Diageo PLC (LON: DGE) – Delivering Consistent Organic Growth

Diageo PLC is a FTSE 100 listed Alcoholic Beverage Company with a portfolio of beer brands and spirits. The Company produces over 200 brands and markets them in more than 180 countries around the world. The Company was formed in 1997, and presently, it employs around 28,400 people across the 150 sites. The Company is engaged in the production, importing, and distribution of premium drinks marketed and sold under the brand names Smirnoff, Guinness, Tanqueray, Captain Morgan, and Johnnie Walker, among others. The Company products include vodka, rum, scotch whisky, gin, beer, wine, tequila, beer, among others. It is listed on both the New York Stock Exchange (DEO) and the London Stock Exchange (DGE).

On 4^th August 2020, the Company is expected to release the preliminary results for FY20.

 
(Source: Company Website)

Key Fundamental Statistics

    
(Source: Refinitiv, Thomson Reuters)
 
Segment Analysis

The Company bifurcates the revenue into five categories, namely Spirits, Beer, Ready to Drink, Wine, and Other. Geographically, the business is segmented into five primary divisions, namely Great Britain, United States, Netherlands, India, and Rest of World.


 (Source: Presentation, Company Website)

Synopsis of Recent Regulatory Updates

25^th June 2020: The Company announced the appointment of Melissa Bethell (currently a non-executive director of Exor and Tesco) as a non-executive director. She will also be joining the Audit, Nomination and Remuneration Committees. The appointment will be effective from 30^th June 2020.

22^nd June 2020:  In pursuant to the Financial Conduct Authority’s guidance on corporate reporting amid the COVID-19 pandemic, the Company postponed the announcement of preliminary results for the year ended 30^th June 2020, from 30^th July 2020 to 4^th August 2020.

9^th June 2020: The Company completed the SEC registration post publishing the listing prospectus for USD 2.5 billion bond offering. It consists of three tranches of bonds – USD 1 billion (2.000% fixed rate notes due 2030); USD 750 million (1.375% fixed rate notes due 2025); and USD 750 million (2.125% fixed rate notes due 2032). The proceeds will be used for operating purpose.  

Non-Financial Key Performing Indicators in FY2019

The Company has a strategy for ‘Positive Drinking’ in place to reduce harmful drinking, while the Company achieved a milestone in terms of safety parameter. Also, it has improved water efficiency by 6% in FY2019 versus FY2018. Moreover, the Company reduced the carbon emission by 5.9% in FY2019 (against FY2018), and cumulatively by 44.7%, compared to the baseline of FY2007.


(Source: Annual Report, Company Website)

Top Shareholders Statistics

 

Trading Update (as on 9th April 2020) - Strongly Positioned for a Recovery in Consumer Demand

In March 2020, the widespread containment actions, comprising the closure of bars and restaurants, were put in place by the governments across the world. The Company is also working closely with the customers and suppliers to minimise business disruption. The Group is donating alcohol for making over 8 million bottles of sanitiser. Regarding the current trading environment, the management said that the social distancing measures had been introduced in several of the markets, including the closure of the on-trade channels. In mainland China, on-trade consumption started to return at a slow pace as bars and restaurants were re-opened gradually. In the North American region, restaurants and bars were closed in most states. In Europe, on-trade premises are closed in the majority of countries. In India, trade channels and production facilities are closed. The Group’s main markets in the African region have been impacted, and two production sites have been closed in Nigeria. During the short-term period, the company is reallocating resources across the Group and reducing discretionary expenditure. The Group has delivered a robust balance sheet, with 2.8 times of adjusted net debt to EBITDA ratio. As earlier announced, the Company has completed the issuance of new sterling and euro bonds for a total consideration of around GBP 1.9 billion.

Financial Highlights for the six months ended 31st December 2019 (£ million)


(Source: Interim Presentation, Company Website)
 
For the first half of 2020, the reported net sales increased by 4.2% to £7.2 billion as compared with the corresponding period of the last year. The operating profit was reported at £2.4 billion in H1 FY20, an increase of 0.5% against the same period last year. Organic operating profit for the first half of 2020 increased by 4.6%, ahead of organic net sales, due to robust price/mix and productivity benefits from everyday cost efficiencies, though was partly offset by weighted marketing investment and cost inflation. The pre-exceptional earnings per share surged by 4.2% to 80.2 pence in H1 FY20, due to the higher operating profit and the capital return programme.
 
Financial Ratios – Strong Profitability for the First Half of FY2020 versus Industry Median

 

Reported profitability metrics were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to peers. Diageo Plc has delivered a substantial return for the shareholders’ as Return on equity of 23.5% was significantly higher as compared to the industry median. On the liquidity front, Diageo Plc’s current ratio was lower than the industry median of 1.38 but has sufficient liquidity to meet short-term obligations. On leverage front, the debt-equity ratio was 1.79x, which was higher as compared to the industry median of 0.41x, reflecting that the company is more leveraged as compared to peers.  

Share Price Performance Analysis


Daily Chart as on 29^th June 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On June 29, 2020, at the time of writing (before the market close, at 8:24 AM GMT+1), Diageo Plcshares were trading at GBX 2,653.50, down by 1.72% against the previous day closing price. Stock 52 week High and Low were GBX 3,633.50 and GBX 2,050.60, respectively.

Bullish Technical Indicator

From the technical standpoint, 14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Valuation Methodology

Price/Earnings Approach (NTM)



To compare Diageo Plcwith peers, Price/Earnings multiple has been used. The peers are Fevertree Drinks Plc (NTM Price/Earnings was 46.42), Kerry Group Plc (NTM Price/Earnings was 28.22), Reckitt Benckiser Group Plc (NTM Price/Earnings was 23.27), Unilever Plc (NTM Price/Earnings was 20.13) and Coca Cola HBC AG (NTM Price/Earnings was 18.01). The Average of Price/Earnings (NTM) of the company’s peers was 27.21x (approx.).

Valuation Metrics


(Source: London Stock Exchange)

This analysis is a useful procedure to decompose the various drivers of ROE. It can be further examined through three financial metrics which are: net profit margin, asset turnover and financial leverage. This analysis helps to assume whether the company’s profitability, use of debt or assets that are driving ROE.

Diageo Plc Vs FTSE-100 Index (5 Years)


(Source: Refinitiv, Thomson Reuters)

In the last five years, Diageo share price has delivered 43.39% returns as compared to negative 7.26% returns of FTSE-100 index, which shows that the stock has outperformed the index during the last five years.

Industry Outlook Dynamics

The alcoholic beverage market is an attractive industry in terms of growth when compared with other consumer categories. By 2030, there are 550 million new consumers expected to enter the market. As per the report from Data Bridge Market Research, the market size for the global alcoholic beverages industry is projected to grow at CAGR (compounded annual growth rate) of 5.6% between 2018 to 2025. The industry valued was around USD 1,272.8 billion in 2017. Regarding the trends, it has been observed that consumers are switching to spirits from wine and beer, and thus, spirits now account for 53% of total alcoholic beverage market by volume.

Growth Prospects and Risk Assessment

The Company has a wide geographic reach in more than 180 countries with a broad product portfolio to deliver sustainable performance. Moreover, the Company owns two of the world’s five largest spirits brand in terms of value, Smirnoff, and Johnnie Walker. In the era of COVID-19 pandemic, the Company is beginning to see revival in trade consumption post lockdown easing as restaurants & bars are gradually re-opening. For the financial year 2020, the company expects organic net sales increase to be towards the lower end of the range of 4% to 6% mid-term guidance.The Company continues to anticipate organic operating profit to increase by approximately 1 percentage point ahead of organic net sales. The Group stays focused on building the long-term health of the brands, a culture of everyday efficiency, and supported by data-led insights. The Company has been taking growth initiatives and expecting a gradual improvement throughout the last quarter of the fiscal year 2020. With continuous monitoring of the current situation, the Group is confident about growth opportunities in Greater China and the Asia Pacific and expecting the recovery in demand soon.

To meet the new regulations, the Group needs to implement new processes, failing to do so would increase the compliance risk. Acquisitions to match rapid transformation may increase integration risk and expected synergies may not be achieved. Furthermore, the sector is exposed to political, financial and operational risks, each of which has the potential to significantly impact company/industry performance. The Potential change in the political environment and regulatory frameworks, failure to meet all the legal and regulatory obligations and inability to provide appropriate resources will negatively impact the operational and financial performance.

Business Outlook Scenario

The Company expects growth opportunities from the Asia Pacific and Greater China business as the situation normalises. During this challenging time, the highest priority is to safeguard the well-being and health of the people, while taking essential actions to defend the business. DGE anticipates that they will deliver the return of up to 4.5 billion pounds of capital to investors from FY2020 to FY2022. Going forward, Diageo is expecting to generate decent organic net sales growth. Though the outbreak for COVID-19 adversely impacted the company’s financial performance, the Group continues to make an investment in Brands to get maximum benefits as consumer demand recovers.The Company’s prospects look good, and it could be an attractive opportunity to invest from a long term perspective.

 
(Source: Presentation, Company Website)
 
Over the course of 3 years (FY16 - FY19), the company’s revenue surged from GBP 10,485 million in FY16 to GBP 12,867 million in FY19. Compounded annual growth rate (CAGR) stood at 7.06 per cent.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation at the current market price of GBX 2,653.50 (as on 29^th June 2020, before the market close at 8:24 AM GMT+1), with lower double-digit upside potential based on 27.21x Price/Earnings (approx.) on FY20E earnings per share (approx.).
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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