Free Diageo Financial Research Paper Report
Diageo, is a New York Stock Exchange Listed company that was established in 1997, through the merger of Grand Metropolitan and Guinness. Diageo trades in over 180 countries, and has offices in 80 countries around the globe. Diageo is the world’s leading producer of Spirits, and a major producer of wine and beer. The products under Diageo’s stable includes, but not limited to; Smirnoff, Johnnie Walker, Baileys, and Guinness, which are world’s best-selling vodka, blended Scotch whiskey, liqueur, and stout. As a Financial manager I will examine a variety of key indicators to examine the attractiveness of Diageo for investment. The indicators include share price analysis, current ratio, and quick ratio, debt to equity ratio, return on equity and return on capital invested. These ratios will provide the potential benefits and losses that an investor can derive from investing in Diageo. The five financial ratios and stock price analysis to provide an in-depth view of the company’s financial strength, level of returns and weaknesses. Through this, the financial risk for the investor will be determined, and this will enable the financial manager to provide an appropriate recommendation to the investor.
Rationale for choosing Diageo
Portfolio’s should have a core holding, or stock that the financial manager, or the investor has most confidence in, willingness, and intention to hold it for a long time either for capital gains, or dividend returns. Diageo PLC, the global leader in exceptional beverages, has numerous characteristics that makes it the preferred stock in my portfolio (Damodaran, 2012). Very few organisations are stable and well managed to enable an investor feel confident about the medium term and long term performance, Diageo, is one of those stocks. Operating in over 180 countries around the globe, Diageo is extremely diversified. Diageo performance is stable and predictable to investors, and this is facilitated by its strong management (Aldem, 2011). Diageo owns a leading collection of alcoholic beverage brands, including Johnnie Walker, Smirnoff, Crown Royal, Ketal One, Baileys, Captain Morgan, Jose Cuevro, Guinness Tanqueray, and many others (United States Securities and Exchange Commission, 2013). The strength and predictability of Diageo’s business model is a major factor why the organisation is a “core” holding in my portfolio (Aldem, 2011). In addition, the beer and spirits market is an excellent hedge during recessionary periods. The beer and spirits industry thrive in overall economic struggles. With over 125 years of operation, Diageo has operated successfully through a well-orchestrated balanced mix of expansion of existing brands and acquisition of new products and brands, as part of a strategic long term industry expansion into new markets and consolidation of existing markets (Aldem, 2011). These drivers of growth, have generated substantial returns to Diageo shareholders in the recent past, and will continue to drive returns and profits in the future. Part of Diageo’s remarkable stability is highlighted by the fact that its investment theses has not changed in the last 25 years (Hobson, 2011). The company continues to hold a dominant position in the recession resistant industry, which permits the organisation to make strategic acquisitions while paying a considerable dividend. Diageo has made an average $23.40 per share payback to its investors in the last ten over the past ten years. This is pretty significant, as is Diageo’s current dividend yield of 4.0%. While this alone, can be the reason for any investor to consider holding Diageo shares (Damodaran, 2012). The best part of the organisation is that it leverages on its past successes to generate future growth. Growth for Diageo originates from acquisitions, for example, the recent acquisition of majority shareholding in United Spirits, India’s largest producer of Whiskey (Aldem, 2011). Diageo’s growth is also generated organically, which is evidenced by Diageo’s announcement last year of its plans to invest $1.5 Billion, in its plans to develop its Scotch production facilities. Diageo efforts to expand and acquire brands capture the market share in established markets, but also put the organisation in leadership position in emerging markets (Hobson, 2011). With emerging markets, such as Asia, Africa, and South America generating 39% of Diageo’s 2012 revenue, there is still plenty room for growth. Diageo is making strategic investments in India and china (Lee, 2013). The seed of emerging markets investment will benefit investors in the long-term as Diageo gains additional distribution scale in the bullish and fast-growing emerging markets, and over a given period the organisation continues to shift additional international consumers into higher margin and premium brands. In fact, Diageo’s management expects profits from emerging markets to double by 2015. In short, there is no doubt for any investor to doubt Diageo’s next ten years.
Diageo has established an inevitable business empire, with unmatched spirits portfolio combined with its vast distribution network. These includes thousands of dedicated sales in United States and the developed markets, which would be very difficult for any competitor to match, or duplicate, and consequently result in a wide “economic mot.” This means that Diageo has a sustainable competitive advantage over its peer group (Damodaran, 2012). To be clear, Diageo competitive group have generated positive returns for customers in the last ten years. So why invest in Diageo? For similar stability and growth in dividend yields, Brown-Forman is a very strong substitute (Hobson, 2011). Brown-Forman is termed as a dividend aristocrat, having increased its dividend returns for the last 25 years. Brown-Forman insignificant product portfolio and market share puts Diageo in a leading position. The other peer, Anheuser-Busch focusses on industry-wide consolidation to drive its growth, with products such as Stella Artois, Budweiser, and Becks and other popular beer brands, such as, Clos Du bois, Robert Mondavi, Ruffino, Ravenswood, Jim Beam, Maker’s Mark, and Courvoisier (Lee, 2013). Anheuser-Busch possess a lot of qualities that make Diageo a safe investment. Diageo commands 27% of the global premium market by volume, which is a significant market share than any of its competitor. Diageo’s management focus to constantly drive the organisation forward through brand expansion, strategic acquisitions and emerging markets growth, the organisation remains a leading and solid performer and remains a outwits its peer group to remain a core candidate in anyone’s portfolio (Lee, 2013).
Diageo’s position in the United States market is particularly strong. The organisation has developed a sustainable competitive advantage in its dedicated distribution network. The organisation has consolidated its distribution network to just a single agent per state (Hobson, 2011). Currently, these distributors relationships accounts for 80% of United States volume, and has over 2,800 dedicated sales agents (Lee, 2013). The army of exclusive sales agents is highly profitable to Diageo, resulting in over 40% in operating margins in North America for Diageo (United States Securities and Exchange Commission, 2013). This is well above the organisation consolidated operating margins that is on the high-20s, which is higher than most competitors in its peer group. Diageo, in the last decade has been focussing on spinning off its non-core businesses, to strategically, focus on spirits industry (Lee, 2013). Although, Diageo has significantly reduced its beer portfolio, Guinness remains one of the organisations core products, and it serves the gateway to spirits. Guinness brand has been driving the organisations growth aspirations especially in the emerging markets, particularly Africa. Diageo boasts of over 40% return on equity, and strong profitability and revenue numbers through-out 2013 (Hobson, 2011). Buoyed by its strong developed, emerging markets growth, and strong upper management team, which is the reason why the organisation is run effectively and efficiently. Diageo is expect to grow further with the increase in consumer spending and as consumers begin to purchase more high-brands (Lee, 2013). Diageo is a core investment for any investor, who is after a more than average industry returns.
Investors risk profile
The appropriate risk profile for Diageo, is moderate to growth investor. This is because Diageo offers moderate risk, balanced income, and higher growth assets, which provides investors with medium term to long term growth horizons in their investments (Lee, 2013). Over the past decade, Diageo has sold-off its non-core business, such as Pillsbury and Burger King, and created a global platform of premium brands. With the steady growth and rise of income and wealth around the globe, Diageo should continue to grow at a steady rate. Diageo investment in china, India and other emerging are expected to offer substantial growth in revenue and profits (Lee, 2013). Diageo’s investment in the emerging markets is expected to benefit investors in the long run. In fact, Diageo expects its profits from emerging markets to double by 2015. This tops Diageo’s attraction list. Diageo has a decent dividend return and a positive outlook, growth in revenue and earnings have been robust, the debt seems to be under control, all these attributes ensures that investors are guaranteed above returns in the middle term (Hobson, 2011). A report by Motley Fool, which is prepared by top analysts in the industry indicate that Diageo shares is possess moat-like features and is impregnable. The shares are desirable to any investor who is seeking to make substantial returns in the medium to long run. Diageo has the potential of outpacing the overall markets total return over time (Hobson, 2011). To investor dividend growth and capital growth are equally important. Capital and dividend growth provide the total return for any investment, and the aim of any investor is to invest in organisation that beat the average market dividend and capital growth delivered by the entire market. Investors should expect more than double returns in their investments in the medium-run, and more than industry-average returns in the long run (Lee, 2013). Even though, Diageo’s shares are pricey, it is still reasonable in light of the organisations track record, all in all, the pros outweigh the cons. Investors should purchase shares that score well on numerous quality indicators, and buy shares that offer decent value. Having noticed the Diageo’s attributes and total share return potential, the shares will be desirable to investors who are seeking high capital and dividend growth in the long run (Damodaran, 2012). With a total return of about 3% annually, Diageo has the attributes for medium to long term substantial returns.
2011 2012 2013
Quick ratio 0.71 0.64 0.75
Return on Equity 41.07 35.85 39.37
Current ratio 1.46 1.52 1.55
Debt/Equity 1.32 1.32 1.17
Return on capital invested 10.21 10.86 12.40
Return on equity
Return on equity shows how well an organisation uses funds to generate growth. The ROE evaluates the rate of return of the funds invested by common stock holders and retained by the organisation (Lee, 2013). Diageo’s return on equity ratio decreased from 2010 to 2011, and improved slightly from 2012 to 2013. Diageo’s ROE of 39.37 is above industry’s average. A rate of return of 39.37 is higher than the recommended about 10% to 30%, which is considered desirable to provide returns to investors and have funds for future growth of Diageo (United States Securities and Exchange Commission, 2013). The above recommended Diageo’s ROE could indicate that the organisation is heavily leveraged.
Return on Capital invested
Return on capital invested is used to evaluate how organisations are generating revenues from the capital invested. When the return is more that the cost of capital then the organisation is considered that it is making returns on invested capital. Diageo’s return on capital has been increasing from 2011 to 2013 (United States Securities and Exchange Commission, 2013). This shows that the organisation has been making returns on its invested capital. This makes the Diageo stack a viable buy to investors.
Debt to Equity ratio
The debt equity ratio is used to examine the creditors’ stake in the organisation. The debt and equity ratio of Diageo remained stable from 2011 to 2012, and reduced slightly from 2012 to 2013 (United States Securities and Exchange Commission, 2013). A debt to equity ratio of 1.17 indicates that Diageo has been borrowing aggressively to finance its activities. A debt to equity ratio of 1.17 indicates that the organisation is aggressively borrowing to finance its activities. The result of aggressive borrowing is that Diageo may incur additional interest expense that may reduce its earnings.
The current ratio measures an organisations ability to meet its short-term debt obligations and other current liabilities that last for less than a year, by comparing the organisations current assets to current liabilities (Lee, 2013). Diageo’s current ratio has been improving from 2011 to 2013. Diageo’s current ratio stands at 1.55, which is below the preferable 2:1. Preferably, investors should look for current assets to current liability ratio of 2:1 indicating that the current assets for the organisation is twice as large as the current liabilities (Aldem, 2011). A current ratio of 1.55 is below the investors’ preference of 2:1, but indicates that Diageo has enough assets to meets its short term obligations.
Quick ratio indicates the extent to which current assets and cash are easily converted into cash in relation to the short term debts of the organisation. The ideal quick ratio should be 1:1, which indicates that the organisation can easily meet its short term obligation with readily available cash. Diageo’s Quick Ratio reduced from 2011 to 2012, but increased from 2011 to 2012 (United States Securities and Exchange Commission, 2013). A quick ratio of 0.75 indicates that Diageo can meet 75% of its short term obligations by using readily available cash or cash equivalents. This is below the recommended
Stock price analysis
Using the DCF valuation of stock price, I established that Diageo’s stock price is expected to grow at an annual rate of 9.30% for the next five years. Assuming that Diageo’s share price will grow by 6.20% of the projected growth rate in the next three years, followed 7.0% annually thereafter. After the three stage DCF analysis with 10% discount rate, a fair valuation of Diageo’s share prices of $185.0 is reached (Lee, 2013). This indicates that Diageo’s shares are trading at a $64.95 discount rate. Diageo’s share price is pricey at the moment, but it is trading at $64.95 discount rate.
Diageo faces Currency risk, regulatory risk, commodity cost risk, and competition risk. All these risks threaten to reduce the organisations earnings. The organisations large collection of high-priced premium brands operates in a fairly recession proof industry bin a globally diverse market, which offers investors cushion (Damodaran, 2012). For investors seeking more than average dividend returns from ADR, a risk that is even if Diageo raises its dividend from the previous year, and is paid in U.S currency might be lower than the previous year. This risk can be off-set by balancing the stock with other high performing stock portfolios (Aldem, 2011). In addition, the economic weaknesses in Europe, which might erode gains can be off-set by the growth in emerging markets.
Diageo’s Current ratio and Quick ratio offer contradictory information about the ability of the organisation to meet its short term obligations. Quick ratio reveals Diageo’s inventory problems. The organisation can only meet 75% of its current debt facilities from its readily available cash and cash equivalents. The debt to equity ratio shows that the organisation has huge debt obligations that outstrip owners’ equity. Creditors have more claims on the assets of the organisation than shareholders. The huge debt facilities makes Diageo incur interest expense that reduces investors’ earnings. Diageo’s diversity, Pepsi’s various brands, considerable global exposure, and increased focus on emerging markets are positioning the organisation to make substantial returns for the foreseeable future. Diageo’s dividend and capital yield is solid, and the expected growth in emerging markets, the dividends and capital returns are expected to grow substantially. Currently, Diageo’s share price is not attractive to investors. The current price would be make respectable investment to any investors because of Diageo’s 3% plus yield, and 5% plus dividend growth. This coupled by Diageo expected growth from the emerging markets, as a financial manager, I would recommended Diageo to an investor who is focussed on the medium term to long-term returns.
A conservative to moderate seeking investor is appropriate for Diageo’s stock. This is because the organisation offers substantial medium to long run high growth. Diageo operates in a resistant-proof industry, therefore, investors are guaranteed returns for the foreseeable future. The investment will continue to rise for the imaginable future backed by Diageo’s global presence and diversity. The organisation financial ratio has exposed the company relatively weak quick and current ratios, which are below the industry and market standards. Diageo finances a huge part of its business activities through debt, which reduces the earning available to investors because of the additional interest expense incurred by the organisation. However, the expected doubling of earnings from emerging markets is expected to provide investors with more returns. Diageo is expected to continue on its impressive path of growth and sustainability. The stock price analysis has provided an in-depth view of the future expected returns for investors. The analysis, has indicated a high growth annual return, which is appropriate to investors.
Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset. New York: John Wiley & Sons.
Hobson, R. (2011). How to Build a Share Portfolio. New York: Harriman House Limited.
Lee, J. (2013). How to Make a Million Slowly: My guiding principles from a lifetime of successful investing. London UK: Pearson UK.
M, A. (2011, February 1). Diageo (DEO) Dividend Stock Analysis. Retrieved from Dividend Monk: http://dividendmonk.com/diageo-deo-dividend-stock-analysis/
United States Securities and Exchange Commission. (2013). DIAGEO plc From 20-F. New York: New York Stock Exchange.