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Guin­ness-to-John­nie Walker brands owner is a high qual­ity com­pounder worth buy­ing and hold­ing

Shares - - CONTENTS DISCLAIMER -

Given the un­cer­tain­ties brew­ing over Brexit and global trade wars, now is a good time to buy into the de­pend­able earn­ings of, and the pos­i­tive mo­men­tum be­hind, Di­a­geo (DGE).

The world’s big­gest spir­its com­pany con­tin­ues to ben­e­fit from its enviable port­fo­lio of win­ning brands in­clude John­nie Walker whisky, Smirnoff vodka, Guin­ness and Cap­tain Mor­gan rum.

The top hold­ing in star fund man­ager Nick Train’s Fins­bury Growth & In­come (FGT), Di­a­geo is a high-qual­ity com­pounder, own­er­ship of which will help in­vestors sleep bet­ter at night dur­ing what could prove tur­bu­lent mar­ket times ahead.

Highly cash gen­er­a­tive, the pro­gres­sive div­i­dend-payer re­turned £1.5bn to share­hold­ers through a buy­back last year and man­age­ment has an­nounced a new £2bn share buy­back pro­gramme for full year 2019 to boot.

HIGH-QUAL­ITY TIPPLE

Shares re­mains an ad­mirer of the spir­its and beer pro­ducer’s cov­eted brands. These rep­re­sent an eco­nomic moat, en­gen­der­ing loy­alty among con­sumers, con­fer­ring pric­ing power upon the busi­ness and cre­at­ing bar­ri­ers to en­try for Di­a­geo’s ri­vals.

This bev­er­ages be­he­moth owns more top-50 global spir­its brands than any other com­pany and boasts earn­ings that are di­ver­si­fied by ge­og­ra­phy and prod­uct cat­e­gory; Di­a­geo is also the big­gest spir­its player in the US, the in­dus­try’s largest profit pool.

PALATE-PLEAS­ING PER­FOR­MANCE

Since Ivan Menezes took over as CEO in 2013, Di­a­geo has in­creas­ingly fo­cused on emerg­ing mar­kets, op­er­at­ing mar­gins and cash gen­er­a­tion. The £69.8bn cap of­fers a com­pelling play on the long-term ‘pre­mi­u­mi­sa­tion’ trend in devel­op­ing economies, where the bur­geon­ing ranks of the mid­dle class in­creas­ingly

as­pire to drink pre­mium brands.

Bet­ter-than-ex­pected re­sults for the year ended 30 June (26 Jul) showed or­ganic net sales growth of 5%, ahead of con­sen­sus es­ti­mates, with Di­a­geo gen­er­at­ing a bumper £2.5bn in free cash flow.

Fur­ther­more, for­eign ex­change guid­ance for a neg­a­tive £10m hit to 2019 op­er­at­ing profit was much more be­nign than the £49m im­pact con­sen­sus had been brac­ing it­self for.

And in terms of the cat­e­gory per­for­mance, scotch and gin sales were firmly on the up, the for­mer driven by John­nie Walker, the lat­ter by Tan­queray and

Gor­don’s, al­beit vodka con­tin­ued to de­cline.

Through Tan­queray and Gor­don’s, Di­a­geo is rid­ing the ma­jor re­nais­sance in the gin cat­e­gory, es­pe­cially in the UK and Spain, that is pow­er­ing the growth at AIM mix­ers mar­vel

Fev­ertree Drinks (FEVR:AIM),

with Gor­don’s ben­e­fit­ting from the suc­cess­ful launch of its Pink vari­ant.

‘While Di­a­geo’s growth rel­a­tive to the US spir­its mar­ket im­proved in full year 2018,’ writes Beren­berg, ‘man­age­ment would not guide on when the com­pany may stop los­ing mar­ket share. How­ever, CEO Ivan Menezes ap­peared con­fi­dent that mar­ket share losses will con­tinue to slow over the course of full year 2019.’

Be­sides boost­ing the cash cof­fers, Beren­berg also be­lieves the ru­moured dis­posal of Di­a­geo’s US ‘tail brands’ would be ‘strate­gi­cally pos­i­tive, as US con­sumers con­tinue to drink less but bet­ter.’

In ad­di­tion to the or­ganic de­vel­op­ment of the busi­ness, Di­a­geo has the bal­ance sheet strength to re­turn cap­i­tal to share­hold­ers whilst boost­ing its in­ter­na­tion­ally-de­rived earn­ings through merg­ers & ac­qui­si­tions (M&A). Hav­ing ac­quired the

Casami­gos tequila brand last sum­mer, Di­a­geo is in­creas­ing its stake in China-based bai­ji­uto-wine seller Shui Jing Fang from 39.7% to up to 60%. And don’t for­get, it also has ma­jor­ity con­trol of United Spir­its, a key route to mar­ket for its brands in the gar­gan­tuan In­dian mar­ket.

RISKS TO CON­SIDER

Risks for in­vestors to con­sider in­clude val­u­a­tion – Di­a­geo trades on 22.6 times the 124p of year to June 2019 earn­ings per share fore­cast by Beren­berg, based on pre-ex­cep­tional pre-tax profit of al­most £4bn.

The in­vest­ment bank looks for £4.27bn of pre-tax profit and 132p of earn­ings in fis­cal 2020, with the div­i­dend es­ti­mated to rise to 0.69p (2018: 0.65p) this year ahead of 0.72p in fis­cal 2020.

Nev­er­the­less, we are com­fort­able with the pre­mium rat­ing given Di­a­geo’s qual­ity, in­ter­na­tional di­ver­sity, re­li­able cash flows and pro­gres­sive div­i­dend, while the new buy­back should pro­vide down­side share price sup­port.

Other risks for in­vestors to weigh up in­clude the po­ten­tial for tighter reg­u­la­tion and higher ex­cise taxes, no­tably in the US, as well as ongoing price com­pe­ti­tion in US vodka and its im­pact on Smirnoff’s prof­itabil­ity.

Fu­ture bouts of Brex­itin­spired ster­ling weak­ness could be pos­i­tive for Di­a­geo, not only pro­vid­ing a trans­la­tion ben­e­fit, but a trans­ac­tion tail­wind too as its scotch would be­come even more com­pet­i­tive in­ter­na­tion­ally. (JC)

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