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Diageo - Share buybacks paused

Nicholas Hyett, Equity Analyst | 9 April 2020 | A A A
Diageo - Share buybacks paused

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Diageo plc Ordinary 28 101/108p

Sell: 2,797.00 | Buy: 2,799.00 | Change -163.50 (-5.53%)
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Diageo's sales have fallen significantly following the closure of bars and restaurants around the world in response to COVID-19.

The group has confirmed that its interim dividend of 27.41p per share will be paid as scheduled. However, the £4.5bn share buyback programme, of which £1.25bn has already been completed, is being paused until the end of June.

The company has also withdrawn all previous guidance for this financial year.

The shares were up 2.9% following the announcement.

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Our View

Diageo's feeling the bite of government lockdowns and we expect the drinks giant to have a rough quarter or two as a result. We think the group's brands are strong enough to fuel a recovery when life returns to normal though.

The group owns established and well-marketed brands like Guinness, Gordon's and Johnny Walker, as well as a broad enough portfolio to hopefully take advantage of whatever the flavour of the recovery turns out to be.

That said, performance in developed markets hasn't been such plain sailing in recent years. Offloading a selection of smaller brands shifts the dial towards sales of more lucrative products but the remedial work isn't over. Management had planned further investments to help build momentum, although COVID-19 may put these on hold for a while.

Elsewhere a growing middle class in emerging markets is playing into the group's hands. It has attractive positions in the key Chinese and Indian markets, and as consumers move up the value chain Diageo is waiting for them with Black, Blue and Double Black labels.

Turning to the balance sheet, Diageo was carrying 2.8 times cash profits as net debt on 31 December 2019. It's issued more debt since then to shore up short term liquidity, and absent a sustained recession we think the group has enough cash on hand to keep the stills running. However, debt was closer to the top than the bottom of the target range to begin with. If debt spikes in the coming months some effort will have to be made to bring it down in the future - potentially denting shareholder returns.

The recent 5% dividend increase continued an enviable record of growth that stretches back to the 1990s. All the more impressive given there have been a string of buybacks too, though these have been put on ice for the time being. With a world class stable of brands and exposure to emerging markets the group has some enviable advantages. However, no investment's a sure thing, and in the face of a recession or changing tastes Diageo may have its work cut out and the dividend could suffer. The shares currently offer a prospective yield of 3.0%.

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Trading update

Bars and restaurants account for 20% of spirit sales in the US and 50% in Europe. As the majority of US states and European countries have imposed some form of "lockdown", trade in these venues has been significantly impacted. Diageo has seen some pick up in sales from retail stores, although it is unclear whether this will be sustained. In mainland China, trade in bars and restaurants is starting to recover.

Disruption to travel retail sales was initially confined to just the Asia Pacific region, although it has now spread to other markets as governments have imposed travel restrictions.

In India the government has shut both venues and retail stores, as well as some production facilities. Other markets, including Africa and Latin America, have also seen disruption.

As of 31 December 2019, Diageo had net debt (debt minus cash) equal to 2.8 times cash profits. None of this debt contains any restrictions from lenders, known as covenants. To support its liquidity Diageo recently issued £1.9bn of new debt, and also has £2.8bn in committed bank facilities.

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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 disclosure for more information.