Diageo PLC (DEO) Q2 2024 Earnings Q&A Call Transcript

Diageo PLC (NYSE:DEO) Q2 2024 Earnings Q&A Conference Call January 30, 2024 3:00 PM ET

Company Participants

Debra Crew – CEO

Lavanya Chandrashekar – CFO

Conference Call Participants

Laurence Whyatt – Barclays

Olivier Nicolai – Goldman Sachs

Edward Mundy – Jefferies

Celine Pannuti – JPMorgan

Sanjeet Aujla – UBS

Simon Hales – Citi

Chris Pitcher – Redburn Atlantic

Sarah Simon – Morgan Stanley

Mitchell Collett – Deutsche Bank

Andrea Pistacchi – Bank of America Merrill Lynch

Debra Crew

Good morning, everyone, and thank you for joining our interim results call for fiscal ’24. I hope you had a chance to read our press release and watch our presentation on Diageo.com.

The first half of fiscal ’24 was challenging as we lapped high single-digit growth in the prior year and faced an uneven consumer environment alongside the inventory challenges in LAC. Performance in the half was in line with the update we issued in November.

The group’s organic net sales, or NSV, declined 0.6% in the first half of fiscal ’24, and organic operating margin declined by 167 basis points. Excluding LAC, organic net sales grew 2.5%, driven by good growth in Europe, Asia Pacific and Africa. And our group organic operating margin declined 53 basis points, excluding LAC, and that’s entirely driven by an increase of 70 basis points in our marketing reinvestment rate.

We unlocked a further $335 million of productivity cost savings across cost of goods, marketing and overheads. We generated strong free cash flow of $1.5 billion, up $0.5 billion, while continuing to invest in the future growth potential of our brands. This is driven by strong working capital management. And once again, we increased our dividend, up 5%.

Specifically, in North America, while NSV declined versus the prior year, we delivered sequential improvement when compared to the second half of fiscal ’23 as our actions and interventions in the region began to show an early impact. We are focused on returning to high-quality share growth as the U.S. beers category continues to normalize. Outside of the COVID period, this was the first time North America delivered operating margin improvement since the first half of fiscal ’18.

In LAC, having conducted a review of inventory levels and monitor performance in the critical holiday season, we’ve taken action and have further plans to reduce inventory to a more appropriate level for the current consumer environment by the end of fiscal ’24.

Looking to the second half in this uneven global consumer environment, we expect our organic net sales growth rate to gradually improve compared to the growth rate for the group in the first half, and we expect an organic operating profit decline compared to prior year, but we expect the rate of decline to improve compared to the first half of fiscal ’24.

While the operating environment in the near term will continue to present challenges, I am confident that we remain well positioned and resilient for the long term. We are diversified by category, price point and region, and we’ll continue to invest behind our iconic brands to maintain our position as an industry leader in total beverage alcohol, an attractive sector with a long runway for growth.

My focus is to generate long-term sustainable value for shareholders by driving performance of our brands, meeting global consumers’ evolving tastes and stepping up our operational excellence to win quality market share.

Thank you very much, and I’ll now hand back to the operator for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from the line of Laurence Whyatt from Barclays. Please go ahead, your line is now open.

Laurence Whyatt

Good morning, Debra, Lavanya. Thanks very much for the questions. Three for me, if that’s okay. Firstly, on — you said that you’ve been a bit disappointed by these results in the presentation that you gave. But have you seen anything in the last 6 months or otherwise that would shape your belief that the U.S. spirits market could grow at 4% to 5% medium term? And that you would expect to take share within that market? And could that happen in 2025? Or at least FY ’25? And is there any reason why you can’t hit your medium-term total guidance range in FY ’25?

Then secondly, on a Bloomberg interview that I saw, you mentioned that inflation was moderating, but it’s still there. At your most recent CMD, you said that we should expect flat margins until inflation starts falling away. Do you maintain that it would be impossible to see margin expansion in FY ’25?

And then finally, on India, it’s facing an election this year. Are you aware of any other regulatory changes that could possibly take place in this market in the sort of medium term that might improve reducing the regulation and help spirit sales? Thanks very much.

Debra Crew

Thanks, Laurence. So I’ll take your first one on just U.S. and medium-term guidance in fiscal ’25. And then Lavanya, if you could just take the inflation and then India. So yes, there’s a lot to unpack there. So look, from a U.S. perspective, as I mentioned in the presentation, we are seeing — it’s still normalizing, it’s not normalized, and I mentioned it not being linear.

And I would say, look, if you would have asked me six months ago, we were seeing — heading into summer, we were definitely — looked to be tracking back into that mid-single-digit growth that you’ve seen the U.S. market consistently perform. And then fall came. And quite honestly, we really saw a consumer more under pressure. And it was — it trended more towards low single digits than mid-single digits.

I mentioned — I’ve been in the U.S. quite a bit over the past 8 weeks and talking with customers. And I saw this bear out a little bit this morning in the NABCA data as well. November, I would say, ended up being better than expected. So a nice improvement. Early December, I think customers were worried. But then December ended up, people referenced the last week particularly of December, trended better. And so you saw NABCA this morning, I think, had the industry at 3.3%.

So I’m not seeing anything change in the fundamentals, particularly as we look at the medium to long term that would say — we know the number of drinkers and volume growth is really driven off of that. Also, spirits stealing beer and wine occasions, that hasn’t changed. We’re actually seeing that, including in this environment.

And then you look at pricing, what we’re looking at, unlike what we’ve done in the past couple of years, we’re seeing pricing get back, particularly if you’re talking about in the U.S., you’re talking about more on that kind of 1% range if you look historically. And then it’s really about premiumization. None of that — Laurence, I mean, you still see what’s driving the category is super-premium, plus-price products. So none of that has changed.

It really is this near-term kind of consumer sentiment that’s normalizing into this post-COVID new normal. There’s still supply chain noise. In our results, we had some supply chain normalization. We were lapping some replenishment on tequila, as an example. So we’re finally getting through that. We’re finally getting through some of the price increases and lapping those.

So that’s why, as we — what we referenced in our guidance for the second half and then going into fiscal ’25 is, as the consumer environment improves, we would expect the industry to improve, we would expect us to continue also to outperform that, because nothing’s changed in our portfolio either.

If you take a look at what’s growing, Tequila is driving the growth. We feel great about our tequila portfolio. In fact, I’m very excited that I am 100% on DeLeon. So we’ve got a broader super-premium price portfolio that will help us on tequila. So there’s nothing that’s changed within the fundamentals that would make me say that the U.S. can’t get back to mid-single digits.

As far as when, I’m not predicting. I’m not going to predict the industry. Could that be six months? Maybe. But look, there’s elections coming up, and it could be 18 months as well. I mean, we’ve just not seen this come back in a very even, linear way. So that’s why we built our guidance the way we have.

Look, it’s January. To be talking about fiscal ’25 already, it’s a bit early, but we wanted to let you guys take a look at what we were seeing. We do see progressing back toward mid-single digits, but a little early to call where the consumer environment is going to be six months from now. Lavanya, you want to take the inflation question and then India?

Lavanya Chandrashekar

Sure. Laurence, on the inflation, look, what I — the word that I would use is it’s an extremely volatile environment. With that — having said that, we are seeing, definitely seeing, signs of inflation moderating. U.K. energy prices have definitely moderated here over the last period of time. We’re also seeing more moderation, and corn has come down quite substantially, aluminum is moderating.

So definitely, I think that we are seeing commodities move in the right direction. And as we’ve always said, as the inflation moderates and the benefits of our supply agility program kicks in, we will be able to get back to operating margin growth. From a productivity perspective, I just draw everyone’s attention to the $335 million that we have generated in productivity in the first half of this year, which is higher than any of the prior years, going back to fiscal ’20. Outside of LAC, our operating margin decline of 53 basis points is entirely — more than entirely driven by A&P up weighing of 70 basis points. So I do think that we are running this business in a very disciplined manner.

Your second question on — your third question on India. Generally, during elections in India, what we have seen in the past is that there are temporary restrictions imposed by various states in terms of like the sale of alcohol. So I wouldn’t — I think that would be something that we would anticipate. We know the team in India know how to manage through that. And I’m sure that they will continue to do a good job on that.

More broadly, trend on regulations has been moving in the right direction in India. Several of the larger states have reduced their stake import duties or excise duties on alcohol products over the last, call it, 18 to 24 months. We’re still hopeful around the FTA. And we’re expecting that the strong growth that we have seen on the scotch business in India, 16% growth on scotch, Johnnie Walker growing 21%. With regulations moving in the right direction, I think this all bodes really well for Diageo as the largest player in this segment.

Operator

The next question today comes from the line of Olivier Nicolai from Goldman Sachs. Please go ahead, your line is now open.

Olivier Nicolai

Hi, good morning, Debra and Lavanya. Three questions, if I may. Just regarding LatAm. First of all, could you give us a bit more color on your inventories by type of product? Essentially, is it mostly primary scotch which is the issue? Or is it actually more premium scotch, such as Johnnie Walker, even Johnnie Walker blue? What you need to see the destocking of?

Second question, regarding the midterm guidance. You do not expect organic EBIT margin to grow ahead of organic sales short term and including in 2025. Is it driven by a specific region, such as North America, why you need to invest more? Or is it a broad-based comment?

And just lastly, Lavanya, just going back to — following up on the provision that you’ve done this morning. Considering your net debt to EBITDA level and the higher interest rate environment, how should we think about the sustainability of the share buyback beyond full year ’24? Thank you very much.

Debra Crew

Great. Thanks. I’ll start with the Latin America. And then Lavanya, if you can take the EBIT margin and share buyback question. Look, so on Latin America, we’ve got — there’s really two answers there. We’ve got scotch — it’s really scotch and tequila. I mean, when you think about our Latin America business, it’s a heavy scotch business, as well as there is of course tequila in Mexico. And what I would say is, as we’ve referenced, there was a lot of premiumization in the region as we went through the COVID super cycle, and we have seen down-trading.

But I think your question is kind of getting to, is this sort of too much of the right stuff or too much of the wrong stuff? What I would say is, look, in Brazil, it’s just too much of the — but it’s the right stuff. It’s just too much of it, and it’s in our scotch portfolio. I would say in Mexico, where we’re seeing some real down-trading, we probably do have too much of the premium tequila in that market. So two different answers for two different countries, but I think that should give you a scope.

But I just will reiterate, from what we announced this morning, we’ve run multiple scenarios against this in the current kind of consumer environment, running multiple scenarios against that, and still feel confident that we can reduce the inventory to the appropriate levels by the end of the fiscal.

And so, Lavanya, if you want to…

Lavanya Chandrashekar

Yes. So Olivier, on operating margin, is it — your question was, is it a specific region? What we’re guiding to — let me actually start the other way around. And in the first half of this year, if you exclude Latin America, we grew net sales 2.5% with operating margin down 53 basis points. As I said, that was all entirely driven by marketing. Where did we increase our marketing investment? We increased our marketing investment to support the global tequila rollout. So that was primarily APAC and Europe, and we have seen strong results there. Tequila growth contributed to almost 19% of the growth of Europe and equally in APAC as well.

So that’s — and that’s investing for the long term. We are building a new category in these parts of the world. It’s going well off of a very small base, but it’s an important investment for us. We invested in Johnnie Walker in Europe, which has grown double digit; and we invested in India, which grew 9%. I gave the scotch numbers earlier, 16% growth. And we’ve invested in Chinese white spirits.

And so what does this tell you about how we approach A&P investment? Is that we invest where we see the best ROI possibility. We are extremely disciplined about it. And where there is an opportunity for us to grow the business, both for the long term, but also more immediately, and we see good returns, that’s where we will make the investments.

So going forward as well, I would say that our investment strategy will continue to be the same. It’s not like the cost to compete has gone up in one region or one market or anything of that kind. I think it’s we will be disciplined and we’ll approach each investment decision from that perspective.

In terms of share buybacks, we’ve — after having a multiyear program, we have moved to having sort of a year-by-year program. We announced a $1 billion share buyback program for this fiscal. We’ve completed $0.5 billion. We will be completing the other half of it at the — by the end of this fiscal.

We remain committed to our leverage ratio, the target range there being between 1.5 and 2 times — 2.5 times and 3 times, sorry. Between 2.5 times and 3 times. I’m looking at a bunch of numbers here, sorry. Yes. And we will stay very disciplined towards our leverage ratio as well. And if there’s a great investment opportunity, we’ll do what’s right for the business. If we end up outside the range, briefly, we will come back into the range. This is a business that has a very strong balance sheet. We generate strong cash flow. I mean, the $1.5 billion in cash flow that we generated in this half is — which is up $0.5 billion despite operating profit being down as a clear indicator of that.

Operator

[Operator Instructions] Our next question today comes from the line of Edward Mundy from Jefferies. Please go ahead, your line is open.

Edward Mundy

Good morning, Debra, and Lavanya. So one question for me just on U.S. tequila. I think you pointed to some pockets of down-trading within the U.S. and also increased price competition within whiskey and tequila. Tequila has been a really strong growth engine for you, certainly over the COVID super cycle and actually take a very long-term view, and you don’t want to impact your brand equities from excessive promos. I mean, how do you protect your share within high-end ultra-premium tequila?

Debra Crew

Yes. So I mean, I think there’s a couple of things just to dig into our U.S. tequila results, and then I’ll talk about the market in general. For one, our shipments in North America look a lot worse on both Don Julio and Casamigos than what we’re seeing in depletions and ultimately what we’re seeing at the point of consumption where we can track it. So as a for-instance there, Don Julio, our depletions were plus 12%. We also see that same kind of plus 11% to 12% also in the Nielsen NABCA data, so you can really see it’s still performing at double digits. But yet in our shipments it’s showing us a plus 2%. Likewise, Casamigos shows is a big negative, is a minus 14% in our results. But the depletion volume is actually positive.

So that should tell you a little bit about — last year, we were — Reposado in particular has been kind of the hot part of our portfolio, and it just took us longer to recover on that aged tequila. And so we were lapping that replenishment last year as well as some price increases on both of those. So we do feel better about the underlying performance of that ultra-premium tequila portfolio that we have.

To your question about how do you handle the price competition going on? Look, it was a really crazy, I would say in particular, the last 3 months of the year, where it wasn’t only within tequila, but also in other categories like cognac that impact ultra-premium tequila. There were — it was quite a competitive environment out there. And so certainly, we don’t want to take our — these great brands that we’ve driven down into those, you know, competing at that level.

That’s why it’s so important that we expand our portfolio. That’s the reason I’m so excited about getting control of DeLeon. And also, of course, Astral came to us. We bought that with the Aviation acquisition. And 21Seeds, gosh, that’s been about a year or so that we bought that brand. So we are rounding out the portfolio to have the full price ladder because we think that is important to be able to effectively compete across all the areas that we’re seeing in tequila.

And tequila is still being driven — that super premium — and yes, ultra-premium has been under a little bit of pressure. I mentioned — especially when you get over $100 bottles, that’s where you are seeing some down-trading from those $100-plus bottles into really the aged tequilas, the Reposado and Anejo for us is seeing a lot of heat right now. So that’s tequila.

Edward Mundy

Thanks. And Debra, do you think the down-trading from, let’s say, the 50 to the 30, the bit more cheap in terms of agave, do you think that’s due to the economic cycle? Or do you think it’s a little bit more structural?

Debra Crew

I think — look, there’s been a lot of new competition out there and at the shelf. I think people are out there experimenting. It’s exactly what we would expect to happen as the category gets big, you actually have people trying more and more. That being said, our household penetration, all the underlying pieces of our equity, people still feel very, very good. So I do think some of that is just the promotional cycle and just some of the new entries of people going out and trying things.

I think I tend to look at how brands are performing in on premise than where they’re calling it. Our on premise performance in tequila is still very strong. So this comes back to when people are paying for something, they want to make sure they get what they want and the right thing. And so when they’re calling drinks, they’re still calling Casamigos. And Don Julio in particular is really having a cultural moment right now.

Operator

The next question today comes from the line of Celine Pannuti from JPMorgan. Please go ahead, your line is now open.

Celine Pannuti

Thank you very much and good morning, Debra and Lavanya. My question is really a follow-up on this one on the U.S. I think listening to your call this morning, it feels that there is more discussion about — or you’re a bit more cautious about the U.S. market. And we just discussed a bit more about the down-trading. So I also see that price/mix is 1.4% in the half, and in the last two halves, it was — which came from 7%, 2.8% and now 1.4%.

So my question is, are we in an environment with more promo and down-trading, where we see the risk of that price/mix even becoming negative? And then how should we think about the profit? Is that magnified when you see down-trading at your profit level? Or is there a way that you can offset that? You’ve spent a lot on A&P. I presume when you sell $100 bottle, you need a lot of A&P for that, but is there a way that you can offset should there be more pressure from the price/mix standpoint? Thanks.

Debra Crew

Yes. I think what you’re seeing in some of the price/mix, don’t forget that like for us, we were lapping. But honestly, I think it’s quite broad across the industry. We’re lapping now those price increases. So what you were seeing before was sort of this really historic kind of levels of price within spirits that came in last year in response to inflation. And so we fully lap that within sort of the half. So you see that, that price in particular come down.

Look, that being said, what I would say is — the promotional environment, I think a lot of it had to do with people who were lapping big numbers from prior year. There is — perhaps some people have more inventory out there that they were trying to do something with. We’re not really seeing this being sort of something that’s for the long term. I think this is really something in response to the particular environment that we’re in right now.

And then Lavanya, if you wanted to say something about A&P, or…?

Lavanya Chandrashekar

Yes. I’ll just pick up on the price/mix piece of it as well, the 1.4% that you referenced, Celine, is what you see in our accounts. So that’s the shipment price/mix that you have. And that’s been — in this half, that’s been negatively impacted by the lap — what Debra referred to just a minute ago about our tequila lapping the replenishment of inventory in the prior year.

If you look at it from a depletion perspective, mix is significantly stronger. And in fact, in my presentation, we did put up a slide where we kind of showed the difference between shipments and depletions in the U.S. on the super-premium, plus-price segments where depletions — where shipments were down double digit, I think 11%. But when you look at it from a depletion on a consumption perspective, the picture looks quite different. And so I do think that the underlying mix that we have within our portfolio is significantly better than what you’re seeing in the accounts in the half.

But as Debra said, some of the extraordinarily high pricing that we have seen over the last 2 fiscals. Last year, price for us was high single digits, the prior year was mid-single digits. We have — we are seeing that pricing come down both across our categories, but also more broadly to the prior point on inflation moderating.

On P&L. Look, the more premium products tend to have the best — tend to have better margins. I mean, that’s part of what — that’s how the structure of the category is. But what — we have many levers to drive profitability within this business. I mean, volume is one of them. The work that we do on productivity helps us to offset inflation and drive margins.

And as you have seen, we have done very well in the half, and we have guided to further stepping up our productivity to delivering $2 billion of productivity over the next 3 fiscal years. So that’s definitely a help. We will continue to drive price, but in a very disciplined and surgical manner, and that will contribute to productivity as well. A&P investment really comes down to the — where a brand is in its growth cycle more than anything else. And so maybe Debra, you can add…

Debra Crew

Yes. I think as you look at the U.S., to your question on — I mean, actually — our brands are actually at a pretty good rate. Where we’re really investing in A&P, it really is in markets where we don’t have quite the scale to be able — so Lavanya mentioned earlier, India, Chinese white spirits. Some of this are places where we’re going after new occasions.

In Europe, we mentioned earlier a little bit about the tequila investments that they’ve made, the non-alc category that’s going after new occasions. That’s really where we’re adding an A&P investment. I would say from a U.S. perspective, look, we don’t manage to a rate. But the U.S. team, we’re at good levels, and we look at that and feel like we’ve got what we need against those brands.

Operator

The next question today comes from the line of Sanjeet Aujla from UBS. Please go ahead, your line is now open.

Sanjeet Aujla

Hi, Debra, Lavanya. My question is just coming back to the medium-term guidance. You don’t seem to be endorsing that 5% to 7% for fiscal ’25. But should we still consider that to be a relevant framework for F ’26 onwards?

Debra Crew

I think, look, what we’re trying to give — like I said, it is January. So we’re trying to give kind of an early look and we’re saying progressing back towards medium-term guidance at this point. It just wouldn’t be prudent with the current consumer environment and some of the uncertainties in the macros to be able to say much more about than what we have.

But that being said, medium-term guidance is still what we’re looking at. And as I answered on kind of the first question, we feel very good about the fundamentals. We feel very good about our portfolio and where we’re at. I’m disappointed in the half because of the LAC performance, and we were disappointed by the North America share, in missing that. We didn’t miss by much, but we missed it.

But we’ve got a second half and the team has put together very strong plans. Always difficult to predict share because you have to predict what competition is going to do. But I feel very good about our plans on Crown, our plans on convenience. We’ve got some exciting innovation launches. And so we’re still very much about our medium-term guidance, it’s just the current operating context that we’re in right now.

Sanjeet Aujla

Got it. And just a quick follow-up on tequila again. You’ve spoken quite a bit today about the need to broaden the price ladder within tequila. How long does that take to meaningfully impact your performance? Is it a 6, 12 months’ kind of time line? Or 2 to 3 years to build a brand awareness on some of those smaller brands?

Debra Crew

Listen, actually, on the half, if you take our total tequila portfolio, we did gain share in spirits. So already, we’re getting some contribution, you can see from those brands. DeLeon, before the miss, we grew DeLeon 150-some-odd percent in fiscal ’23. So we feel very good about the brand. We understand the brand. And so to have full control of that, we’re very excited about. And so see a lot of opportunity there. 21Seeds also, we’re feeling very good about that.

Astral is just launching. So to your point of how long will that take. We’ve got some markets that we’re really kind of focused on where we feel like it will make the most impact to our portfolio. But we are managing this as a total portfolio. And — but I feel good about where we’re at, and I think there’s really great opportunities yet still to go.

Sanjeet Aujla

Great. Thank you, Debra.

Operator

The next question today comes from the line of Simon Hales from Citi. Please go ahead, your line is now open.

Simon Hales

Thank you. Good morning, Debra, and Lavanya. So I’ve got one main question then just one quick clarification, if that’s okay. Firstly, I think we’re all just trying to get our heads around, given the move to dollar reporting, what that means from an FX standpoint going forward. You’ve clearly indicated in the press release you expect a big tailwind from transactional FX in the second half of the year based on H1 rates. But I wonder if maybe Lavanya, you could give a bit more clarity as to which currencies are driving that and associated with that?

I appreciate it’s early, but when we think about transactional FX into the first half of 2025, I suppose I’m crucially trying to understand whether we see any unwind of that H2 ’24 transactional benefits in 2025. So that’s a slightly technical FX question. And then just to clarify, really, Debra, on Latin America, you said you were confident that the destock would be done by the end of 2024. I just wanted to check, there isn’t any assumption therefore, going forward in your fiscal 2025 cautious guidance you put out this morning, of further destocking?

Debra Crew

Yes. So I’ll take Latin America while Lavanya gets into the FX. I’m not going to do FX. So yes, just be very clear on Latin America, we are not looking at that in relation to what we put out for fiscal ’25. In fact, I mean, actually, we would expect, as we lap that inventory issue that clearly gives us a bit of a tailwind, right? So that’s actually a good guy for fiscal ’25. That being said, it is a weaker consumer environment, right? That’s part of how we got into this. And so what we don’t want to do is over-predict at this point how quickly that consumer environment recovers in Latin America. So I would say the cautiousness in fiscal ’25 was really around the consumer environment in NAM and in LAC. That’s really the cautiousness, but it doesn’t have to do with the inventory. It’s more about the consumer environment and not wanting to over-predict a steep recovery.

So Lavanya, you want to try to handle that FX question?

Lavanya Chandrashekar

Yes. So on — let me first start with this fiscal. I mean, Simon, for the full year, what we are expecting to see as the tailwinds on transaction FX really comes from the pound, the Mexican peso and the euro versus the dollar. So that’s our three big — that’s the main currency pairs. And so that’s where we are expecting to see the transactional FX benefits flow through.

In terms of fiscal ’25, look, I mean, gosh, that’s a long way off. But here’s how I would think about it. The two things that impact FX for us is, one is, of course, the prevailing rates. And then the second is the hedge positions that we take and especially on these main currency pairs, that’s where we hedge on a rolling basis.

And so I think those are the two things that I would look at to be able to build a model on what we would expect to happen on FX. We’re not providing guidance for fiscal ’25 FX right now, and we will definitely come back with more clear guidance on it as we get into the fiscal year, as we traditionally do. So July is when we do that.

Simon Hales

Okay. Thanks, Lavanya. Thanks, Debra.

Operator

The next question today comes from the line of Chris Pitcher from Redburn Atlantic. Please go ahead, your line is now open.

Chris Pitcher

Good morning, Debra, Lavanya. I’ve got a question on Latin America. In the presentation, you listed an impressive list of initiatives underway to improve visibility. But many — in other markets sort of raises the question, why are we not already doing things such as data sharing, independent stock counts and investing more behind your sales resources? I mean, is it — would it be fair to say the region had lapped focus and resource for many years? And hence, in hindsight, the high operating margins you were delivering, we’re unlikely to return to those.

And as sort of a follow-up, with transatlantic freight rates to LatAm now down to pre-pandemic levels. So has the economics of primary scotch has improved such that you can give brands like Black and White and White Horse a push again? And that could help capture some of the volume loss to down-trading in Mexico and Brazil. But again, would limit the scale of any margin recovery in the region. Thanks.

Debra Crew

Yes. So a couple of things on that. I’ll take the resourcing, you can talk about Transit-Atlantic rate. But I will just say before I get into this is, yes, the team is really focused on. We do have a broad scotch portfolio, and so we can absolutely pivot to where the consumer is going down there. And actually, we do have great margins on our primary portfolio as well. So I’ll just get that one out of the way.

So just talking a little bit about Latin America and what we’re doing there vis-a-vis sort of the rest of the world. This is a unique — it is quite unique in how we go to market in Latin America compared to many of our other markets. And I think we talked about that a little bit with the President as we went kind of around the room at Capital Markets Day, and people talked about the various ways that we went to market that way.

Latin America is a place, I’ve operated in it before in other categories, and it’s not unique to our category, this multiple-layer structure. And often — first of all, you’re never going to have perfect visibility. But what you try to do is have enough visibility so that you can make — so that your models and your estimates give you a better idea of what’s going on with the inventory.

It really was kind of a perfect storm of what happened to us because we were coming off of this COVID super cycle. So I would say two things behind the resourcing that we had in Latin America. I would say, first, it was rapid growth in a region, remembering how much bigger and frankly more material it became to the group in a very short time span. And so hindsight being 20/20, as we looked at the resourcing and the robustness of some of the models down there, we certainly have taken a look at that and said this isn’t good enough. And so that’s where we’re making some additional investments and making sure that really these models are much more robust.

And maybe the biggest thing that didn’t come through is it’s about the frequency of which you revisit some of these pieces and assumption. I mean, you’re not going to be doing physical counts daily, but you need to do it frequently enough so that you’re not making any misjudgments as you do some of these calculations and triangulation about what kind of inventory you have out there.

So I would say we’re upping the quality of the data, making it a real focus. As you can imagine, we are — we have a lot of governance around this. And this is — these are activities that we have elsewhere. I mentioned some of the technology stuff that we’re bringing over from China. China can be another place where you can have some of these issues. Well, we don’t have these issues because we do have some of that technology in place in China.

So it is a matter of just learning from the rest of Diageo and bringing Latin America up to where the standard that we would expect it to be. And like I said, we’ve had great learnings there and we are putting those into action to make sure that we do not have this type of misstep again.

Lavanya, do you want to take the margin question around LatAm?

Lavanya Chandrashekar

So look, what I would say, Chris, is that, yes, we are going to be making some additional investment. But it’s — and some of it is going to be in overhead in Latin America. But Latin America — the nature of our business in Latin America is what drives our margin structure. And Latin America business is mostly a scotch business, especially when you look at a market such as Brazil. And as Debra said, our margins are very strong. Our primary scotches as much as — as well as on the — of course, on the more premium scotches.

Overhead is a very small percentage of our net sales across the company, but more so in a market like Latin America, where a lot of our sales is run through distributors. And so yes, if we end up adding — I don’t know, a dozen people. That’s not going to move our margin in Latin America in any significant way. The reduction in freight rates, of course, helps us. It helps us for Latin America, but it also helps us across the world. So the structural economics of Latin America are not going to be materially changed here because they are driven by the categories that — our scotch sells at the same price points around the world. I mean, it has to because it’s a single product that we sell everywhere.

Chris Pitcher

So sorry, can I just push you on that? If I look at the margins in Latin America post the collapse of Venezuela, they averaged high 20s, 27%. And then they expanded rapidly during the pandemic to the mid-30s. Are you saying that you expect to get back to mid-30s again? Or is high 20s a much more sustainable margin in Latin America with the additional overheads, it sounds like, you need to put in?

Lavanya Chandrashekar

Our Latin America margins got all the way up to the 40s, operating margin was in the 40s in the last fiscal. And again, this was driven by two things. One, we have been very disciplined about taking pricing on our entire portfolio to offset the impacts of inflation and devaluation. We do this across all of our emerging markets, especially on our global portfolio of scotches and tequila. We are very disciplined about that because we do operate within — we do try to keep these brands to operate within a corridor of pricing around the world. And so that will continue to be the case.

The second thing that helped us with margin improvement in Latin America was scale. The business has grown at a 15% CAGR over the last four years, and that has added significant scale to us and operating leverage, which has helped us to offer improved operating margins. And again, both of these are structural improvement.

Debra Crew

And supply agility. So we also have done some things within our supply geographic footprint that also is structurally, I would say, help our primary scotch margin. So look, we don’t give out sort of margin guidance by region. But certainly, there are things that have advanced, I would say, structurally in the market from that — the period of time in the ’20s.

Chris Pitcher

Thank you.

Operator

The next question today comes from the line of Sarah Simon from Morgan Stanley. Please go ahead, your line is now open.

Sarah Simon

Yes, morning. I’ve just got one question on cash flow. You talked about it growing organically. Obviously, the first half, you had a very strong working capital inflow. What do you mean by organically?

Debra Crew

Lavanya, do you want to talk about cash flow?

Lavanya Chandrashekar

We expect cash flow to grow for the year. So I mean, I think the word organic just implies that it is net of FX. But maybe because the question hasn’t come up, I take this opportunity to talk a little bit about our working capital improvements that we have done here in the first half of the year, which I do expect that these are structural improvements that will continue to benefit us.

We’ve rightsized inventory. And again, inventories had increased. Our days’ inventory in our system has increased through the COVID period, and that was simply because of the volatility in supply chains that we saw. We’ve added quite a bit of data analytics and technology to the system to help us to get to the right safety stock levels. We’ve started to make some structural interventions as well in terms of where we hold inventory closer to the market versus in every market or holding it only in a market like Scotland. More of that will come through as we run through the supply agility program, that will help us well.

And we’ve made some structural changes on processes as well, improvement of work processes, standardization of work processes, getting to better terms with our suppliers as our contracts come up for renewal. So these benefits are structural, and I expect that they will continue.

Sarah Simon

Okay. But when you say — I mean, obviously, the free cash flow in the first half was — the growth was exceptionally strong. Are you saying you expect materially — you’re saying it’s going to grow organically, but can you give us the kind of range in terms of what that organic growth might be the full year, and then what that implies to the second half?

Lavanya Chandrashekar

The way I would think about it, Sarah, is 2 steps. One is cash flow is correlated to operating profit and directly driven by operating profit. So as the business grows and as operating profit recovers, I would expect that cash flow will improve. The second thing I would say is, in terms of our days of working capital, we have seen an improvement driven by some of the interventions that I just mentioned.

And I expect that those interventions will — I mean, those are structural interventions. Those will continue. We are not going to go back to increasing safety stock and inventory levels back to kind of like the COVID period as we go forward. We will continue to invest in CapEx. We’ll continue to invest in maturing stock as we have done in the first half of this year.

Operator

The next question today comes from the line of Mitch Collett from Deutsche Bank. Please go ahead, your line is now open.

Mitchell Collett

Good morning, good morning, Lavanya. I’ll ask one question. I think, Debra, you said in the U.S., that there’s been no change to the fundamentals as you see it. But I think one possible change is that the growth in prepared cocktails appears to be cannibalizing the rest of spirits. And then on top of that, some of those cocktail players are now coming into the mainstream spirits categories.

So I guess I’d be interested in your thoughts on that and your strategy to fight that headwind because so far, although I appreciate you’ve already got a big FMB business within ready-to-drink cocktails, you’ve very much gone for a premium multi-serve strategy. And with that in mind, I just wondered why you haven’t maybe had a more aggressive push into mainstream single-serve canned cocktails given that, that’s where the growth is currently? Thank you.

Debra Crew

Thanks for your question, Mitch, because actually, we haven’t talked a lot about it. But we are launching our Smirnoff Smash vodka spirit in the second half. So we are getting a bit more into this canned cocktails as well as we are expanding our Crown canned cocktails into a multipack of lemonade. So we certainly are into it. We have said we have a targeted participation in this ready-to-drink cocktail space. We are wanting to keep it premium, we are wanting to make sure that it is differentiated, and we want to make sure that it adds to our brands and build our brands.

To your point, we’ve been in the FMB space for a long time. This can be a space where you’re kind of in and out if you don’t do it right, and so we want to do it right. So we’re very excited about getting into a bit more mainstream on that — on those ready-to-drink cocktails. And you did mention, look, the ready-to-serve piece as well. We feel very, very good about the launch of Ketel One. The Espresso Martini and Cosmo are already showing up. You can see those in the database already reading through on Nielsen in a great way. And we do have the Tanqueray Negroni and Astral Margarita also launching second half.

So we are upping our game, I would say, across convenience. You mentioned the fundamentals to this. Actually, we do not see it cannibalizing spirits. If you take things in cans that are not beer that has been fairly flat over the last I’d say, 3 fiscals as we’ve looked at it. You had quite a peak during COVID. But as you take a look, it really is sort of trading people up from that seltzer space, right? So seltzers are in decline.

And of course, that’s still the bulk of those canned things that are not beer. And what you’re seeing is growth in FMBs and growth in the cocktails in a can. So what we are seeing there actually is premiumization across that convenience cocktail. And so look, we’re going to play it in a way that makes sense for our portfolio, and that will certainly help us from a share perspective and get us in the game. But yes, we’re not seeing that, say, cannibalization from core spirits.

Lavanya Chandrashekar

In fact, we’re seeing quite the reverse. Like what we are seeing is that consumers coming into Bulleit ready-to-serve, are then choosing to buy — a lot of them were not Bulleit drinkers are now choosing to buy Bulleit, the base brand. So we are seeing this as being quite incremental to us.

Mitchell Collett

Understood. Thank you, both.

Operator

Our final question today comes from the line of Andrea Pistacchi from Bank of America. Please go ahead, your line is now open.

Andrea Pistacchi

Yes, thank you. Hi, Debra, hi, Lavanya. Just wanted to compare a little the U.S. with Europe. So you seem a bit more cautious from the U.S. for the next 6, 12 months given the environment, but you seem more confident on Europe where you’re also now lapping some big, big price increases. So the question is, what are you seeing really on the ground in Europe in terms of consumer pricing environment? And what is giving you this incremental confidence? Is the difference that you’re gaining share in Europe, is it the tequilas you’re rolling out? Or do you think you’ll be able to take a bit of more pricing this year?

Debra Crew

Yes. I think it’s several things, actually. And some of them, you mentioned. We are gaining share across most of Europe, which certainly helps us. And of course, Guinness being a big part of our gain in Ireland and GB, where Guinness is a big business. And so that certainly helps us.

The other thing is how our portfolio is arranged. Actually, in Europe, we have much more of a standard price portfolio. So if you think about — I talk about our broad portfolio in the U.S., and we do feel like we can go wherever the consumer pivots to, but still super-premium plus is driving the growth in the U.S. market. In Europe, we’ve got more of a standard price portfolio, which I think is helping us weather what’s going on in Europe. And yet we do — we are gaining with some of the premiumization. So we’re really getting both sets of benefits of kind of the now and the future, and we have really a full PVA portfolio that is helping us.

But certainly, I will add. We are lapping double digit. We did call that out in the second half. We certainly — I think we referenced a resilient growth. But this is certainly a tough comp for us in Europe.