Diageo plc (DGE) Ordinary 28 101/108p

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Diageo reported first-quarter revenue of $4.9bn, reflecting flat organic sales growth (expected: 1.3% decline). Performance was driven by a 2.9% uplift in volumes, which offset an unfavourable shift in sales mix and weakness in China and North America.

The cost-cutting programme remains on track, expected to deliver savings of around $625mn over the next three years. Diageo still expects to deliver around $3bn of free cash flow this year.

Due to the weak start, some of its other full-year guidance has been lowered. Organic sales growth is now expected to be flat to slightly down (previously: flat), and organic operating profit growth is expected to be low to mid-single digits (previously: mid-single digits).

The shares fell 3.1% in early trading.

Our view

Diageo reported flat sales growth in the first quarter as weakness in China and North America offset progress elsewhere. Markets were disappointed to hear that the search for a new CEO continues, causing the shares to fall on the day.

After more than two years of relatively underwhelming performance, former CEO Debra Crew stepped down with immediate effect in mid-July. A clear strategy and direction seems lacking at the drinks giant right now. Former CFO and now interim CEO, Nik Jhangiani, has previously hinted at offloading some brands, freeing up cash to strengthen the balance sheet. But until the position is filled on a permanent basis, investor sentiment is likely to remain subdued.

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 in the past. That trend appears to be slowing in most regions, and alongside a soft underlying market, the outlook for sales growth looks muted in the near term.

Tariffs are another issue, and look 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.

We should point out that while demand is holding up okay for now, tariffs have the potential to cause a global economic slowdown. If that happens, consumers will have less cash in their pocket, and are unlikely to spend much of their tight budget on the discretionary drinks that Diageo sells.

The shares offer a prospective dividend yield of 4.4%. This can’t be guaranteed though, and with net debt sitting on the wrong side of the company’s target range at the last count, the scope for dividend progression in the immediate future looks limited.

We see the group as fundamentally strong, with a world-class stable of brands to fall back on. But a subdued alcohol market, combined with concerns over tariffs, has driven the valuation below the long-term average. That could prove an attractive entry point, but with plenty of uncertainty ahead, including a CEO vacancy to fill, investors should be prepared to be patient.

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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