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Diageo - Currency supercharge solid results

Equity research team | 26 January 2017 | A A A
Diageo - Currency supercharge solid results

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Diageo plc Ordinary 28 101/108p

Sell: 3,509.00 | Buy: 3,510.00 | Change 22.00 (0.63%)
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Reported sales (£6.4bn) and operating profit (£2.1bn) were up 14.5% and 28% respectively, boosted by the weaker pound. Underlying volumes and sales, up 1.8% and 4.4%, were ahead of market expectations. The interim dividend increases 5% to 23.7p.

The shares rose 4.4% on Thursday 26 January morning trading.

Our View

Thanks to the weaker pound, headline half year results were spectacular. As a sterling reporter which generates most its revenues overseas, the group is seeing the value of its profits surge as overseas sales are converted back to pounds at favourable rates.

Underneath those currency movements results are far more boring, but that's just the tipple many investors were looking for. Low single digit volume growth, albeit with stronger growth in emerging markets, may not sound exciting, but combined with increasing prices, this means operating profits are ticking up nicely.

The group's top quality brands, which include Guinness, Baileys and major players in pretty much any spirit category you could care to mention, mean that consumers keep on coming back despite price increases. A growing middle class in emerging markets is playing into the group's hands too. As consumers move up the value chain, Diageo is waiting for them with a selection of aspirational brands to meet every taste.

Performance in more developed markets hasn't been such plain sailing in recent years, with North America in particular struggling. Turning performance around has been a priority for CEO Ivan Menezes, and the underlying business is performing well. Although Vodkas still seem to be suffering on the other side of the pond, the advantage of Diageo's huge portfolio is that it can simply switch to other parts of the portfolio when spirit trends change. North American Whiskies seem to be the place to be at the moment.

The 5% dividend increase continues an enviable record of dividend growth that stretches back to the 1990s. With a world class stable of brands and exposure to emerging markets around the world, this trend could well continue, although of course there are no guarantees.

The stock currently offers a prospective yield of 3.1%, and trades on a price/earnings ratio of 19.5 times versus a longer term average of 16.3 times.

Half Year results:

Sterling weakness has supercharged a steady operating performance, adding 12p to half year earnings per share of 60.3p, up 7.4% on a year earlier. Currency effects also had a significant positive impact on free cash generation, which increased by £245m year on year to £1,084m.

Underlying sales growth of 4.4% is consistent with the group's target of mid-single digit growth in revenues. The group delivered organic volume growth across all regions, with the exception of Latin American and the Caribbean where sales remained flat. Organic net sales are ahead of volumes in all markets, implying the group is successfully raising prices.

The strong dollar resulted in particularly strong result from North America, where operating profits jumped 26% on the back of a 3% increase in organic net sales. This performance was supported by a strong performance from North American Whiskies, with Crown Royal showing volume growth of 15% and Bulleit up 27%, and positive contribution from the Scotch and Tequila categories.

Globally, North American Whisk(e)y volumes grew 11%, with Tequila up 22%. Rum was the weakest performer in the period, with volumes down 4%.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.