Alcohol giant Diageo (DGE) remains one of the highest quality stocks listed in the United Kingdom. For one, its business is an absolute profit machine – with net margins running in excess of 20%. Further, it constantly showers its shareholders with cash. The company has earned around £13.5b over the past five years, around £7.5b of which was paid out in dividends.
Most readers will know the business well, or at least its products, so I’ll keep the introduction brief. Firstly, a word on the breadth of its drinks portfolio, which is massive. The company owns around a quarter of the world’s top one-hundred brands. Well-known names include the likes of Smirnoff vodka, Gordon’s gin, Captain Morgan rum and Johnnie Walker scotch. It also owns famed beer brand Guinness. Sales of scotch account for around 25% of the company’s total, with beer and vodka representing another 16% and 11% respectively.
Second, its geographic breadth is similarly vast. The company sold 245m units of booze across the globe in its last full fiscal year (one unit being the equivalent of a nine-litre case of spirits). North American operations currently generate around half of total profit, with its Europe & Turkey segment accounting for another 25% or so. Asia Pacific, Africa and Latin America & Caribbean make up the rest.
Typically, this one is a very stable business since alcohol sales don’t really depend on the wider economy. Of course, this is anything but a typical year for most firms. The company obviously sells its goods to bars, restaurants, nightclubs and so on, and this accounts for around a third of total sales. The impact of COVID on those type of establishments requires no further explanation. The firm has withdrawn profit guidance for FY20 for obvious reasons.
On that note, I’m not sure it is worth talking too much about the pandemic. Diageo’s financial year ended in June, so most of it was not affected by COVID. Analysts expect the company to make around £2.6b in net profit this year. That is on the back of revenue estimates of just under £12b. Obviously that also means the hangover will last well into its FY21.
Before the pandemic, the company targeted mid-single-digit revenue growth and EBIT growth a point or so higher. COVID obviously wrecks that, with analysts now expecting the company to only earn 120p per share in FY21. That puts the stock at 23.5x forward earnings. The current dividend yield works out to around 2.5% based on a TTM dividend of 69.9p per share.
That may look somewhat rich, but this does not factor in current interest rates. I mention the fixed income environment in most articles now because it is tough to ignore. The 2.5% dividend yield that Diageo currently sports is hardly unattractive given ten-year UK government debt offers a yield of just 0.15%. The former can also grow each year, unlike the latter. This will keep Diageo stock from falling too much in my view.
Longer-term, I don’t really see why the company won’t get back into the swing of things after FY21. After all, its current plight remains largely a result of a unique public health situation rather than anything intrinsic at the firm. Looking slightly further ahead, Diageo reckons that 750m people in the developing world will soon be wealthy enough to afford its premium brands. North America and Europe – which currently account for most of profit – will remain a stable base.
Using the growth figures from above, it seems reasonable to assume that the stock can grow per-share profit in the 8% per annum region. The extra bump above EBIT growth comes from the long-term impact of stock buybacks funded internally from retained earnings. Add that onto our 2.5% dividend yield, and we are looking at a double-digit compounder. Factoring in some long-term multiple contraction – that is assuming that interest rates eventually rise – only knocks that down a point or so. That strikes me as more than acceptable for such a stable and high quality business.
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