Risks Management of Diageo PLC

Introduction and Background

Diageo is a public limited company incorporated in 1886 which is based from the United Kingdom. The company was entitled as Diageo from Guinness plc from 1997.Diageo handles food beverages and tobacco sector, listed in the LSE (London Stock Exchange) have a market cap. of 86,928 mil USD (on 22/11/2018). The company is in a premium drinks business with a huge collection of international brands like Smirnoff vodka, Johnnie Walker Scotch whiskies, Guinness stout, Captain Morgan rum, Tanqueray gin, Crown Royal, Beaulieu Vineyard. Diageo is listed in both LSE and NSE (New York Stock Exchange). Currently, the company is selling their products more than 180 countries in the world (Diageo, 2018). There are many popular brands which are associated with the global business. Currently the company is operating in the five regions in the world such as North America, Europe, Russia & Turkey, Africa, Latin America & Caribbean and Asia Pacific (Diageo, 2018).  The global reach makes the company rich in terms of operation and profit generation. This clearly shows that the company is focusing towards the development of market portfolio and reputation. The firm also owns top five largest spirits brands in the worlds and top 20 largest spirit brands over the world. Diageo plc must deal with various currencies (such as Euro, Dollars, INR, Chinese Yuan etc) in the international trade (Diageo, 2018). Diego has changed its finance leadership style to protect the profit margin for the global investors. The firm is growing in the international market with various respected product. The culture and the performance in terms of ability movement have changed the sustainable performance of the firm. These are the primary reasons to invest in the company.

According the views of Hopkinson (2017) the key attractions for FDI for a company are low wage rate, labour skills, transport and infrastructure, economic size etc. These key factors are the centre of attraction for foreign investment for Diageo plc. The firm may be interested in investing to the international market. This will give them opportunities to explore the various countries.

Five-Year Trend Analysis

             Net sales % share by 5 region of Diageo plc from 2013-2017

2017 2016 2015 2014 2013
North America 34.7 34.1 32.2 34.4 37.3
Europe, Russia and Turkey 23.4 24.3 24.4 21.7 22.2
Africa 13 13.4 13.2 20.7 22.8
Latin America and Caribbean 8.7 8.3 9.6 11.4 14.6
Asia Pacific 20.2 19.9 20.6 13.5 16.7

(Source: Diageo plc annual report)

        Net sales % share by 5 region of Diageo plc from 2013-2017(Graph)

(Source: Diageo plc annual report)

The above graph represent that North America has a good position compared to other regions because of the increasing trend. On the other hand, the Latin America and Caribbean has a decreasing trend in terms of sales in the global market in 2017. Asia pacific region is also improving in 2017. There is a significant drop in the trend line of Africa in 2014. The revenue of the firm is fluctuating with a little increasing trend in the business. The most common reason for such increase in revenue was the decrease of costs.

Operating profit % share of Diageo plc by 5 regions from 2013-2015

2017 2016 2015 2014 2013
North America 50.7 51.8 45.4 45 9
Europe, Russia and Turkey 24 26.8 25.2 19 -7
Africa 5.8 7.1 10 17 10
Latin America and Caribbean 6.7 2.7 8.2 10 26
Asia Pacific 12.8 11.6 11.2 9 6

(Source: Diageo plc annual report)

Showing operating profit % share of Diageo plc on basis of five regions for five consecutive years (Graph)

 (Source: Diageo plc annual report)

The above chart represent the North America has the most satisfactory performance regarding the profit of the firm. The European region has a good increasing trend which starts from loss in 2013. However, this has decreased in 2017 (Diageo, 2018). The operating profit trend of Africa has failed to satisfy with desired performance because this has decreased. On the other hand, Latin America and Caribbean operating profit of business has decreased in 2017. However, the Asia pacific operating profit is increasing from 2013. Most of the trend lines are decreasing; this was due to the increase in the operating expenses of the firm in all regions.

Key Challenges and Changes Affecting the Business of Diageo PLC

The most common key challenges of Diageo plc were Currency risks & Forex risks, uncertainty in foreign risks, regulation risks; accounting practices risks, volatility of the economic variable, fiscal challenges introduced by local government etc. In addition, there are the following risks factors affecting the business of Diageo PLC.

The above-mentioned risks areas have significant impact in the financial and overall performance of the Diageo plc. These risks factors are major and accumulating with the overall risk’s factors of the company. As a result of this, overall performance in the global market has changed. The major market regulators are exposed to the risk’s factors associated with the indirect tax. The consumers are moving towards other brands this has made the business very competitive in the environment. The non-compliance with laws and regulations can create a severe damage to the financial penalty.

Different Types of Risk Factors

When trading and investing over the international market Diageo plc has faced different types of risk factors in the business. These risks factors have changed the business condition by a great margin.

Political Risks

The political risks factors are visible in the Diageo plc. The geopolitical volatility has increased in recent years. The exit of UK from the European Union has received a major shift in the US trade policy. The economic nationalism was observed along with the Macroeconomic volatility. The cyber security threats have evolved in recent years and the shifting in the local. Diageo is facing the following risks factors.

India

The political risks are quite high in India. There is slow movement of government decision, labour unrest, cultural problems, legal disputes, fluctuation of interest rates, corruptions etc. These risks factors might affect the performance. But still Diageo plc have a total of 30% of the total market share which makes India a favourable market for the company. (MarketLine industry profile)

US

The company is facing tax reformation, rising interest rate of the firm. A major shock from the current investment in US and privacy scandal is also present in the US political environment. The company held a total of 17% of the whole market share which makes it as a leading brand. (MarketLine industry profile)

China

The company has expanded in the mainland China. The sales have increased by 27% in the Chinese market. The expanded distribution in the investment market has increased by a good number. However, the net sales of scotch have declined by 5% in China. Alternatively, the marketing investment has increased by 15% in china and India.

Brazil

The firm has entered into the Brazilian market. Due to the impact of climate change and water stress there is some issue for company. The sales were stabilised in Brazil and other markets. The best part is that, company has collected 20,000 tonnes of glass for recycle.

Comparison

The US market has lowest political risks compared to India and other market. However, the major sales growth has been recorded in China compared to US and other markets. Additionally, the Brazilian market has the best glass recycling programs than other markets. But when we check the overall market share in every country it is in India where the company have larger share and then USA. This clarifies that Diageo has diversified skills in different country.

Exchange Rate Risk

The standard deviation of the currency is used here to measure the potential risks in the countries. Generally, this analysis will helpful for the potential investors for evaluating the performance of the firm in respect to the country risks.

  Standard Deviation of the two major market from 2013-2015

Currency USD
2013 2014 2015 2016 2017
Currency Exchange Rate 0.605 0.64 0.67 0.81 0.74
BASE CURRENCY RATE(POUND) 1 1 1 1 1
Standard Deviation 0.279307179 0.254558 0.233345 0.13435 0.183848
Currency  INR
2013 2014 2015 2016 2017
Currency Exchange Rate 0.0098 0.0101 0.0102 0.012 0.011
BASE CURRENCY RATE(POUND) 1 1 1 1 1
Standard Deviation 0.700177135 0.699965 0.699894 0.698621 0.699329

     (Source: Bank of England)

             Standard Deviation of the two major market from 2013-2015(Graph)

(Source: Bank of England)

The standard deviation of INR and the USD was in the range between 0 to 1 and the sample size of two currencies are not narrow. The associated risks factors are little to high in this analysis of INR and USD currency for Diego PLC.

             Showing the 2 major currencies in the international market trading(recent)

POUND 1
INR (INDIAN RUPEE) 88.3
USD 1.27

           (Source: Bank of England)

The above tables represent mainly the GBP in respect with INR and USD. When the USD and INR increases, the international trade will have a major impact.  The exchange rate movements are also visible in the transaction of the business. The exchange rates are continuously moving. The appreciative movement of the foreign currency may create a problem because this depreciates the domestic currency. The impact of movement in the exchange rates has weakened the Euro, sterling and other major currencies.

Market Risk

Beta of companies
Diageo plc 0.15
Pernod Ricard SA 0.7
Brown-Forman Corp 0.86

Table 4: Showing comparison of beta of three companies

(Source: Yahoo finance)

Diageo plc has a beta value of 0.15 (DGDE.L). This is very important to calculate the capital asset pricing model (CAPM) for estimating the return of the asset. The beta of the company is 0.88 which is below 1; this is a good indicator of low market risks. On the other hand, Pernod Ricard SA (0HAT.L) has beta of 0.7 which is greater than Diageo. This means Bacardi has a high level of risk compared to the Diageo. Brown-Forman Corp (0HQ3.L) has a beta of 0.86 which is greater than that of Diageo but lower than beta 1. This means the competitor has more risks than Diageo but low risk than beta 1. This is clearly stating that Diageo has more risk handling capability than its competitors.

Risks Management Strategies

The political, overseeing, physical and other risk for markets (India, US, China and Brazil) has been moderated by the subject matter experts. The company has used local monitoring and security situations for crisis management. The political risks were eased by legislation support and policies. Threats, incidents, government and other factors were controlled by embedded packaging solutions for the products. In addition to that, there are lot codes on the products for recalling purposes. This has reduced the quality issues in different country. Currency risks are mitigated by using diversification and hedging support. Diageo plc has developed different types of strategies for managing the risks factors in the business. The international risks management strategies of the firm have proved to be very good at risks management. The free cash flow of the firm was 2633 million £ which is better than that of the previous year (2097 £ million). The return on average invested capital was 13.8% in 2017 which is also better than the 12.1% of the 2016. The financial performance of the company has improved this was due to the implication of the risk management strategy of the firm. Diageo executive reviews the effectiveness of the audit and risk committee regularly. Generally, the Exchange rate risks are minimised by using the proper hedging strategies. The principle for maintaining the code of conduct was implemented to do business in ethical manner. The policies are defined with clear strategies by the executive committee to increase the strong success of the business. The success was reflected in the global, local, reserve, financial and non-financial areas. Other risk like market restrictions, economic changes, laws and regulations business acquisitions and cyber threat are handled in a well perspective manner with an counterfeit to each and every possible impact that could happen by these risks. (Diageo, annual report 2017).

Strategic Change and Recommendation

There is no need to change the near perfect risks management strategy of the Diageo plc. However, the following recommendation can further improve in risks mitigation of Diageo plc. They need to focus on the efficiency growth, value creation, creation of trust and employee engagement to mitigate the risk factors.

Justification

It is necessary to build clearer public policy to avoid any conflicts in the operation of the business. This will effectively reduce the financial distress and dispute from different stakeholders. The development of customised internal audit committee can effectively reduce the financial contribution of the business. Quarterly review of the financial and audit materiality can reduce the potential operation risks. The market and Forex risks will be minimised by using the options and other derivative strategies. As a result of this, Diageo plc will prosper in future with growth in the global market. The investor should investment in the Diageo plc because of low rate of systematic risks and high market cap. The corporation also has strong risks management capabilities in the currency market. The operating profit of the firm is also increasing (as per graph). Hence, it is recommended that the investors should invest in the company.

References

Diageo, 2018.  [online] Diageo. Available at https://www.diageo.com/en/investors/financial-results-and-presentations/  [Accessed 30 Nov. 2018].

Bank of England, 2018.Statistical Interactive Database. [online] Bank of England. Available at https://www.bankofengland.co.uk/mfsd/iadb/fromshowcolumns.asp?Travel=NIxSCxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2013&TD=30&TM=Nov&TY=2018&VFD=Y&html.x=28&html.y=24&CSVF=TT&C=NSR&Filter=N [Accessed Date: 30 November 2018].

Bank of England, 2018.Statistical Interactive Database. [online] Bank of England. Available at https://www.bankofengland.co.uk/mfsd/iadb/fromshowcolumns.asp?Travel=NIxSCxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2013&TD=30&TM=Nov&TY=2018&VFD=Y&html.x=8&html.y=14&CSVF=TT&C=DN8&Filter=N [Accessed Date: 30 November 2018].

Yahoo finance ,2018. Diageo plc [online]. Available from:
https://uk.finance.yahoo.com/quote/DGED.L?p=DGED.L [Accessed 30 November 2018]

Yahoo finance ,2018. Pernod Ricard SA [online]. Available from:
https://uk.finance.yahoo.com/quote/0HAT.L?p=0HAT.L&.tsrc=fin-srch-v1 [Accessed 30 November 2018]

Yahoo finance ,2018. Brown-Forman Corp [online]. Available from:
https://uk.finance.yahoo.com/quote/0HQ3.L?p=0HQ3.L&.tsrc=fin-srch-v1 [Accessed 30 November 2018]

MarketLine Advantage ,2018.Industry Profile [online]. Available from:
http://advantage.marketline.com.ezproxy.northampton.ac.uk/browse?q=DIAGEO&f_informationType=Industries [Accessed 30 November 2018]

Hopkinson, M., 2017. The project risk maturity model: Measuring and improving risk management capability. Routledge.

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