Investment: Diageo raises spirits by hitting its targets

Drinks group cheers the City after Allied Domecq shock

DIAGEO, the drinks group formed formed by the merger of Guinness and Grand Metropolitan in 1997, cheered wary drinks investors yesterday with a trading statement that contained no nasty surprises.

After the grim profits warning from Allied Domecq last week the City feared the worst, but Diageo defied the sceptics with figures "in line with expectations", with growth in some key markets.

The company also said it was on target to meet its aim of achieving pounds 125m of cost savings this year, while the half-year currency impact is expected to be pounds 60m Analysts expect a further pounds 15m to pounds 20m hit in the second half.

Diageo said there had been no material change in market trends since the full-year results in September. Although markets such as Latin America have been under pressure, key regions such as the US and Europe are still performing well.

The news boosted the Diageo share price, which has rebounded from less than 500p in the autumn to 682p, another 7p yesterday. A key factor here is the future of the 11 per cent stake held by Bernard Arnault, chairman of luxury goods group, LVMH. The City expects the stake to be placed before long to fund a possible move on Gucci. Given the prickly relationship between Diageo and the Frenchman, an honourable withdrawal would probably be seen as positive by the market, but until that overhang is removed the shares are likely to tread water.

Operationally the company is making solid progress. In spirits and wine, first-half profits will be lower after the sale of brands such as Dewar's and Bombay, combined with the impact of the economic crisis in Asia and tougher trading in Latin American countries such as financially-stricken Brazil.

The North American spirits business is doing well, with price increases and more concentration on top brands helping margins. The prospect of the euro leading to lower prices could be a false dream if Diageo's strategy is widely followed: it has implemented price increases in certain markets as it "harmonises" prices in the Eurozone.

In beer, total volumes grew by 2 per cent although the Guinness brand saw 5 per cent growth worldwide, helped by a good UK performance and double- digit growth in the US. Asia is still struggling, with volumes down by 18 per cent year on the year. Burger King marches on, with underlying sales growth of 3 per cent.

But, as in the full-year results in September, the laggard is still packaged food. Certain product lines such as canned vegetables and desserts are seeing volumes fall as rivals turn up the heat. Even top names such as Old El Paso are still declining.

But analysts remain sanguine: John Beaumont at Merrill Lynch says that despite the weakness in certain sectors, underlying growth is still good in the main businesses. On full-year profit estimates of pounds 1.8bn, the shares trade on a forward multiple of 20. The Arnault stock overhang will depress the price in short term, but after that the outlook could be more promising.