Diageo said it expects full year organic operating profit growth of at least 14%. The business has seen a "good recovery" in all regions, and trading in the group's largest market, North America, has been especially strong. In Europe, Diageo says it is performing well in retail stores, although global travel retail is still severely impacted by the pandemic.
Following this performance, Diageo is restarting its £4.5bn share buyback and special dividend programme. The group intends to return £1.0bn before the end of the 2022 financial year. Management expects the group's net debt to underlying cash profits (EBITDA) ratio to be within the top end of the target 2.5-3.0x ratio at 30 June 2022.
The shares rose 2.5% following the announcement.
Diageo's had a rough year thanks to the pandemic, but ultimately we think names like Johnny Walker, Guinness, and Gordon's, should be strong enough to fuel a recovery as life returns to normal - as the expected 14% operating profit growth in the most recent trading update demonstrates. The portfolio's breadth will help the group benefit regardless of the flavour of the recovery.
Whisky is an especially attractive market because it takes a lot of up-front investment and time for a newcomer to compete. Good whisky needs to be aged, so a new competitor would need to be comfortable waiting for their investment to pay off. Alternatively, they could buy existing distilleries and spend heavily on marketing, but scaling up would be difficult and expensive. Strong brands and barriers to entry have meant attractive margins in normal times.
A growing middle class in emerging markets is playing into the group's hands too. 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.
That said, performance in developed markets hasn't been entirely 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 is forging ahead with investments in e-commerce, capacity, sustainability and marketing. Covid may slow some of this down, but it's encouraging to see the group staying on the front foot.
Diageo is also carrying more debt than we'd like. The ratio of net debt to cash profits will come down as the group recovers, but some effort will need to go into reducing the debt. Management is feeling confident though, and is restarting the share buyback programme. As the shares are currently trading on a PE ratio well above the long run average and debt is still higher than we'd like, we think there's a strong case for keeping buybacks on ice for the time being.
Nonetheless, recent dividend decisions continue an enviable record of growth that stretches back to the 1990s.
With a world class stable of brands and exposure to emerging markets, the group has some enviable advantages. It's well positioned to benefit from a smooth recovery, if the global vaccine rollout is as successful as hoped.
Diageo key facts
- 12m forward Price/Earnings ratio: 25.7
- 10 year average 12m forward Price/Earnings ratio: 19.6
- Prospective yield (next 12 months): 2.3%
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
Half year results (figures given at constant currency, and don't include the effect of acquisitions and disposals or exceptional items, 28/01/21)
Diageo's reported net sales fell 4.5% to £6.9bn at the half year. There was a 1% increase in organic net sales, but this was offset by adverse exchange rates. The lower sales fed into an 8.3% reduction in operating profit. That includes an organic decline of 3.4%, driven by changes in product mix and higher costs.
An interim dividend of 27.96p per share was announced, up 2% on last year. Diageo is not giving detailed financial guidance, but is lapping the initial onset of the pandemic, which will flatter this year by comparison.
Diageo's first half volumes were flat overall. Volume grew in the North America (8%) and Latin America and Caribbean (4%) regions, but fell in Asia Pacific (-3%), Africa (-1%) and Europe and Turkey (-5%).
Net sales grew 12% in North America to £2.7bn, driven by strong customer demand, increased market share and restocking by distributors and retailers. Sales in Africa were flat at £745m, but fell 10% in Europe and Turkey to £1.4bn, 3% in Asia Pacific to £1.4bn and 1% in Latin America and Caribbean to £579m, reflecting ongoing disruption to travel retail and bars and restaurants.
Organic operating margins fell 1.53 percentage points to 32.6%, driven by unfavourable changes to sales channels and product mix. Cost efficiencies only partially offset cost increases. Management expects channel and product mix changes to continue to put pressure on margins.
Over the half Diageo's free cash flow rose from £966m to £1.8bn.
Net debt was equivalent to 3.4 times cash profits as at the end of December 2020.
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