Diageo plc Goes Head To Head With Pernod Ricard SA

Diageo (LSE: DGE) (NYSE: DEO.US) and Pernod Ricard  are two of the biggest players in the beverage world. In fact, Pernod and Diageo ship around three times as many cases of booze every year than their closest peer. 

But now the two groups are going head to head. Pernod’s ambitious new CEO wants Pernod to overtake Diageo as the world’s largest beverage company.

Room to grow

Pernod’s sales are around a third lower than Diageo’s on an annualised basis but management now wants to change this.

You see, in the past the group has been quite happy to let sales stagnate over the past few years, as management has focused on cash generation and debt repayment. 

Pernod’s net debt hit a five-year low last year and now the group is ready to start growing again. Unfortunately, Diageo’s net debt jumped to a five-year high last year, which putting the group on the back foot when it comes to defending its territory.

Diageo’s net gearing ratio — net debt divided by shareholder equity — stands at 146% while Pernod’s net gearing stands at only 67.4%. That’s a big difference. 

Different strategies 

The two groups are pursuing different growth strategies but in similar regions. Africa and Asia are the two regions where the market has the most room for growth, so Pernod and Diageo are targeting these markets. 

Diageo is going for volume, as exhibited by the company’s acquisition of India’s United Spirits. India is the largest whiskey market in the world and Diageo wants a slice. Meanwhile, Pernod is going down the quality route, aiming for the high-end market with a tactic of “premiumisation”.

And this becomes obvious when you look at the weapons Diageo and Pernod are bringing to this fight for sales. Pernod’s drinks cabinet is full of specialities, such as Absolut Vodka, Malibu, Kahlua and Glenlivet, while Diageo is targeting the mass market, offering brands such as Smirnoff Vodka, Capitan Morgan’s rum and Guinness. 

The best pick 

It’s is difficult to try and figure out which one of these two beverage behemoths will come out on top. Both have similar profit margins and achieve a similar return on equity, although I can’t help but think that Diageo’s high level of debt will hold the company back.

What’s more, Diageo is paying out around 50% of its net income to shareholders as a dividend, compared to Pernod’s payout ratio of 36%.

While a higher payout ratio is great news for shareholders, it does mean that there is less cash left in the business to pay down debt and fund growth. Diageo’s dividend yield of 3.0% may be attractive for income seekers, but it comes at a cost.

The bottom line

So overall, Diageo could struggle to compete against Pernod. The group's weak balance sheet is likely to hold it back. Nevertheless, I strongly recommend that you do your own research before making any trading decision -- you may come to a different conclusion.

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Rupert Hargreaves has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.