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Diageo - dividend and profits rise, but outlook disappoints

George Salmon | 25 July 2019 | A A A
Diageo - dividend and profits rise, but outlook disappoints

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Diageo plc Ordinary 28 101/108p

Sell: 3,487.00 | Buy: 3,488.00 | Change 0.00 (0.00%)
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Diageo has announced full year net sales of £12.9bn, 6.1% ahead of last year, thanks to organic growth in volumes and pricing. Organic operating profit increased 9% to £4bn, as operating margins came in higher than expected.

However, medium-term guidance for 5-7% operating profit growth was slightly behind analyst expectations.

The shares fell 1.6% following the announcement.

The final dividend of 42.47p is 5% ahead of last year. Diageo expects to complete a further £4.5bn buyback programme, between 2020 and 2022.

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Our View

Diageo's a global giant with a footprint large enough to shift almost £13bn worth of drinks.

Its established and well-marketed brands like Guinness, Baileys and Gordon's, means Diageo has a good degree of pricing power. Being able to up prices without losing customers is good news for revenues and margins.

Another advantage of Diageo's huge portfolio is it can simply switch on different parts of the collection when spirit trends change. Tequilas and Gins are current flavours of the month - but these still only account for a small percentage of sales.

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 Black and Blue and Double Black labels.

Performance in developed markets hasn't been such plain sailing in recent years. Offloading a host of brands that made up the tail of its portfolio shifts the dial towards sales of more lucrative products. The hard work isn't over yet though, with further investments ongoing to help build momentum - including teaming up with Game of Thrones to create a novelty line of whiskies.

Still, the 5% dividend increase continues an enviable record of growth that stretches back to the 1990s. All the more impressive given there have been a string of buybacks too. With a world class stable of brands and exposure to emerging markets the group is well set to continue that track record, although of course there are no guarantees. The shares currently offer a prospective yield of 2.2%.

Diageo is more leveraged than it has been, and carries 2.5 times cash profits as net debt on the balance sheet. We don't see that as a major issue now, but it could be a problem if there's an operational problem.

Investors should also note the shares trading on a price/earnings ratio of 24 times, versus a longer term average of 18. We think that reflects the fact steady compounders like Diageo are in vogue in the context of global uncertainty. If tastes change, the shares could de-rate, even without any hiccups.

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Full year results (on an organic basis -ignoring currency and portfolio changes and exceptional items)

In Europe & Turkey operating profit of £1bn was 2% ahead of last year. That reflects the lower operating margin, as inflationary cost pressures in Turkey and increased marketing spend, were offset by price increases. Net sales growth of 4% was driven by Europe, where gin grew strongly, which helped offset declines in Vodka.

North America delivered net sales growth of 5%, with the sale of a portfolio of 19 brands to Sazerac helping performance. The disposal of lower-end brands meant sales were concentrated on Diageo's more expensive products. There was particular success from its 'ready to drink' products, as well as Tequila. Operating profit increased 3% to £1.9bn as cost efficiencies offset higher costs.

Asia Pacific saw very strong growth in China, with total net sales of £2.7bn. Operating profit increased 26% to £703m, as improved pricing and the success of new products helped boost margins.

Latin America & Caribbean and Africa saw profits increase 19% and 50% respectively.

The group's two largest categories, Scotch and Vodka, both saw sales growth (Scotch: 6%, Vodka: 2%), with a new Game of Thrones themed Johnnie Walker whiskey performing well. Gin and Tequila both delivered impressive growth, but continue to only make up a small amount of overall sales.

Free cash flow improved £85m to £2.6bn, and £2.8bn of share buybacks meant net borrowing increased 24% to £11.2bn.

The group expects to maintain organic net sales growth in the mid-single digit range over the medium term, and is targeting further margin increases.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.