Diageo plc (DGE) Ordinary 28 101/108p
HL comment (4 August 2020)
Diageo's full year net revenue were £11.8bn, reflecting an organic fall of 8.4% after COVID-19 significantly reduced second half sales. Organic operating profit fell 14.4% to £3.5bn, largely due to the group's high fixed costs. Management also wrote down the value of some assets in India, Nigeria, Ethiopia and Korea by £1.3bn, after which operating profit fell 47.1% to £2.1bn.
Management has recommended a final dividend of 42.47p per share. This brings the full year dividend to 69.88p per share, 2% ahead of last year. Given the ongoing uncertainty Diageo is not giving detailed guidance for its next financial year.
The shares fell 6.2% following the announcement.
Diageo's had a rough quarter thanks to the pandemic, but ultimately we think the group's brands are strong enough to fuel a recovery when life returns to normal.
Whisky is an especially attractive market because it takes a lot of up-front investment and, crucially, 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 this proposition up would be difficult and expensive.
The group owns established and well-marketed brands like Johnny Walker Guinness, and Gordon's, as well as a broad enough portfolio to 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.
Diageo is 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. This shouldn't be a problem, but it may restrict management's options, especially when it comes to returning capital to shareholders.
The recent dividend continues an enviable record of growth that stretches back to the 1990s. This is 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, in the face of a severe recession Diageo may have its work cut out - and the dividend could suffer in the medium term, there are no guarantees.
Diageo key facts
- Current 12m forward P/E ratio: 24.1
- 10 year average 12m forward P/E ratio since floating in 2014: 18.8
- Prospective yield: 2.5%
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Full year results (organic)
Diageo's full year volumes fell 11.2% but were partially offset a 2.8% improvement in pricing and the combination of products sold. Volume fell furthest in the Asia Pacific (-15%) and Latin America and Caribbean (-15%) regions, followed by Africa (-13%) and Europe and Turkey (-11%). Volume was flat in North America.
The decline in net sales reflects a 4% increase in the first half and a 23% fall in the second. Second half revenue fell by 30-40% in all major regions except North America, where second half revenue fell just 1%. In North America lower second half sales in bars and restaurants were largely offset by a strong performance in retail shops, especially among ready to drink Smirnoff products. Other markets, such as India, Mexico and South Africa imposed more stringent lockdowns.
Organic operating margins fell from 31.4% to 29.3% as lower volumes were less able to absorb higher fixed costs. Savings through efficiency and lower marketing investment did not fully offset this.
Over the year Diageo's net debt rose from £12.1bn to £14.0bn, and is now 3.3 times cash profits. Management is will not engage in further share buybacks until net debt is back within the 2-2.5 times cash profits target range. Free cash flow fell from £2.6bn to £1.6bn, largely due to the lower profitability.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.
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