Company Reports

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions—some transformative, others bolt-on—have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to grow their developing markets footprint.

Diageo reported a first half of fiscal 2024 performance that was better than our recently-lowered forecasts. It is a relief that performance was no worse than we had feared following the company's profit warning in November, but broad-based volume weakness suggests that discretionary consumer spending remains soft. We are reiterating our wide moat rating and raise our fair value estimate to GBX 3,100 from GBX 3,000 to account for the better-than-expected results. We believe Diageo is moderately undervalued, based on our assumption of gradually recovering revenue growth, but near-term visibility is limited, and if consumer spending deteriorated further, there could be further downside to the current market price.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions—some transformative, others bolt-on—have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to grow their developing markets footprint.

We are lowering our fair value estimate of Diageo to GBX 3,000 per share from GBX 3,200 after lowering our near-term growth and margin estimates following the company's profit warning. Management disclosed a "materially weaker" outlook in its Latin America and the Caribbean, or LAC, segment, and cited macroeconomic pressures that have affected volume and mix, and high channel inventory from distributor stocking a year ago. We reiterate our wide moat rating and still think Diageo is a strong franchise with competitive advantages from its broad portfolio and scale in a very attractive consumer category. We are not surprised that management left medium-term guidance of 5% to 7% organic net sales growth in place, which we think is achievable. For the first time since the pandemic, we believe Diageo is undervalued, but the cyclical nature of the business means it could take several quarters for channel inventory to normalize and for sales to return to organic growth, and we recommend waiting for further volatility in the stock to invest at a wider margin of safety.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions—some transformative, others bolt-on—have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to grow their developing markets footprint.

Diageo's preliminary fiscal 2023 results provided further confirmation that consumers are scaling back beverage consumption, but price elasticity remains below that in other consumer staples categories, and we think this supports our thesis that the large-cap distillers have some of the strongest pricing power in the group. We are retaining our GBX 3,200 fair value estimate and our wide moat rating. After a slight derating in the stock in the second quarter, the shares now trade only slightly above our valuation, and Diageo now trades at its lowest level since the early days of the post-COVID-19 reopening of on-premises establishments. However, the spirits category is one of the most cyclical in the staples sector, and if consumer sentiment continues to weaken, Diageo's operating environment could deteriorate further.

In the first half of fiscal 2023, it was evident that Diageo's volume growth has begun to cool in some key markets. We lowered our full-year volume growth assumption modestly, but this has no impact on our fair value estimate, which remains GBX 3,200 for the ordinary shares. Although investors may be disappointed by this volume miss, our thesis that Diageo will generate faster long-term growth remains firmly intact, and we view the pullback in the shares to be appropriate, given the frothy expectations being priced in recently.

Diageo is to acquire Philippines-based dark rum manufacturer Don Papa for an initial consideration of EUR 260 million (GBP 228 million). If certain undisclosed performance metrics are achieved however, the total consideration could be as much as EUR 437.5 million (GBP 383 million). Valuation notwithstanding, we think this is aligned with Diageo's acquisition strategy to increase its exposure to superpremium price segments, which offer faster growth rates than the mass market and significant headroom to further "premiumise" the consumer. We are raising our fair value estimate for Diageo to GBX 3,200 per share from GBX 3,100, but this is related to updating the model for foreign-exchange rates rather than material value creation from this transaction.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions—some transformative, others bolt-on—have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to strengthen their presence in developing markets.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions--some transformative, others bolt-on--have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to strengthen their presence in developing markets.

Diageo beat our full-year estimates in an impressive second half of fiscal 2022, wrapping up an outstanding year for the spirits maker. Second-half consolidated organic sales growth of almost 28% year over year is likely to be among the strongest growth numbers reported among our consumer staples coverage this season. Business momentum is very strong and Diageo is a safer inflation hedge than most of its peers, but it seems likely that conditions will become more difficult next year. The company will cycle the impressive 21% full-year revenue growth in 2022, and also because both volume and mix are likely to come under pressure as consumers suffer from the pressures on disposable income and due to softening asset prices.

We are lowering our net revenue and gross margin estimates for the European beverage companies under our coverage to reflect the expected impact of the conflict in Ukraine. The impact on our valuations is minimal, however, and the only fair value estimate we are lowering is that of Carlsberg, from DKK 965 to DKK 945. Following the impositions of sanctions, most of the beverage manufacturers have temporarily ceased exporting products to Russia, and although this has made headlines, exports into Russia represent a small segment of the market.

Diageo reported a strong first-half fiscal 2022, with revenue growth comfortably above our forecast. With discretionary consumer spending looking likely to continue to be fairly strong for the foreseeable future, we are taking a slightly more optimistic view of growth in the near term, assuming that the momentum of the first half of the year can be extended into the second half, albeit against stronger comparables. Accordingly, we are raising our fair value estimate to GBX 3,100 from GBX 2,900. Our new valuation implies fiscal 2023 multiples of 23 times earnings and 16 times EV/EBITDA, consistent with midcycle multiples in the distillers group. Diageo is undoubtedly one of the highest-quality developed market consumer staples businesses, and we recognise the strong momentum in the business at present, but at almost 20% above our estimate of intrinsic value, the stock is being priced for sustainable growth at current rates, which we think is unlikely.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions--some transformative, others bolt-on--have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to strengthen their presence in developing markets.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions--some transformative, others bolt-on--have established Diageo as a global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to strengthen their presence in developing markets.

Diageo's preliminary fiscal 2021 results indicate that the firm beat our forecasts on the top line and delivered margins that were in line with our expectations. Organic net sales growth of 16% was marginally above our forecast, driven by 20% growth in North America. Operating profit grew almost 17% organically, implying underlying margin expansion of around half a percentage point. Management said growth was broad-based across categories, but tequila and baijiu are likely to have been the key drivers, while product innovation in Baileys is likely to have gained traction in the off-trade this year.

Although it gave little away in terms of detail, Diageo confirmed that it is on course to meet our full-year expectations, which implies that the markets that are reopening are experiencing fairly high on-trade demand. Management expects operating profit to grow 14% in fiscal 2021 (ending June), bang in line with our forecast. With some markets yet to fully reopen, however, and given the evident pent-up demand for social occasions, we are raising our estimates slightly for fiscal 2022. With the growth engines almost fully lit, the GBP 4.5 billion share-repurchase program, announced in 2019 but paused at the onset of COVID-19, will resume. Management plans to repurchase GBP 500 million by November 2021 and GBP 1 billion by the end of fiscal 2022. We had already modeled the reinstatement of the repurchase program and in fact would not be surprised if repurchases exceeded GBP 1 billion by the end of fiscal 2022.

We are reiterating our GBX 2,600 fair value estimate and wide moat rating for Diageo following the company's virtual meeting between investors and Sam Fischer, the President of Asia-Pacific and Global Travel. The meeting was a reminder of the strong structural tailwinds that should drive volume growth in the very long term, and we have tweaked our regional growth estimates slightly higher, although this does not materially affect our valuation. Diageo is currently trading 15% above our fair value estimate, and from a valuation perspective, we see better opportunities in neglected stocks such as Anheuser-Busch InBev, or AB InBev, and the unloved tobacco industry. Nevertheless, Diageo and Pernod Ricard, another distiller with strong exposure to China, are two of the highest-quality franchises in our global consumer staples coverage, with very strong pricing power. That pricing power is usually strongest late in the economic cycle, when the consumer is confident, and it is possible Diageo can sustain an above-average market valuation of 24 times forward earnings for as long as the economy remains strong.

Diageo was created in 1997 following the merger of Grand Metropolitan and Guinness. Mergers and acquisitions remain part of the firm's DNA, and subsequent transactions--some transformative, others bolt-on--have established Diageo as the global industry leader. Although the industry is fairly concentrated (we estimate a four-firm concentration ratio of 0.6, above many other fast-moving consumer goods categories, including the global brewing industry at 0.5), we believe there is more consolidation to come. Outside the top five firms, the industry is highly fragmented, and regional players often dominate in niche product categories or local markets. These firms present a new wave of merger opportunities for the industry consolidators, including Diageo, to strengthen their presence in developing markets.

Diageo's performance in the first half of fiscal 2021 was a touch better than our forecasts on both the top line and EPS. Given the circumstances, this was an all-round solid performance. We have updated our model for these results but make no changes to our GBX 2,600 fair value estimate. Investors' focus will understandably be on the speed of the volume recovery, but pricing is the more important metric in our view and was more or less in line with our forecast. We think the fairly robust volumes and margins and the strong free cash flow generation show that Diageo remains a wide moat business that is well-positioned for some favourable consumer trends and is executing as well as can be expected. This appears to be reflected in the current market price, however, which looks slightly bullish to us. We see greater value opportunities in companies facing short-term headwinds and risks, such as Anheuser-Busch InBev, and in the misunderstood tobacco category.