Diageo: Best of Sin Stock Breed Offers a Spirited Market Position

by Chris Barella

During a time of great uncertainty in the stock market, investors are looking to minimize the risk in their portfolios. With a flight to the safe haven well underway, it is tough to look past the position of strength Diageo PLC (DEO) has maintained throughout this latest economic downturn. Diageo is the main player in the global wine and spirits business carrying a number of the world’s most popular brands among which are Smirnoff vodka, Johnnie Walker scotch whiskey, Captain Morgan rum, and Crown Royal Canadian whiskey.

Showing Strength in Rough Times

With a market cap of $48.3 billion, their powerful brand recognition and global footprint, Diageo has weathered the worldwide economic swoon. Earnings for the 2008 fiscal year ended in June with numbers remaining strong as net sales increased by 7%, underlying EPS up 11%, and there was also a 5% hike in the dividend.

The main contributor to their continued growth in net sales was the international markets from Latin America to the Middle East with net sales rising 16% versus 3% in Europe and 5% in North America. They also reported back in June that they have partnered with The Nolet Group of the Netherlands to form a new company that has exclusive rights to the super-premium brands Ketel One Vodka and Ketel One Citroen. Diageo continues to expand its reach even as the global economy slows.

Outlook

With forward 2009E PE of 15.1x and 2010E PE of 13.7x, there is plenty of room for growth with or without a turn around in the global markets. Everything from rising corn, wheat, and aluminum prices has put a damper on Diageo’s bottom line. Also with the sharp rise in petrol prices this year, transportation costs have been a major concern.

Even with rising input costs due to the commodities boom and the recent strengthening of the dollar versus the pound, Diageo has kept focused on the future to provide top-of-the-line products to consumers all around the globe. Recent deflationary forces have helped relieve DEO’s problems with rising commodity prices, but high input costs are a problem management must deal with in the long run.

Who else is out there?

As far as the Diageo's competition, there is no one even remotely close to their proven track record in Europe and North America and penetration into emerging markets. Two of their closest threats, Brown-Forman Industries (BF.B) and Central European Distribution Corp. (CEDC)  have strong brands in the major markets but nowhere  near the worldwide exposure of Diageo.

Central European Dist. Corp. is the smaller of the two players with a meager $2.57 bil market cap compared to DEO and makes their market primarily in Poland. Brown-Forman on the other hand has been hyped up as the next big player in the alcoholic beverage industry with characteristics of a young Diageo years ago.

As one of the biggest American-based winery and distillers, with product reach to 135 countries, Brown-Forman has much upside growth potential with added branding and continued global expansion. With strong market share from top-quality brands such as Jack Daniel’s and Southern Comfort driving domestic growth, and over 50% of consolidated sales arising from overseas, Brown-Forman looks to be an increasingly viable competitor to Diageo’s stranglehold on the market as a whole.

But with a market cap of just under $10 billion and the risk level of their ventures into the international and emerging markets, they just cannot be held in the same light as Diageo.

Best of Breed

Overall, Diageo is the most dominant when it comes wine and spirits around the world. With proven consistency in increasing sales and doubling their dividend over the last 10 years with year over year dividend growth around 8%, their position in the market cannot be questioned as less than best of breed.

Having a gross margin of 59.86% and return on assets of 10.16%, almost triple the industry average, it is easy to see the strength Diageo holds over the field. Projections for fiscal 2009 and 2010 combined with a recent slump extending back to the beginning of summer, have provided investors with a real opportunity to own a top company at a reasonable price.

With the current stock market turmoil and 5-year lows on the Dow, Diageo has become an even more enticing bargain even after its recent pop. Keep a close watch on the financial markets and how any future bank failures will have an effect on the markets as a whole, but the sin stocks tend to be fairly stable even during economic slowdowns. On top of it all, their 5% dividend isn’t a bad way to wait out the financial mess.

Disclosure: None

Comments

[JIM BLAKENEY:]

IN FIVE (5) YEARS BF.B WILL BE MAKING HAY DAY ON THEIR TWO MAIN BEVERAGES--JACK D AND FINLANDIA VODKA--AND DEO WILL BE TRYING TO CATCH UP BOTH HERE AT HOME AND IN THE EAST.

2008 Oct 19 02:32 PM

[Emerald:]

DEO has a wide moat through its excellent worldwide distribution network. Competitors lack this. Best of breed. Long:DEO

2008 Oct 19 05:10 PM

[john s. gordon:]

have been long DEO for some yrs now. before that, long grand metropolitan.
> jack

2008 Oct 20 09:02 AM

[Old Rick:]

Also long DEO and with a 5.3% current yield and a growing dividend, I'm adding. For Jim Blakeney: Why will it take 5 years for long existing brands to "make hay" for BF? If you do feel strongly about BF, maybe you could write an article for SA.

2008 Oct 20 10:07 AM

[D-D:]

I agree that DEO is a good company. What is the "fair value" of this company?

2008 Oct 20 10:57 AM

[bobbobwhite:]

DEO and BF-B have very high price/book costs compared to CEDC, which is priced very cheaply at about 1X book now. I believe there is much more upside to CEDC than these others even though it does have greater risk and volatility which can be upsetting to many. For a 5 year hold though, I would choose CEDC every time.

2008 Oct 20 03:18 PM

[Mad Hedge F...:]

Those who believe that the wine and spirits business is recession proof should take a look at UK based Diageo (DEO). Its shares just hit a new low for the year of $50, down 42%. Although the giant purveyor of alcoholic beverages posted profits up 18% in the recent half, CEO Paul Walsh says that a consumer in retreat is forcing him to scale back expectations for this year. The UK firm is hoping to limit the damage by restructuring to cut costs. There is no doubt they have buyer’s remorse for the many wine labels it acquired at premium prices in recent years, including Rosenblum, Blossom Hill, Sterling, Acacia, and Chalone. The economic collapse has been so rapid and so severe, that old, trusted models for predicting consumer behavior are now useless. Shoppers are trading down to less expensive labels, and it is harder to realize higher prices on everything. People are going out to drink less, but taking beverages home for consumption more. Shoppers are more inclined to buy well known brands, and less prone to risk limited disposable income on experimenting with unproven new brands. Of course the world’s largest owner of alcohol brands would say this, talking his own book.

Feb 21 08:54 AM

[cvraman:]

Despite a slightly improved valuation with the fall in price ($44.47 and trailing PE of 9.3), and a great stable of alcohol brands, I have some concerns on the company's fundamentals. The total sales revenues has been on a steady but slow decline. The financial position is less than stellar if you consider their Debt to Equity is nearly 3x today. Despite the great brands, the P/BV is still very high at about 5x. The story gets much worse if you take into consideration the size of the Intangibles on their balance sheet. In summary I think it has some strong assets, and a great business franchise but I am not convinced it is managed well enough.

Mar 26 10:01 PM