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