Diageo Earnings Confirm the Long Case for Investors

Diageo's (DEO) stock has struggled along with the overall market this year.

The concerns surrounding the stock (strong GBP, weak consumer, and rising input costs) should have been eased after last week’s conference call. If anything, Diageo’s H2 earnings reaffirmed the long case for investors.

The Long Case:

• Cost Control
• Demand Growth Continues
• Very Attractive Valuation

Cost Control

By far, the two most sensitive costs DEO faces are its input costs and transportation costs. While DEO is largely levered to these costs, the profit growth in H2 was directly achieved through cost cutting and cost control. This is substantial because other distillers and brewers have suffered from rising corn, wheat, hops, aluminum, and plastic costs. Furthering this point, Organic net sales increased 6.6% while profits increased 9%.

Demand Growth Continues

While Europe and North America have recently slowed, the overall industry appears stable.

For example, Brown-Forman’s recent quarter reported:

• Jack Daniels volumes were up +4% globally, single-digits in the U.S., and +8% internationally
• Southern Comfort down in the U.S.
• Finlandia continued strong growth outside the U.S. +16% globally.

These results were echoed by Constellation Brands, Fortune Brands and Diageo.

DEO’s H2 sales growth was largely driven by international performance. International sales grew by 16%, North America by 5%, and Europe by 3%. The strong performance was lead by positive growth in all brands with the exception of Johnny Walker. This should relieve the fears investors have over slowing demand growth.

Valuation

After the release analyst estimate remain unchanged, leaving the shares on at a 2009E PE of 15.1x and 2010E PE of 13.7x with an expected yield of 3.7%. This is slightly ahead of the market average, but given their earnings constancy and strong results it is probably deserved.

DEO’s recent earnings show that management is executing flawlessly in a potentially difficult environment and its customers continue to purchase it spirits. DEO stands out in the consumer products space not only in performance but valuation.

Disclosure: none

Comments

[WEBISKING:]

why buy this when MO PE is lower and PM is similar.The company itself is good but want the PE to be about 13

2008 Sep 03 04:20 PM

[weiwentg:]

in response to Webisking, Altria also has potential legal liabilities. additionally, a recent Morningstar article contends that the US Federal government and many state governments have finally hiked taxes to the point where they are actually discouraging smoking.

Philip Morris International does indeed have very good positioning in the international market. But I would argue that their eventual fate will be the same as Altria: governments everywhere will hike taxes on cigarettes, both as a source of revenue and to promote public health.

As for Diageo, I like this company the best out of all the 'sin' stocks. I think they're a very good buy right now.

2008 Sep 03 09:26 PM

[Larry Belle...:]

Mark -- Thanks for stealing my thunder, I was just finishing up on an article praising Diageo! =)

Great long term buy, as it plays some very important trends (Emerging markets moving up the "drinking" scale, the move towards finer Spirits by Developed Nation's "Baby-boomers" and the spike in Guiness sales thanks to the rise in disposable income in Africa).

Cheers
Larry

2008 Sep 03 10:03 PM

[tipalia:]

wonderful company indeed,great ROE ,nice dividend,international... buyback but WEBISKING does not own so he probably won t like it.I believe he only owns 2 companies read his frequent messages and it won t take you long to find out which companies they are.There are many good companies in this world and diversification is a must for a healthy portfolio.

tipster

2008 Sep 04 08:45 AM