EUR 850.00 For Business Accounts Only

Morningstar | DGE Updated Forecasts and Estimates from 13 Nov 2018

Diageo is to sell 19 mostly peripheral brands to Sazerac, the maker of Southern Comfort whiskey for $550 million in cash, and it will use the proceeds to increase its share repurchase program. We regard this as a positive move, and a big step toward optimizing the current portfolio. The sale is likely to be modestly dilutive to EPS this year, but will accelerate growth in the U.S. this year and next. Longer term, we believe Diageo's wide moat--its powerful distribution and pricing power--will help it to grow at a faster organic clip than most consumer staples companies in the U.S. Although the deal appears to have been executed on reasonable terms for both parties, at roughly 2 times sales, it is relatively small and does not move the needle on our valuation, so we are retaining our GBX 2,700 fair value estimate.

The brands in question are essentially value brands that are collectively declining at a low-double-digit rate every year. They include Seagrams VO Canadian whiskey and Goldschlager cinnamon schnapps. In our opinion, these brands neither fit Diageo’s premium strategy nor the company’s business model, which is dependent on scale. However, with Diageo trading close to our fair value estimate, we do not think that share repurchases are the best use of capital. We would have preferred the company to have used the aftertax proceeds of approximately $340 million to increase its stakes in its emerging-market subsidiaries, in order to harness its long-term growth opportunities.

The deal will be dilutive to EPS to the tune of 2 pence next year, but we estimate it should add around 15 basis points to organic growth once the deal has been cycled.