Diageo PLC (DGE) is a London, United Kingdom-headquartered global leader in beverage alcohol with an outstanding collection of brands across spirits and beer, which aspires to become one of the best performing, most trusted and respected consumer products companies in the world. Every year it produces more than 240 million equivalent units of its brands, from more than 150 manufacturing sites in 30 countries, and the geographical diversity of its business helps to continuously improve its performance. While the group is still a relatively young company – it was established in its current form in 1997 but its foundations were laid years before by giants of the industry – Elizabeth Cumming, John Walker, Arthur Guinness and many more to grow into a group with an outstanding collection of over 200 brands enjoyed in more than 180 countries and employing 30,000 people across its global business.  The company is listed on the London Stock Exchange and is a constituent of the FTSE 100 index.

The group is the custodian of internationally renowned brands built over hundreds of years and each of its markets is accountable for its own performance and for driving growth. The group has a large beer business in Africa with a portfolio that reaches across price points and beer is its second largest category after scotch, as the company has a global beer business, led by its premium brand Guinness. The company participates in mainstream spirits, so consumers can access its brands at affordable price points, and it aims to grow participation in international premium spirits in emerging markets, while its support premiumisation through its premium core and reserve brands in developed markets to enable consumers to trade up into luxury categories.

Key Statistics



Management

Javier Ferrán was appointed as Chairman of Diageo Plc on 1 January 2017, with prior experience at Bacardi Limited as President and CEO, along with other appointments. Ivan Menezes is the Chief Executive and Kathryn Mikells is the Chief Financial Officer.

Segments

The operations of the group are differentiated in five geographical segments, namely North America, Europe and Turkey, Africa, Latin America and Caribbean, and Asia Pacific. North America accounts for more than 33% of the sales and is the largest segment by sales and operating profit. It accounts for more than 50% of the total operating profit. Reflecting the pricing pressures in Africa, the region accounts for the lowest share of operating profit, while Europe and Turkey are the second biggest source of operating profit and revenue.

Top Shareholders


 (Source: Thomson Reuters)

Recent Development

The company on 1 October 2019 announced that it had launched and priced a $1,600 million SEC-registered bond offering which would be used for general corporate purposes, with the offering consisting of $600 million 2.125% fixed rate notes due 2024 and $1,000 million 2.375% fixed rate notes due 2029.

Financial Highlights (FY 2019, in £m)


 (Source: Company Filings)

Reported net sales grew by 5.8% on a reported basis to £12.9 billion, driven by an organic growth and favourable exchange rate, while total sales were £19.3 billion. All regions reported organic net sales growth and the group delivered 6.1% organic net sales growth, as it reported organic volume growth of 2.3% and 3.8% positive price/mix. Increase in gross profit from £7.53 billion to £8 billion was more than the corresponding rise in revenue as the cost of sales rose marginally slower to £4.9 billion from £4.63 billion in the prior year. Though partially offset by acquisitions and disposals, organic growth, lower exceptional operating charges, and favourable exchange helped the group to post a growth in reported operating profit of 9.5% to £4.04 billion from £3.7 billion in the previous year. Operating profit before exceptional items grew ahead of net sales at 9.0% on an organic basis and 8% on a reported basis to £4.11 billion from £3.8 billion. Although partially offset by cost inflation and higher marketing investment, improved price/mix and productivity benefits from everyday cost efficiencies helped the company in achieving organic operating margin improvement of 83 basis points and reported operating margin increased by 107 basis points. Expenditure on marketing rose by 8% on an organic basis and 9% on a reported basis during the period to £2.04 billion from £1.88 billion. Profit before taxation rose from £3.74 billion in the previous year to £4.23 billion while profit for the period rose to £3.33 billion against £3.14 billion in the prior year. Basic EPS increased by 7% or 9.0 pence to 130.7 pence. Profit attributable to shareholders rose by 5% to £3.16 billion against £3.03 billion reported in the previous year. Free cash flow continued to be strong at £2.6 billion, which represented an increase of £85 million, while net cash from operating activities was £3.2 billion, an increase of £164 million as compared to the last year. Return on average invested capital increased by 80 basis points to 15.1% and bringing the full-year dividend to 68.57 pence per share.

Segmental Analysis


 (Source: Company Filings)

North America

With growth across all three key markets, North America delivered net sales growth of 5% in organic basis to £216 million and 8% on a reported basis to £344 million, reflecting the disposal of a portfolio of 19 brands to Sazerac. Organic value in the region grew by 2%, while as the marketing expenses on an organic basis grew by 11%, operating profit grew modestly to £52 million.

Europe and Turkey

In Turkey, net sales were up by 11% due to inflation and excise duty led price increases, while driven by Continental Europe, Great Britain and Ireland, net sales in Europe were up by 3%, helping the company to deliver 4% net sales growth to £104 million. Operating profit rose by 2% on an organic basis to £22 million.

Africa

Net sales grew by 6% in South Africa driven by growth in spirits and due to growth across both beer and spirits. East Africa and Africa Regional Markets net sales grew 13% and 8%, respectively, helping the region to deliver 7% net sales growth on an organic basis to £100 million. The continued benefit from productivity initiatives and improved price/mix drove operating margin improved to 494bps. Operating profit during the period was reported at £91 million, which represented an increase of 50%.

Latin America and Caribbean

As Colombia grew by 19%, Mexico grew by 8% and net sales in Brazil grew 11% largely driven by gin, Latin America and Caribbean delivered 9% growth in net sales to £90 million. Operating profit in the region rose by 19% to £59 million.

Asia Pacific

With strong growth across the region except for North Asia, Asia Pacific delivered 9% growth in the net sales on an organic basis to £226 million. Operating margin increased by 341bps driven by positive price/mix and productivity led savings, while operating profit rose by 26% to £143 million as marketing investment increased by 7% only.

Financial Ratios

                                          
  (Source: Thomson Reuters)

Over the years, the profitability margins of the group have gradually risen and are considerably more than the industry median, exhibiting the superior efficiency recorded by the group. While the current ratio is more than the industry median, the corresponding figure for quick ratio is lower, indicating that the company has a lower proportion of liquid assets as compared to its peers. Additionally, the company is more leveraged than its peers, and the debt as compared to equity has risen over the years. The asset turnover ratio is lower than the industry, suggesting that the group could improve its financials by better utilising its resources.

Valuation Methodology
Method 1:Price/Cash Flow Multiple Approach (NTM)



To compare DGE with its peers, Price/Cash Flow multiple has been used. The peers are Carlsberg A/S(NTM Price/Cash Flow was 12.52), Constellation Brands Inc(NTM Price/Cash Flow was 15.90), Pernod Ricard SA(NTM Price/Cash Flow was 21.28), Treasury Wine Estates Ltd(NTM Price/Cash Flow was 25.85), Remy Cointreau SA(NTM Price/Cash Flow was 34.78), and Brown-Forman Corp(NTM Price/Cash Flow was 35.09). The median of Price/Cash Flow (NTM) of the company’s peers was 23.56x (approx.).

Method 2: Price/Earnings Multiple Approach (NTM)



To compare DGE with its peers, Price/Earnings multiple has been used. The peers are Heineken NV(NTM Price/Earnings was 19.44), Carlsberg A/S(NTM Price/Earnings was 21.65), Pernod Ricard SA(NTM Price/Earnings was 22.41), Remy Cointreau SA(NTM Price/Earnings was 29.66), and Davide Campari Milano SpA(NTM Price/Earnings was 30.97). The mean of Price/Earnings (NTM) of the company’s peers was 24.83x (approx.).

Share Price Commentary


Daily Chart as at 4^th November-19, before the market closed (Source: Thomson Reuters)

On 4 November 2019, at the time of writing (before the market closed, at 11:34 am GMT), DGE shares were trading at GBX 3,154.50 and remained flat against per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 3,633.50/GBX 2,630.00. The company's stock beta was 0.71,reflecting less volatility as compared to the benchmark index. The outstanding market capitalisation was around £74.16 billion, with a dividend yield of 2.17 per cent.

Growth Prospects and Risks Assessment

Driven by the increasing penetration of spirits around the world and population and income growth, global spirits category has shown resilient, long-term growth, while broad portfolio helps it to access different consumer occasions with brands, across price points. Consistent with what the company is targeting over the medium-term, organic operating profit is expected to grow roughly one percentage point ahead of organic net sales, which is expected to grow towards the mid-point of the 4% to 6% range. However, the company reports that it is not immune from significant changes to global trade policy and uncertainties, including uncertainty with respect to the process surrounding the proposed exit of the United Kingdom from the European Union.

Conclusion

Over the last five years, the company has shown impressive growth, with revenue increasing by 4.64% and gross profit rising by more than 5%. Moreover, operating income also rose at an impressive rate of 8%, while net income before tax gained 9.33% every year.
 
Based on the decent prospects, and supported by valuation undertaken using the above two methods, we have given a “BUY” recommendation at the closing price of GBX 3,154 (as on 1^st  November 2019) with single-digit upside potential based on 23.56x NTM Price/Cash Flow (approx.) on FY20E Cash Flow per share (approx.) and 24.83x NTM Price/Earnings (approx.) on FY20E Earnings per share (approx.).
 
*The “Buy” recommendation is valid for the current price as covered in the report (as on 4-November-19).
*All forecasted figures and Peer information have been taken from Thomson Reuters.

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