manage it on a global basis. We manage global pricing very tightly. Our goal is to improve equity and improve share country by country, and clearly, with the lens on improving margins over time.

So we don't knee-jerk pricing on scotch. We take a very -- we tale a sustained view of -- even when these currencies like in Brazil and Russia devalued, we didn't recover the devaluations right away. You move slowly. You want to make sure you don't drive consumers away from your category.

So we have a global team that looks at scotch pricing in excruciating detail, and we are making some adjustments clearly where we are uncompetitive. Then, we can benefit and see the return we would get from adjusting pricing because of FX.

Your last one was on marketing savings in the US. Yes. I think if you look at the US, actually, the US is a good example. We got good savings in procurement and efficiencies. However, if you look at our premium core brands in the US, so Captain, Smirnoff, Crown Royal, we increased investment 6% on those brands. If you look at our momentum brands like Bulleit and Don Julio and Buchanan's, we increased investment 16%.

So the real weight against our brands is going up. We're really driving out the inefficiency. We're reallocating effectively. And in the US, we really put our money behind the brands that really need to move the needle, and there's a real shift in weight against those brands.

If I can just come back to the FX side of things, if you do hedge 18 to 24 months forward, I guess I'm struggling to understand why the transactional benefit wouldn't be more material in 18 to 24 months' time. So why wouldn't you have a bigger impact than the GBP110 million you've guided to for FY17? And I guess is the underlying assumption flat scotch pricing behind the transactional benefit you expect?

Again, it's a year-on-year impact. Right? FX is always a year-on-year impact. And so we're going to get a pretty significant transactional benefit this year. And in FY18, at current spot rates, we'll get another impact, but then ultimately, that impact is going to get weighted against what we've already achieved in FY17.

And finally, I'm not going to give specific guidance for FY18. You can ask me about it again in a year's time. It's a year over year, and that's what I'm giving you color against.

Okay. Thank you.

Tristan Van Strien, Deutsche Bank.

I just want to ask a little bit more about India. In particular you -- just three things on that. One, your margin increase was 700 bps. How much of that --? If you strip out the UB share buyback, what is the margin there and how should we think about the margin progression in India the next three years as you're emphasizing growth in that business?

The second one is on working capital. Kathy, you mentioned it in the webcast about the local regulations preventing some of the working capital improvements. I was hoping you'd give a little bit more insight into that and what the opportunity really is around working capital in India.

And then the third bit. You've benefited a bit from excise reductions in Uttar Pradesh. I was wondering if there are any other regulatory risks or opportunities that you're seeing in the horizon over the next 18 months in India, please.

Thank you.

Okay. And so on the first question, the benefit from the UBL share sale was a gain of GBP28 million, so you can think about it in those terms.

On working capital in India, two things. What I mentioned in the presentation was India runs at a heavier working capital NSD rate relative to the rest of the Company. That doesn't at all take away from the fact that there are areas where we can and are improving overall in our working capital efficiency in India as well.

Like the rest of Diageo, as the Company grows, we get a natural headwind in terms of building inventory and building receivables supporting that growth that we then look to offset. Like we get a little bit of benefit on trade credit, but we then have to offset that by getting more efficient, by effectively reducing our working capital days on average. But the growth naturally causes a (inaudible).

On your bit about Uttar Pradesh, the nature of India is you've got ups and downs all the time across the state. And, yes, we do get some gains and benefits, and we are -- our business in UB is strong, coming back strong.

I would say that in the overall context, there's no real change up or down when I look across all the state, but it's something that we obviously stay very close to and manage very tightly against.

Okay. I think we have time for one last question.

Komal Dhillon, JPMorgan.

Just another follow-up on India, particularly on GST. So it seems to be gaining traction, but could you comment on how much pressure would put on USO margins if the bill does become law and what mitigating steps USL can take?

And then the second one on Nigeria. I know it's a relatively small market for Diageo, and you have obviously an easy comp, as you mentioned in [FY17], but just wanted to get an idea of the underlying demand impact as long as the naira doesn't devalue further, and given the discrepancy between the official and black market rate.

Thank you.

On India GST, it's as you point out, yes, it's gaining steam, but it's still in parliament and going through the political process. So really hard to predict as and when it will happen. Also, the timing of implementation is also unclear because this is a massive change and getting all the systems and information in place also will take time.

What are we in the industry doing about it if alcohol was being excluded from GST? We have very detailed work underway on -- the two issues we've got to look at is how do we recover, [trapped access] on input cost; and, B, how do we get pricing flexibility in states which have price control. And both the industry forum and us as a company have got a lot of activity in both of those.

So let's see what happens. We're very closely on top of it and we will manage through the margin impacts of it by working very hard with the regulators and the government to ensure that the industry doesn't suffer.

On Nigeria, the underlying demand is about -- trending at about 5%. You've clearly got stronger growth on the value brands than on the premium segments in beer. And spirits continues to do well at the high end, and we're going into mainstream spirits in a bigger way next year.

Good. Thank you.

So let me just close the call here. Thanks, everyone, for joining. Appreciate you calling in early in the morning, or evening, wherever you are.

To summarize, we're pleased. This was a good set of results. We've delivered on the goals we've set for ourselves. We do have momentum as we go into the new fiscal, and are positioned well to improve our performance again in FY17 and on delivering our guidance.

Kathy and I look forward to meeting many of you on our roadshows, and if you've got any more questions, do contact Kathryn and the IR team. They're all on standby and ready to help.

Thanks again. Bye bye.

Ladies and gentlemen, that does conclude today's call. Thank you for participating. You may now disconnect.