FTSE Friday: Climate concerns and Diageo's rum punch

After Terry Smith re-opened Mayonnaise-gate in his annual Fundsmith letter last week, Alan Jope (the boss at Unilever, which is the company under fire from Smith) has claimed this week’s best soundbite: “we’re at peak inflation, not peak prices,” he told an audience at the World Economic Forum on Tuesday.

The first part of his statement is correct or incorrect depending on which inflation metric you use. In December, CPI retreated for the second consecutive month on falling energy prices, but Core CPI (which excludes food and fuel) rose back up to its October levels and wage inflation hit a new high of 6.4%. And so, while the price inflation of goods might have stabilised, service inflation looks like it might have further to run. This week stocks wobbled as investors priced in the likelihood of a 0.5% increase in interest rates when the Bank of England meets again in February.

But final quarter trading statements from some of Britain’s biggest businesses continue to provide respite from the gloom of the economic situation. This week we’ll be looking at the announcements from:

• Diageo - which has made another big acquisition
• Pearson - where turnaround plans continue to look good

Diageo hopes rum can become its new tequila

Diageo (LON:DGE) doesn’t tend to cheap out when it makes acquisitions. An upfront payment of €260m, plus performance fees of up to €177.5m might seem exorbitant for a single brand of rum. But in 2017, the company paid $700m for George Clooney’s four-year old tequila company Casamigos. By comparison this latest acquisition is small fry.

Don Papa (the newly acquired brand) is characterised as a super-premium rum and it seems to have been bought to fill a gap in Diageo’s high-end rum offering (a role Casamigos played in the tequila market). And how did that acquisition work out? Pretty well so far. In the financial year to June 2018, the first full year following the Casamigos acquisition, tequila contributed 4% of the company’s total sales. In FY2022 tequila’s contribution had risen to 10% and Casamigo sales rose more than 90% off organic volume growth of 82%.

Hefty spending isn’t too much of a problem for companies that can squeeze profits out of their investments like Diageo can. In the five years since Casamigos joined the fold, the company’s return on invested capital (ROIC) has averaged 11.25%. Revenues have risen at a compound annual rate of 5.1%, despite a major blip in 2020 when most of the world was in lockdown.

Going forward, Diageo is doubling-down on its premium brands, which have been the biggest source of growth for both the company and the wider spirits market. The company has bought 13 premium brands in the last five years and sold five, compared to the sale of 21 standard or value brands. It’s a strategy that has worked well in the recent years of plenty, but whether demand in the premium segment of the market will continue to grow at the same pace during tighter economic times is another question.

Energy and climate: Two crises

It’s a shame, observed a journalist on Twitter earlier this week, that the current skiing conditions in the Alps are more likely to make some people sit up and think about the effects of climate change than extreme flooding in Pakistan. As the world’s business heavyweights head to a balmy Davos for 2023’s World Economic Forum it’s hard to disagree.

Climate change is, of course, one of the topics up for discussion in Davos. Delegates from many of the world’s energy companies are there, armed with their green energy investment plans for tackling the climate crisis. For many (including Greta Thunberg who was hauled off by German police this week for protesting the expansion of a coal mine), efforts are falling far short of what is needed. And, while I am firmly of the opinion that threatening to jump into a coal mine is not the right way to enact change, there is an argument to be made for corporations doing more to help the green energy revolution.

But that is easier said than done when Europe is simultaneously battling an energy crisis. Energy prices are forecast to decline both this year and next, but are likely to settle some 50% higher than previous levels. New oil and gas fields could help solve one problem, but further investment in fossil fuels won’t help the climate agenda.

And the would-be innovators aren’t pulling their weight. This week, fledgling battery company Britishvolt collapsed into administration after failing to attract a bid that would provide it with enough financial support to build its factory. Meanwhile, ITM Power (LON:ITM) - once one of the big hopes for the UK’s hydrogen power industry - announced that financial results for the year to April 2023 will be “materially different” to previous forecasts. The company’s share price has now fallen 87% from its early 2021 highs.

The dynamics of the energy market had a big impact on the stock market in 2022. Anyone fortunate enough to be overweight in the energy sector in 2022 is likely to have had a far happier investing year than the rest of us. But at the start of 2023, with oil and gas prices coming down momentum has started to swing:BP (LON:BP.) andShell (LON:SHEL) are on a downward arc, Vestas and Orsted (the two Danish wind giants) are tip-toeing upwards.

Pearson: A turnaround in full swing

For the second year in a row,Pearson (LON:PSON) has managed to report an annual increase in revenues. After five consecutive years of falling sales and narrowing margins, it is good to see the turnaround plan initiated when Andy Bird became chief executive in 2020 continuing to deliver.

The dynamics of the international education market are still in place - learning and testing are increasingly happening online - but Mr Bird seems to have a far better grasp of Pearson’s failure to shift the company’s products and services to match those dynamics than his predecessor. Learning materials across all of the group’s business segments are being moved online and those which can’t make the change are under strategic review. In 2022, Pearson sold its old international courseware publishing business after deciding it couldn’t be brought up to date.

Across the company, increased digitalisation is expected to push up operating margins which had fallen into low single figures. By 2025, management says it is aiming for double digit margins across all its main business divisions. Adjusted operating profit growth of 11% (ahead of expectations) suggests that the company is still on track to deliver on those goals.

But Pearson will have to keep on innovating if it is going to remain competitive in the education market. Since the end of November 2022 (when OpenAI released ChatGPT), students have been using artificial intelligence to augment their learning (and maybe their essays). It will be interesting to see how Mr Bird plans to address the latest development in his industry when Pearson releases its results on 3 March.