Shares in Diageo (DGE), the world’s biggest spirits company, softened 2% to £32.88 on Thursday despite pleasing annual results.
Figures from the Johnnie Walker whisky, Smirnoff vodka and Casamigos tequila maker show growth across all regions.
That fact makes today's share price reaction look a little odd. Investors need to consider the terrific share price run in the lead up to the results, modestly light organic sales growth, plus a widespread view that the stock is up with events.
ORGANIC SALES MISS
For the year ended 30 June, Diageo delivered robust organic net sales growth of 6.1%. However, this was slightly below the 6.2% growth called for by consensus as growth moderated in the second half.
And while organic operating profit grew 9% to more than £4bn, boosted by improved prices and a more favourable product mix as well as cost savings, an £85m increase in free cash flow to £2.6bn missed the market’s demanding expectations. Reported basic earnings per share of 130.7p was also below the 132.8p analysts were looking for.
COMPELLING PREMIUMISATION PLAY
Encouragingly Diageo, whose other brands include Guinness stout, Captain Morgan rum and Don Julio tequila, enjoyed growth in scotch and vodka as well as continued growth in gin and tequila, continuing to capitalise on the trends towards premiumisation in developing economies. The advantage of the company’s considerable emerging markets footprint was in evidence with Africa, Latin America and Asia Pacific all contributing strongly.
READ MORE ABOUT DIAGEO HERE
‘Diageo has delivered another year of strong performance,’ insisted chief executive officer (CEO) Ivan Menezes. ‘Organic volume and net sales growth was broad based across regions and categories, with new product innovation being a strong contributor. We expanded organic operating margin ahead of our guidance and increased investment behind our brands ahead of organic net sales growth.’
In terms of the outlook, Menezes added: ‘In the medium term I expect Diageo to maintain organic net sales growth in the mid-single digit range and to grow organic operating profit ahead of net sales in the range of 5% to 7%.’
ARE THE SHARES FULLY VALUED?
Diageo’s board has approved a further capital return of up to £4.5bn for the period covering full year 2020 through to full year 2022. However, the board is vague on whether this will be via a buyback or a special dividend.
Liberum Capital believes the potential step away from buy-backs is a hint the board believes Diageo’s shares are fully valued following a staggering run. Indeed, they have frothed up by a stunning 47% since Shares highlighted Diageo’s myriad attractions here in August 2018, some appreciation for a FTSE 100 stock.
WHAT THE EXPERTS ARE SAYING
Russ Mould, investment director at AJ Bell, commented: ‘At first glance you might have expected the numbers to leave investors feeling refreshed, with solid sales growth which came in a smidge ahead of analysts’ forecasts and plans to return £4.5bn to shareholders over the coming two years - with the question of whether this will be through a special dividend or a share buyback still in the air.
‘However, free cash flow and earnings were slightly short of expectations and the North American business also disappointed a bit. A premium priced stock like Diageo can’t afford even a modest miss on estimates if a hangover is to be avoided.’
Liberum Capital insists Diageo is ‘a juggernaut in the beverages world with an unrivalled portfolio of brands, providing the company with scale and a wide economic moat’, observable in the drinks giant’s industry-leading margins and high return on capital employed (ROCE).
Yet the broker’s enthusiasm is tempered by factors including ‘an expensive valuation, tough comps with White Walker, renewed Captain Morgan challenges, a long tail of standard spirits and a patchy mergers and acquisitions (M&A) track record. We have a strong preference for the value end of our beverages and tobacco coverage, specifically Imperial Brands (IMB).’ For more on the latter name, take a look at this week’s Under The Bonnet article here.
