Stock price: p1089 (16.32 USD)
Conclusion: Notwithstanding stronger sales in Q3, Diageo (NYSE:DEO) reconfirmed low organic growth guidance, implying that its key markets (Europe and the US) remain pretty flat. We think the stock is close to its fair price, based on our valuation range of p1100-p1200.
Q3 sales up 9% reported (+12% organic). 9m up 4% (+2% organic). Guidance FY10 unchanged: low single digit organic profit growth.
Recovery could take longer for Diageo
- Q3, up 12%, not really significant, was largely driven by easy comps, early Easter and front loading ahead of tax increases.
- Geographic mix skewed towards mature markets. North America and Europe account for 33% and 30% of sales respectively. Signs of recovery in these markets remain fragile owing to unemployment and fiscal tightening. The outlook is clearly better for International sales (Latam and Africa 45% sales each) and Asia Pacific which account for a smaller part of the business.
- Price/mix could remain slightly negative due to faster growth in the off trade, combined with continuing promotional activity, notably in the US but also in Europe.
- Full year growth should remain in line with 9m trend (+2%).
Bottom line: small organic growth but forex will help
- Profit growth will be held back by slower expansion in mature markets where margins are higher, notably the US.
- We look for 2% organic EBIT growth following -3% decline in H1. Gross margin should remain negatively impacted by pricing/mix, while opex will be impacted by a higher marketing investments. These factors should be offset by £120m of costs savings. In addition, corporate costs are expected to return to normal in H2, following non-recurring charges in H1 (bonus accrual, system investments, M&A and legal costs).
- Reported EBIT numbers will be boosted by forex (+3.5-4% positive impact), based on current rates, which might continue to fluctuate.
- Our EPS estimate (p72.5 up 9.6%) is adjusted for £180m of one off restructuring charges.
Diageo trades at 15xP/E (in line with Pernod Ricard) based on 2010 calendar estimates, and 11.2xEV/EBITDA (10% cheaper than Pernod Ricard). The stock looks relatively cheap in the spirits sector. Nevertheless, we find the brewers multiples (ABInbev (NYSE:BUD) and Heineken (HINKY.PK)) more attractive.