EUR 850.00 For Business Accounts Only

Morningstar | Decent Year for Diageo, but Share Buyback Not Likely to Create Value at Current Levels

Diageo's preliminary full-year results were very close to our estimates, with only a lower effective tax rate driving upside to our estimate of GBP 1.16 in earnings per share. We are unlikely to adjust our GBX 2,500 fair value estimate by more than the impact of the time value of money. The company announced a new GBP 2 billion share repurchase program over the next 12 months. After a very strong two-year rally, we now regard Diageo as being fully priced, and we doubt the buyback plan will create much value for shareholders. Instead, we would have preferred to see a more aggressive dividend increase than the 5% approved by the board. Nevertheless, we are retaining our wide moat rating for Diageo, and we still think this is a high-quality business.

Full-year organic growth of 4.4% is decent, especially when compared with the travails of some of the other large-cap consumer staples companies that are struggling to generate organic growth of more than 2%-3%. It is also comparable to the 4.5% underlying growth reported by fellow beverage manufacturer AB InBev in the first half of its fiscal year. It is also significant that Diageo's growth is driven in almost exactly equal measure by volumes and price/mix. O ver one third of Diageo's net sales are generated in the U.S., where inflation is approaching 2%, but nevertheless, we think t he 2.4% price/mix achieved in the past fiscal year is indicative of a strong portfolio.

Emerging markets were the standout last year, with 6.6% organic sales growth in Latin America and the Caribbean, and 9.2% in Asia-Pacific, which includes India (up 9%) and China (up 27%), although Africa grew by just 2.7%, providing further evidence that the South African consumer is under pressure from a recent tax hike and higher oil prices. Growth in the Europe and Turkey segment of 3.9% is also above-par, and the 8% growth in the U.K., driven by market share gains for Tanqueray, was very impressive given the competitive pressure from craft gin.

Operating leverage, price/mix and cost efficiencies in procurement and distribution all look to have played a part in Diageo's 150-basis-point improvement in its EBIT margin. We now believe that Diageo is close to its steady-state profitability level, and we would not be surprised to see margin enhancement slow down over the next 12 months as rising commodity prices and higher distribution costs begin to bite. If this proves to be conservative, however, there may be upside to our valuation.