Weak dollar clouds the outlook for Diageo

Diageo, the world's largest spirits company, which counts Guinness and Smirnoff among its brands, said yesterday that the weak dollar would slice £100m off its pre-tax profits this year and next.

Shares in the company fell nearly 3 per cent during the day as Diageo also warned of margin declines and static sales growth. They finally closed down 1.7 per cent at 712.5p.

In a trading update ahead of its full-year results in September, Diageo said growth in sales had stagnated at 6 per cent in the second half of the year, as had volumes at 3 per cent. Underlying operating profits were expected to grow by 6 per cent.

Diageo said that this stagnation in growth of sales, volumes and profits would continue through to next year, and would be at similar levels to those over 2003/04.

Investors concluded from the statement that although volumes in the US have been strong where demand for cocktails has increased, Diageo has found trading tougher in the UK and Ireland. In the UK, drinks companies are being forced to push down their prices by supermarkets and bars, and the smoking ban in Ireland is hurting trade in pubs.

Anthony Geard, an analyst at Investec Securities, said yesterday: "The company is not giving much away on underlying trading, but it does look like things have got more difficult in the UK and Ireland. South Korea is also probably still tough, where consumer spending has had a crunch. Some of the company's problems are beyond its control, like currency and tax rates, but nothing else is really moving and its growth looks pretty anaemic."

The company also said that its measures to improve efficiency have cost it £50m and will hit profit margins in the short term. One of the main contributors was the closure of its Park Royal brewery in London and shift of Guinness production to Dublin. Paul Walsh, the chief executive, said: "While the costs of our restructuring programmes adversely impacted margins, we believe improved efficiencies when these initiatives are completed will lead to margin expansion."

Its earnings per share before exceptionals is expected at about 48p for 2003/04, compared to forecasts of around 52p. Most analysts are now planning to cut their forecasts to around 47p.

Combined with the underlying growth stagnation, costs and currency movements, Diageo's earnings will also be hit by a change in accounting for its 21.6 per cent stake in General Mills. Diageo is planning to sell is $3.66bn (£2bn) stake in the food manufacturer and as it is now being treated as an investment on its books rather than an associate, this will knock another 3p off its earnings per share this year.