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Diageo - Medium term outlook intact but challenges remain

In a brief announcement ahead of Diageo's Annual General Meeting, CEO Ivan Menezes...

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In a brief announcement ahead of Diageo's Annual General Meeting, CEO Ivan Menezes, said there has been a ''good start'' to the new financial year, with organic net sales growth across all regions. He said the group's well-placed to meet medium term guidance of organic net sales growth "consistently" in the range of 5% to 7%, and organic operating profit growth between 6% to 9%, between the current financial year and 2025.

However, he also acknowledged that current conditions are ''challenging''. Menezes referenced ''ongoing volatility due to geopolitical uncertainty, a weakening of consumer spending power, inflationary pressures and disruption related to Covid-19'' as the reasons for this.

The shares were unmoved following the announcement.

View the latest Diageo share price and how to deal

Our view

Diageo looks to be making good progress in the new financial year, with management reaffirming its confidence in meeting the medium-term guidance for the next few years. This comes despite a challenging backdrop, and follows last year's results, which were impressive by any stretch of the imagination.

One the things we admire about Diageo is that is has many levers to pull during tough times.

A key lever remains Diageo's brand power. The group's ability to raise prices without hurting volumes is testament to the impressive catalogue of brands ranging from Guinness to Don Julio tequila.

Whisky is also in the portfolio and 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 also 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.

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. For now, that looks to be the right move, as consumers continue to brush aside cost of living pressures and favour more premium brands.

Investors shouldn't be holding their breath for another set of double-digit growth either. Sales aren't expected follow the path seen last year, with organic net sales growth expected in the mid-single digit range over the next few years.

Looking to the balance sheet, Diageo's in a decent position. The ratio of net debt to cash profit has come back down into a comfortable range as profits recovered. We wouldn't mind the absolute value of debt coming down a little further, to give a cushion if things turn.

Recent dividend decisions have continued an enviable record of growth that stretches back to the 1990s but it should be remembered all dividends are variable and not guaranteed.

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 recovery and there are some long-term attractions. Keep in mind, the valuation means there's pressure to deliver and the current economic environment adds some extra short-term risk.

Diageo key facts

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.

Full Year Results (28 July 2022, sales growth organic)

Net sales for the full year of £15.5bn reflects organic growth of 21.4%, driven by double digit growth across all regions. Operating profits grew 26.3% organically, to £4.4bn, with more efficient supply chains and price increases offsetting the impact of rising costs.

The board has proposed a final dividend of 46.82p, up 5%. £3.6bn of the £4.5bn share buyback has been completed, the remainder due to complete in the new financial year.

In North America, net sales grew 14% to £6.1bn. That was largely driven by US spirit sales where bars and restaurants recovered well, while supermarket sales remained resilient. US Spirits growth was primarily driven by tequila, up 57%, as well as double-digit growth in scotch and US whiskey. Higher sales and price hikes more than offset an increase in costs from marketing and inflation, underlying operating profit rose 10% to £2.5bn.

Europe reported net sales of £3.2bn, up 30%. Growth reflects the recovery of bar and restaurant sales, particularly in Ireland, Great Britain and Southern Europe. Cost inflation was more than offset by higher sales and higher prices, underlying operating profit rose 60% to £1.0bn.

Net sales grew 16% in the Asia Pacific region, to £2.9bn. That was driven by strong growth in India and Greater China, and a partial recovery of Travel Retail Asia and Middle East. Underlying operating profit rose 17% to £711m.

Africa saw growth across all markets with net sales up 22% to £1.7bn. Operating profit grew 84% to £315m, as price increases and cost saving more than offset inflationary pressure.

Latin America and Caribbean reported net sales of £1.5bn, up 43% with double digit growth across all markets. A higher proportion of premium brand sales and price increases mostly offset marketing investment and cost inflation, which meant operating profit grew 78% to £538m.

Free cash flow dropped £0.3bn to £2.8bn. Net debt stands at £14.1bn, with the group's ratio of underlying net debt to underlying cash profit (EBITDA) down from 2.8 to 2.5, at the lower end of target range.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 6th October 2022