Diageo: inflation will test the limits of premium pricing strategy

Will high inflation dampen high spirits? On Thursday, FTSE 100-listed Diageo warned of challenges ahead. But there is no sign yet of people losing their taste for upmarket drinks. Sales over the past year rose by more than a fifth.

Previous downturns have dented sales. In the 2008 financial crisis consumers traded down to cheaper drinks for several quarters. Spirits are high-value, slow-moving goods with no sell-by-date. That makes them prone to stocking up in good times, and destocking in bad.

Nervousness is reflected in the share price. This has underperformed the FTSE 100, down 6 per cent this year. The price/earnings multiple has fallen by 29 to 23, though it is still a notch above its long-term average and that of rival Pernod Ricard.

The degree of belt-tightening will depend on the severity of the economic downturn. The average spirit-drinking American household spends a relatively modest $360 a year on liquor. It is not the most obvious extravagance to cut.

Diageo had no difficulties pushing through mid-single-digit price increases last year. Together with productivity savings, they more than offset higher input costs. Diageo is less vulnerable to destocking trends than in the past. Since 2014, it has monitored sales to consumers, not distributors — only replenishing stock when needed.

As a specialist in spirits, Diageo has benefited from a shift in tastes away from wine and beer. Sales of alcoholic drinks, in general, have grown at an annual rate of 4.1 per cent since 2010. Within that, the share of spirits has grown by 9 percentage points to 40 per cent.

Diageo also benefited from a shift upmarket. Its pricier products, such as Johnnie Walker blended whisky, now make up 57 per cent of net sales, up 10 percentage points over the past five years. Sales are supported by heavy spending on marketing, which grew by a quarter last year.

Diageo is well-positioned to take advantage of what appear to be long-term trends. But the darkening economic outlook will take a toll. At the very least, expect the shift towards more expensive brands to slow.