The Risks Of Investing In Diageo plc

Today I am highlighting what you need to know before investing in Diageo (LSE: DGE) (NYSE: DEO.US).

North American growth on the slide

The major takeaway from Diageo’s latest set of financial results last month (as I pointed out in my previous article) was the issue of worsening sales activity in emerging markets, most notably in China.

Although signs of falling demand in key growth geographies is of course a huge headache for the firm, news that Diageo’s key brands are also falling out of favour with drinkers in its established North American marketplace should equally make investors sit up and take notice. The business sources around 53% of group profits from this territory alone.

The beverages giant saw organic net sales here edge 3% higher during the 12 months concluding June 2014, although this indicates the onsetDiageo of a steady yet significant slowdown. And organic volumes actually dipped 1% from the previous year.

By comparison, net sales growth from June 2013 to December advanced 4.6%, while revenues advanced 3.7% in the nine months to March. As Diageo noted, the ‘economic recovery in the US is uneven, and this is reflected in the consumer trends seen in US spirits, with overall spirits category growth slowing and premium and above price points driving category growth.’

Beer giant SABMiller has also noted lumpiness in North America, and its own organic net producer revenues — on a constant currency basis — edged 3% higher during April-June, mainly due to a positive sales mix and higher prices. But like Diageo, SABMiller has also seen volumes decline in recent months, and physical consumption dipped 2% during the period.

Colossal sums needed to resuscitate sales?

In a bid keep sales ticking even modestly higher, Diageo is embarking on an extensive programme of new product launches and fresh innovations across existing brands, examples of which include Johnnie Walker Platinum and Gold Reserve which were wheeled out in the highly-lucrative North American premium market during the past year.

Such launches of course require vast amounts of cash to get consumers to sit up and take notice, and as a consequence the firm’s marketing spend in North America leapt 10% in fiscal 2014.

These hefty sums have failed to arrest declining sales growth in the region, however, and questions have been raised over how much Diageo will have to raise the advertising budget by in order to put a rocket under sales performance. And with revenues in emerging regions also taking a hammering, global marketing spend may have to explode in order to underpin even modest sales expansion.

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Royston Wild has no position in any shares mentioned.