How to align shareholder interests with societal benefit is one of the biggest challenges facing corporations today, and Diageo has come up with a solution of sorts. Its management will be rewarded in part on what schoolchildren think of a visit from a touring theatre group sponsored by the company’s distilleries.
Details of a new executive bonus scheme provide one of the more interesting aspects of Diageo’s 2020 annual report, published earlier this month. The maker of Smirnoff vodka and Guinness stout has added environmental, social and corporate governance (ESG) measures to its long-term incentive scheme alongside the more conventional financial metrics. ESG targets will account for 20 per cent of rewards and will include “positive drinking”, as measured by “positive attitudinal change on the dangers of underage drinking following participation in the Smashed education programme”.
The benefits of moderation always get a page or two in Diageo’s annual reports. The latest edition explains that drinkers “are seeking new experiences and higher quality products” so will want “brands and categories that stand out for superior quality, authenticity and taste”. The catchphrase “drink better, not more” appears regularly as Diageo seeks to impress on investors a slogan more ESG-friendly but perhaps less honest than the one said to have been offered to the company by Irish poet Brendan Behan: “Guinness, it gets you drunk.”
Might it be time for the more straightforward approach? Diageo is the European large-cap liquor sector’s worst performer in the year so far, falling more than 20 per cent while Pernod Ricard slid by a more modest 8 per cent and Campari was little changed.
Diageo’s recent suffering reflects its reliance on the European leisure and hospitality industries, which in normal times provide about half of net sales. Lockdowns have been ruinous for its beer business, which accounted for 15 per cent of revenue last year, and unhelpful for defending market share in the spirits categories. Sales of the company’s Johnnie Walker whisky were down 40 per cent in the six months to the end of June as airport duty-free shops emptied and customers in emerging markets went for cheaper alternatives.
Rivals have coped much better. Shares in France’s Rémy Cointreau are up more than 26 per cent this year as sales of cognac for at-home consumption soared, particularly in the US. Brewers such as Heineken have also outperformed Diageo, having stepped up their grocery promotions when the pubs were closed. Flagship brands such as Captain Morgan rum and Bailey’s cream liqueur are neither luxury nor especially cheap, however, leaving Diageo stranded in the middle market.
Its weakness also reflects a dependence on gin, UK sales of which have more than quadrupled by value over the past decade. Diageo has a near 50 per cent share of the UK gin market and Gordon’s Premium Pink has powered much of its organic growth in recent years. But industry data suggests UK gin sales growth peaked in 2018 and the global market remains tiny. Diageo’s purchase this month of the Aviation American Gin brand from actor Ryan Reynolds at a price of up to $610m, or 22 times annual sales, suggests a company running out of ideas.
Recent history is not an endorsement of Diageo’s “total beverage alcohol” strategy, which seeks to deliver consistent growth through the economic cycle with a broad brand portfolio. But then, complexity is not the same as breadth.
Guinness breweries have few synergies with Diageo’s spirits operations in mature markets and its Indian and Chinese operations are hobbled by listed subsidiary structures. There is also what appears to be an increasingly fractious relationship with French luxury group LVMH over their Moët Hennessy venture. The recent share price weakness makes a case for simplification, even if current management does not.
A more subtle theme than ESG runs through Diageo’s 2020 annual report. “Succession” gets 11 mentions, more than twice the number in the 2019 update, and the board has updated job descriptions to give a clear separation of duties between the chairman, chief executive officer and senior independent director.
That puts the focus on Ivan Menezes, Diageo’s CEO since 2013. Over his tenure Diageo has consolidated its position as the world’s biggest distiller while improving margins and boosting shareholder returns. A share price gain of around 30 per cent over the past seven years is well ahead of the FTSE 100’s performance. His 2020 bonus — shares and options equivalent to five times base salary — can be justified on conventional measures alone.
But Diageo’s shape no longer has the look of a defensive workhorse, and Mr Menezes is yet to show any signs of being a reformist. If performance remains drab, investors would be forgiven for welcoming some fresh thinking and straight talking in addition to the new-found virtue.
