Diageo plc DEO reported preliminary fiscal 2020 results, ending Jun 30, 2020, wherein pre-exceptional earnings per share fell 16% year over year (in local currency). This was mainly driven by a decline in organic operating profit due to the impacts of the coronavirus outbreak. The company’s performance in fiscal 2020 was hurt by the significant challenges related to the coronavirus outbreak in the second half, which more than offset the consistently strong results in the first half.
Moreover, it notes that the lockdowns across the globe have eased, with the return of the on-trade channel, which includes bars and restaurants, in some regions. This has led to a gradual recovery in on-trade volumes. However, restrictions on travel retail continue, which is likely to mar results in the near term. Driven by the significant uncertainty over the pace and the shape of the recovery owing to the pandemic, the company did not provide specific guidance for fiscal 2021.
Nonetheless, it expects organic net revenues to witness sequential gains in the first and second quarters of fiscal 2021 as the on-trade channel further reopens and consumer demand begins to recover. Despite these gains, it expects the results for the first half of 2021 to reflect significant impacts of the pandemic. Although the company predicts sequential volume growth in the first half, it continues to anticipate significant COVID-related impacts and margin dilution compared with the robust performance in the first half of fiscal 2020.
Additionally, the company expects operating margin to improve sequentially in the first half of fiscal 2021 compared with the peak of the pandemic impact experienced in the fourth quarter due to significant volume declines. Notably, operating margin in the fourth quarter of fiscal 2020 was impacted by more than 10 percentage points. Additionally, the company plans to increase marketing investment as demand recovers. Overall, it anticipates sequential improvement in operating margin in the first half of fiscal 2021 as compared with the second half of fiscal 2020.
Diageo’s stock declined 4.7% yesterday, backed by the soft fiscal 2020 results and uncertain view. Shares of this Zacks Rank #4 (Sell) company have moved down 13.8% in the past year compared with the industry’s decline of 25.9%.
Fiscal 2020 Highlights
On a reported basis, net sales and operating profit declined 8.7% and 47.1%, respectively, owing to organic declines. During fiscal 2020, organic sales declined 8.4% as top-line gains in North America were more than offset by declines across all regions.
Notably, organic volumes dipped 11.2%. While the company delivered strong volume growth across all regions in the first half, volume in the second half of fiscal 2020 was largely impacted by the coronavirus outbreak. The volume declines in the second half were primarily due to the widespread closure of bars and restaurants around the world (on-trade channel) and the disruption to global travel.
However, the company delivered a positive price mix of 2.8% in fiscal 2020, which partly offset the decline in organic volume. Price/mix benefited from a strong market mix, with resilience in North America, which is its most profitable segment. However, volume declines across all other regions partly offset growth in the price/mix.
Gross margin contracted 174 basis points (bps) in fiscal 2020, hurt by inflation in cost of goods sold (COGS), slightly negative product mix and lower volume with reduced fixed cost absorption. This was only slightly negated by productivity-led gross margin gains. During fiscal 2020, the company witnessed inflationary pressures from commodity costs, including base neutral spirits in India and agave as well as glass globally.
Moreover, organic operating profit was down 14.4% on soft volumes, cost inflation and unabsorbed fixed costs, partly negated by short-term cost reductions and ongoing productivity benefits. Organic operating margin contracted 212 basis points (bps) in fiscal 2020, owing to soft gross margin and costs arising from the disruptions in the operating environment, partially negated by overhead efficiencies and lower marketing spend in the fiscal fourth quarter.
Diageo generated net cash from operating activities of £2.3 billion in fiscal 2020, which reflected a decline from the last year due to lower organic operating profit, lower dividends from associates, one-off tax impacts and increased working capital use. Furthermore, the company reported free cash flow of about £1.6 billion in fiscal 2020, down £1 billion from the last year.
Notably, the company delivered solid free cash flow of about £1 billion in the first half of fiscal 2020, which was only slightly enhanced by its second-half performance due to operating profit declines related to the Covid-19 pandemic.
Driven by the impacts of the pandemic, the company halted the current three-year return of capital program. In the first seven months of fiscal 2020, through January, it returned £1.25 billion to shareholders through its return of capital program. Further, to reinforce its already solid liquidity, it issued a £2.0-billion bond in April 2020 and put in place an additional credit facility of £2.5 billion.
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