DGE Diageo Plc

By Saabira Chaudhuri 

LONDON-- Diageo PLC reported lower first-half operating profit on the back of slumping sales in North America, underscoring the pressure on Chief Executive Ivan Menezes to deliver a promised uplift in the second half of the year.

The world's largest spirits maker on Thursday said its operating profit tumbled 3% as net sales in North America--Diageo's largest and most profitable market--slipped 2%.

Diageo had warned of the decline as the company shifts away from shipping large quantities of new products at once to a more demand-led model it says will help it respond to trends more quickly. However, Mr. Menezes has promised "strong growth" in the U.S. for the rest of the year as it comes up against prior periods that followed the new model.

"We have a tale of two halves in the U.S. this year," said Mr. Menezes at a meeting with reporters in London on Thursday, sporting a bright pink tie promoting the company's Ketel One vodka. He described the U.S. market as his "top priority" saying he is "confident" that second-half results will be stronger.

Turning around the U.S. is important for the 56-year-old Mr. Menezes, who has presided over 2 1/2 years of slumping volumes in the region as consumers abandoned the company's large, mainstream brands.

Over the past few months, Mr. Menezes has named a new North America head, employed more data-driven marketing strategies, beefed up Diageo's sales-team visits to bars and restaurants, and cut prices on once-blockbuster brands such as Smirnoff vodka and Captain Morgan spiced rum.

Some of those measures are starting to bear fruit. North America depletions--or actual sales to retailers, as opposed to shipments--rose 3%.

Still, Diageo's new chief financial officer, Kathryn Mikells, told reporters the company's depletions underperformed the broader North America spirits market. She warned that margins for the year won't pick up as marketing spending rises. Mr. Menezes said he doesn't expect Diageo to gain U.S. market share in the second half of the year.

Diageo's shares closed Thursday down 1.4% at 1,842 pence in London trading.

The London liquor giant is grappling with a peculiar conundrum that is hurting sales of brands such as Smirnoff, Crown Royal and Cîroc. Some of its reliance on flavored spirits has hammered results. Smirnoff in particular suffered as U.S. consumers spurned the vodka brand's bewildering range of flavors for more niche and classic offerings from rivals. But the Regal Apple flavor of Crown Royal Canadian whisky enormously helped sales last year, with Crown Royal sales climbing 8% in North America in the first half of fiscal 2016. Cîroc sales in North America plunged 43% during the first half of fiscal 2016, despite strong sales of its pineapple flavor.

Ms. Mikells told reporters Diageo is looking to a new apple-flavored version of Cîroc to boost vodka sales over the remainder of the year.

"Flavors are going to cause you to have more ups and downs by its nature, " she said, but "if you've got the right flavors, we think they can really resonate with customers."

Analysts have criticized Diageo's dependence on flavors. Exane BNP Paribas noted the apple variant of Crown Royal was responsible for 85% of Diageo's U.S. growth in 2015.

Overall, the maker of Johnnie Walker Scotch whisky and Tanqueray gin reported a net profit of GBP1.41 billion ($2 billion) for the six months ended Dec. 31, compared with GBP1.31 billion a year earlier. Results were buoyed by the sales of certain beer assets and by higher income from joint ventures and associates.

Net sales declined 5% on a reported basis on the back of unfavorable currency movements and asset sales to GBP5.61 billion, but they rose 1.8% on an organic basis.

Diageo reported a 7% rise in beer sales, driven by a 15% jump in Africa.

The company posted a 1% rise in Scotch, its largest and most profitable category. Scotch has taken a beating over the past two years as the emerging-markets-heavy business was hit by currency fluctuations, political instability and destocking. The company is also facing increased competition from bourbon and Japanese whiskies. On Thursday, Diageo said net sales of Scotch improved across all regions except for "very troubled areas" of Africa.

In Europe, Russia and Turkey, net sales climbed 3% on an organic basis, as did they in Africa. In Latin America and the Caribbean, net sales rose 9%, while in the Asia-Pacific region, they edged up 2%.

As in previous periods, Diageo said volatile currencies buffeted its performance, citing the weakness of the euro, the Venezuelan bolivar and the Brazilian real against sterling, partially offset by the strengthening of the dollar.

Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com

(END) Dow Jones Newswires

January 28, 2016 14:56 ET (19:56 GMT)

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