(The following statement was released by the rating agency)
MILAN/PARIS/LONDON, April 24 (Fitch) Fitch Ratings has affirmed Diageo plc's
(Diageo) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at
'A-' and Short-Term IDR at 'F2'. The Outlook on the Long-term IDR is Stable.
Diageo's subsidiaries, Diageo Finance BV, Diageo Finance plc, Diageo Capital plc
and Diageo Investment Corporation's senior unsecured ratings have also been
affirmed at 'A-'/'F2'.
Diageo's ratings continue to factor in its leadership in global spirits and its
advantages over other players in terms of breadth of alcoholic beverage
categories, the ownership of large, globally known brands as well as a presence
across all pricing points, particularly premium and above. These aspects are
contrasted by the agency's expectation that Diageo's rating headroom will remain
constrained by M&A spending and other growth-related investments.
KEY RATING DRIVERS:
Healthy Operating Profile
Diageo's strengths are reflected in a high EBITDA margin of over 30%, the
resilience demonstrated by its sales and profits in FY09 and FY10, and its
strong innovation capability, which contributed to improved performance in FY11
and FY12. In addition, Fitch views positively Diageo's geographical spread
across North America, Western Europe and other markets, with an increasing
contribution from high growth developing markets (40% of net sales at FYE12).
Growth Markets Offset Europe
Diageo derives over one-quarter of its profits from Europe, where weak consumer
spending in Western and Southern Europe has been weighing negatively on its
trading performance since FY09. Conversely, good organic revenue growth in North
America and developing markets resulted in strong consolidated revenue growth of
6% in FY12 and a still good 5% in 9M2013, despite an industry slow-down in sales
in Asia since the beginning of FY13. Fitch factors in positively the company's
current investments on long-term growth in developing countries, including the
shift of focus of advertising expenditure, although it expects a temporary
dilutive margin impact from the increasing weight of developing countries.
Weakness in Tequila from FY14
While tequila is a far smaller global category than whisky and vodka, it is an
important constituent of the product offering in the US. Diageo's loss of the
rights to distribute Jose Cuervo from FY14 is relevant from a strategic
standpoint rather than the cause of a material profit reduction. Fitch believes
it could lead Diageo to invest in the development of alternative brands, both
in-house (including expanding Don Julio - a brand it manages through a joint
venture, focused on the super-premium price point) but possibly also through
Manageable Excise Duty Risk
Governments in need of tax income or with policies intended to protect the
health of citizens have increasingly been considering excise increases. Excise
duties are related to alcoholic content and mostly affect lower-priced products.
Therefore, demand for higher-priced products, such as those sold by Diageo,
typically suffers less, as excises and VAT account for a lower proportion of
their retail price. As a reference, in France taxes represent 84% of a 700ml
bottle of vodka that retails for EUR13 but only 52% for a bottle retailing at
EUR25. However, following increases of excise on spirits and beer since 2010 in
Russia, Turkey and France, no increases are currently planned in major European
markets or the US.
Despite Diageo's uptick in M&A spending over 2011-2012, Fitch does not rule out
the possibility of further transactions, be it on developing-world targets, or
on products with scope for global roll-out. Diageo could evaluate a takeover of
Beam, Inc. ('BBB'/Stable), an important spirits company which owns the major
bourbon whisky portfolio and Sauza, the second largest tequila brand in the US.
Gaining Sauza could help Diageo with retaining its leadership in tequila;
however Fitch estimates that a debt-funded acquisition of Beam would cause a
disbursement of well above Beam's current market value of USD8.6bn introducing a
negative pressure on the company's rating.
Additionally, Diageo has a number of minority participations which it mostly
consolidates fully despite only having title to a proportion of their profits.
Fitch believes Diageo is likely to invest in increasing some of its stakes in
these strategic investments, which include United Spirits India. While these
assets remain minor profit contributors, a step up in the use of acquisition
structures with minority participations could absorb Diageo's rating headroom.
Rating Headroom Testing Limits
Over the next two years, Fitch expects cash from operations to be absorbed by
higher working capital and capex outflows in relation to planned increases in
whisky capacity, as well as a regular increase of dividend distribution in at
least the high single digits. Therefore FCF should remain aligned with FY12's
GBP500m (lower than FY10-FY11) despite the increase of profits. This provides
some headroom within the current 'A-' rating and a degree of flexibility for
bolt-on acquisitions despite Diageo's FY13 lease-adjusted net FFO leverage being
likely to reach 2.9x (including the full consolidation of United Spirits).
Positive: Future developments that could lead to positive rating actions
- FFO adjusted net leverage (including put options) on a permanent basis below
- FFO fixed charge cover ratio above 8.0 x
- Continuation of consistently positive, at least low-mid single digit organic
revenue and profit growth
- Free cash flow moving well above GBP600m - GBP700m
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage (including put options) on a permanent basis above
3.0x - either as a result of shareholder distributions / acquisitions / business
- FFO fixed charge cover ratio below 6.0 x
- Organic revenue and profit growth negative or expected to be negative for
three successive six-month periods
- Permanent EBITDA margin erosion by more than 150bps - 200bps caused by trading
- Free cash flow below GBP300m
- Materially adverse regulatory changes causing declines in global spirits
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Fitch Italia SpA
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Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
Additional information is available on www.fitchratings.com. For regulatory
purposes in various jurisdictions, the supervisory analyst named above is deemed
to be the primary analyst for this issuer; the principal analyst is deemed to be
Applicable criteria, 'Corporate Rating Methodology', dated 8 August 2012, are
available at www.fitchratings.com.
Applicable Criteria and Related Research
Corporate Rating Methodology
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