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Diageo: Don’t count out China, U.S. vodka

Inside Diageo North America's Bottling Facility As Company Marks Completion Of Center's ExpansionInside Diageo North America's Bottling Facility As Company Marks Completion Of Center's Expansion
Bottles of Smirnoff vodka.Photo by Bloomberg—Getty Images

Despite recent sales weakness from Diageo’s U.S. vodka portfolio, the company is convinced consumers will keep saying: “I’ll have another.”

The alcoholic-beverage giant has reported full-year sales and profit were stung by weak vodka sales in the U.S. and a broader drop in demand in China, though the alcoholic-beverages giant isn’t dissuaded and sees progress ahead.

Overall, the maker of Johnnie Walker Scotch, Ketel One vodka and Don Julio tequila reported net sales slid 9% to 10.3 billion British pounds ($17.3 billion) for the year ended June 30.

In North America, reported net sales dropped 7% due to weakness from the company’s vodka brands: Smirnoff and Ciroc reported sales declines while Ketel One demand was unchanged from the prior year.

Vodka is by far the most popular spirit sold in the U.S., generating $5.6 billion in revenue for distillers last year and accounting for 32% of the industry’s total volume, according to the Distilled Spirits Council of the U.S. But volume growth has slowed the past few years, as more consumers turn to tequila, bourbon and Tennessee whiskey. Diageo’s results highlighted that divide North America. Don Julio’s sales leapt 22% while Bulleit bourbon posted a 63% jump in sales.

“We don’t see a trend where vodka is going to no longer resonate with the consumer,” Diageo Chief Financial Officer Deirdre Mahlan told Fortune. “The vodka category grew 4% this year in the U.S. Our brands didn’t perform as well.”

Mahlan said while it is “absolutely true that whiskeys are in vogue,” Diageo was pressured by heightened competition and some promotional pricing in the category. More than 200 new vodkas have hit U.S. shelves the past two years, and some of the lower priced brands are using promotions to drive scale. As a result, Diageo says Smirnoff in particular lost some market share as the company wanted to maintain pricing power against its rivals.

Diageo says a better way to read its U.S. performance is to look at how well the higher priced beverages sold compared to more affordable options. Bulleit, Don Julio and the higher priced Johnnie Walker Scotches sold well, while Smirnoff and Captain Morgan rum were pressured as some consumers traded down to lower priced spirits.

Mahlan and other consumer-product companies have in recent weeks called out pressure middle- and low-income Americans have felt as a result of payroll tax changes and an economic recovery that has left those on the lower economic rungs feeling left out.

“I’m optimistic,” Mahlan said. “While you might trade down to a less expensive brand temporarily, when you can go back to a more aspirational brand, you tend to go back up.”

The Greater China region was another area of concern, where sales slumped 33% in the latest fiscal year. Those problems didn’t drastically weigh down Diageo’s overall results, as China generates about 1% of the company’s global sales.

Still, worries of weakness in China always generates headlines. Western-style spirits companies are facing challenges there as they aim to bolster low consumption and limited knowledge about their products. A bulk of China’s alcohol consumption is of baijiu, China’s native alcohol, and so it’ll take time to change their habits.

“As the Chinese consumer becomes more familiar with Western-style spirits, we think there is huge potential for the business,” Mahlan said.

To court those preferences, Diageo later this year is launching a single-grain Scotch called Haig Club, which has a lighter flavor and could be more suitable for the Chinese market. Because many Chinese consumers prefer to drink alcohol with their meals, Diageo is hopeful Haig will be a more suitable pairing.

“It is such early days for [our categories] in China,” Mahlan said. “It is an investment market for us.”