Diageo plc (DGE) Ordinary 28 101/108p

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Diageo reported first-half net sales of $10.5bn, down 2.8% on an organic basis, with volumes and average selling prices both falling. This was driven by declines in North America and Asia Pacific, which more than offset growth in other regions.

Underlying operating profit also fell by 2.8% to $3.3bn, with lower marketing investment helping to offset the impact of higher tariff costs.

Free cash flow fell by $0.2bn to $1.5bn. Net debt remained broadly flat at $21.7bn.

Full-year guidance has been lowered again, with organic net sales now expected to decline by 2-3% (previously: flat to slightly down). Organic operating profit growth is now expected to be flat to low-single digits (previously: mid-single digits).

The interim dividend has been cut to 20 cents per share, down 51%.

The shares fell 6.2% in early trading.

Our view

Diageo’s first-half performance remains weighed down by weakness in the US and China, which led to profit guidance being lowered for the second time this year. Alongside the dividend being cut in half, the shares understandably moved lower on the day.

Diageo is a giant in the alcohol world, with 13 billion-dollar brands on its shelves. Its world-class stable of spirit brands includes the likes of Smirnoff, Johnnie Walker and Tanqueray. In beer, Guinness remains a stout performer, recording yet another period of strong revenue growth.

The past few years have seen a trend towards more premium brands, which has helped to prop up margins. That trend now appears to be slowing in most regions, and the outlook for near-term sales growth looks weak.

Freshly minted CEO Sir Dave Lewis can hardly be blamed for the poor sales performance, given he’s only seven weeks into the job. He’ll need time yet to identify key areas of improvement and formulate a remedy, which he’s expected to present to markets in the third quarter.

Ongoing tariff uncertainty is another issue, and looks set to add around $200mn of extra costs annually, or around 3.5% of last year’s underlying operating profits. To help offset this, Diageo’s looking to streamline operations elsewhere in the business, hoping to find a total of $625mn of cost savings over the next three years. Half of this will fall to the bottom line to improve profitability, while the other half’s set to be invested back into the business to drive future growth.

Trends such as the rise in use of GLP-1s (for anti-obesity) and a structural shift in alcohol consumption, particularly among younger consumers drinking less, shouldn’t be overlooked. Both have the potential to weigh on future sales volumes, which would compound Diageo’s woes if pricing power remains pressured.

With net debt sitting on the wrong side of the group’s target range, the new CEO’s moved decisively by cutting the dividend in half to help shore up the balance sheet. This is a stark reminder that shareholder returns are never guaranteed.

We see the group as fundamentally strong, with a world-class stable of brands to fall back on. But a subdued alcohol market, especially in the US, combined with concerns over tariffs, has damaged the valuation. We’re eager to hear how the new CEO plans to transform the business later in the year. But until then, with continued uncertainty around demand, some caution would be wise.

Environmental, social and governance (ESG) risk

The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry-wide, especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry-wide risks, with other issues varying by sub-sector.

According to Sustainalytics, Diageo’s management of ESG risk is strong.

The group aims to achieve net zero emissions by 2050, or sooner, with Scope 1,2 & 3 emissions targets in place. Diageo has set water reduction targets and deadlines, however, it does not disclose its initiatives to achieve this and there is no external certification for its environmental management activities.

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 LSEG. 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.

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