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Diageo - growth continues but outlook softens

Sophie Lund-Yates, Equity Analyst | 30 January 2020 | A A A
Diageo - growth continues but outlook softens

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Diageo plc Ordinary 28 101/108p

Sell: 3,433.50 | Buy: 3,434.50 | Change -23.00 (-0.67%)
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Diageo's half year net sales grew 4.2% to £7.2bn, and organic operating profit grew 4.6% to £2.4bn. That reflects cost savings and a more favourable mix of price and sales.

The group expects full year organic net sales growth to be at the lower end of the 4-6% target range.

The interim dividend has been increased by 5% to 27.41p per share.

The shares fell 1.1% following the announcement.

View the latest Diageo share price and how to deal

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. Tequila is the current flavour of the month - but still only accounts 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.

Diageo is currently carrying 2.8 times cash profits as net debt on its balance sheet. We don't see that as a major issue now, but it could become one if interest rates rise significantly or there's an unexpected operational hiccup.

Investors should also note the shares trading on a price/earnings ratio of 21.7 times, versus a longer term average of 18.4. We think that reflects the fact steady compounders like Diageo are in vogue in the context of global uncertainty. But if tastes change, the shares could de-rate, even without any setbacks.

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%.

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

Net sales in North America grew 6%, with growth across all three key markets. US Spirits grew 6%, led by Tequila where net sales increased 35%. Operating profit increased 5% to £1.1bn, as margins declined due to a strong relative performance of the lower margin Diageo Beer Company USA.

In Europe & Turkey sales grew 3% on the back of a consistent European performance and double digit growth in Turkey. Operating profit of £615m was up 2%, behind sales growth which reflects lower operating margins. Inflationary cost pressures in Turkey and higher marketing investment offset productivity savings and higher average prices.

Asia Pacific saw sales growth of4% thanks to strong performances in China and Australia. Operating profit increased 6% to £432m, as improved pricing helped boost margins.

Latin America & Caribbean and Africa saw profits increase 3% and 13% respectively.

Scotch saw flat global sales, and Vodka declined 1% due to declining North American sales offsetting growth elsewhere. Tequila delivered impressive growth of 31%, but continues to make up just a small amount of overall sales.

Free cash flow fell £0.4bn to £1bn, reflecting one off tax payments. Net debt increased £2.5bn to £12.9bn.

Find out more about Diageo shares including how to invest

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.