Diageo cautious on deals after ending Cuervo talks

ZURICH Thu Jan 31, 2013 8:40pm IST

A signage is seen on the outside of Diageo offices in west London October 10, 2008. REUTERS/Toby Melville

A signage is seen on the outside of Diageo offices in west London October 10, 2008.

Credit: Reuters/Toby Melville

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ZURICH (Reuters) - Diageo (DGE.L), the world's biggest spirits group, signaled a more reticent acquisition strategy following a recent buying spree, saying it wants to develop its own tequila brand after ending talks to buy a stake in Jose Cuervo.

Diageo will announce details later in the year of its plans for the tequila market after it said last month it would not buy a stake in top-selling brand Jose Cuervo, which has a distribution deal with Diageo due to end in June.

"An organic play is the best entry into the tequila category for us," Chief Executive Paul Walsh told Reuters television.

"The main thrust of our attention will be the creation of our brand, not dissimilar to what we have done with Ciroc," he said, referring to the premium vodka it launched in 2003 and which recorded 62 percent growth in the 2011/12 financial year.

Faced with sluggish demand in recession-hit European economies, Diageo has been snapping up brands particularly in the growth markets of Africa, Asia and Latin America, where it aims to make around half of its turnover by 2015.

That strategy helped the maker of Johnnie Walker whisky and Guinness beer report sales growth of 5 percent to 6.04 billion pounds ($9.5 billion) in the half year to December, as strong demand in emerging markets made up for contraction in Europe.

In November, Diageo paid $2.1 billion for a majority stake in India's largest spirits company United Spirits, and it has also secured smaller deals for producers of baiju, cachaca and raki in China, Brazil and Turkey.

Chief Financial Officer Deirdre Mahlan said the acquisition was on track and she expected a response from the Indian regulator by the end of the first quarter.

Diageo's biggest rival Pernod Ricard (PERP.PA) has said it also plans to expand in the thriving Indian whisky market, but will do so mostly through organic growth, chief executive Pierre Pringuet told Reuters in an interview in November.

Walsh said Diageo would proceed with caution on any future takeovers: "We will only do the acquisitions that we are confident will be accretive to our growth rate and will add value for shareholders."

Walsh declined to comment on whether Diageo will seek a deal with U.S. group Beam (BEAM.N), home of the world's No.2 tequila brand Sauza as well as Jim Beam bourbon whiskey, but told CNBC the company already had a full portfolio in North America.

SWITCH INTO DIAGEO FROM PERNOD RICARD?

Shares in Diageo, which trade at 16.8 times expected earnings to 17 times for Pernod Ricard and 25 times for Remy Cointreau (RCOP.PA), were up 1.5 percent, compared with a 0.4 percent firmer European food and beverage index .SX3P.

"We continue to be positive on the Diageo story due to its strong and resilient business model and its growing exposure to faster growing markets," said Shore Capital analyst Phil Carroll.

"However, we believe market sentiment may be lower in the short-term as the M&A story becomes less obvious and uncertainty remains over the U.S. economy in particular."

Analysts at Canaccord Genuity noted that Diageo shares have underperformed Pernod by 13 percent in the last three months.

"Aside from western Europe, momentum is reassuring, particularly in the light of fears about a recent slowdown in the U.S.," they wrote in a note. "There is scope for a relief rally here, and we would switch into Diageo out of Pernod."

Pernod, the world's no. 2 spirits group that makes Absolut vodka and Mumm champagne, said last month it faced slowing growth in Asia. It reports results on February 14.

Underlying sales in North America, which accounts for around a third of Diageo sales, grew by 5 percent. CFO Mahlan said Diageo was not concerned about the unexpected fourth-quarter contraction in the U.S. economy, in particular a weak December.

"Our team in the U.S. think this was related to the fiscal cliff. We currently don't anticipate a change there," she said.

However, Mahlan said Diageo was not seeing an improvement in crisis-hit southern Europe, where sales fell 19 percent in the period, pulling sales to the region as a whole down 2 percent despite fast-growth in Turkey, Russia and eastern Europe.

She added, though, that results in Europe had been hit by one-off technical factors in Diageo's July-December first half, that should not be repeated in the second half.

Underlying sales in Asia, which accounts for about 14 percent of the total, rose 6 percent, weighed down by a contraction of the whisky market in South Korea.

Diageo reiterated its medium-term guidance - including a targets for 6 percent average organic sales growth - saying its confidence supported a 9 percent hike in interim dividend.

(Additional reporting by Nigel Stevenson in London; Editing by Mark Potter)

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