The Investment Column: Diageo still has the fizz to make it a hold

Serco; Avis Europe
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Our view: Hold

Share price: 935p (-24p)

Diageo, the world's largest drinks company, has brewed up full-year results that have left some investors feeling a bit flat. Although the company owns the Johnnie Walker whisky, Gordon's gin, Smirnoff vodka and Guinness stout brands, it could not bring much cheer to the City yesterday.

In the year to the end of June, the company grew sales to £9.7bn and reported underlying earnings growth of 7 per cent to breach the £2bn level for the first time. But it seems investors had hoped for a bit more, leaving the stock down 2.5 per cent yesterday.

Although Diageo tried to soothe the disappointment with a further share buy-back worth £1.4bn, the prospect of a similar performance in 2007 has led many analysts to trim their future earnings forecasts. Diageo said it expected organic sales growth at around the same level in fiscal 2007 with organic operating profit growth of at least 7 per cent. Tempering enthusiasm for the stock was also worry about the pros-pects of higher costs and a weaker US dollar.

Yet the disappointment should not be overstated as Diageo is performing well. While it is keeping pace in the competitive European market, it is benefiting from its investment in emerging markets such as Russia and China, where its sales increased 80 per cent. At 16 times forward earnings the stock is worth holding on to.


Our view: Buy

Share price: 352p (-1.25p)

Serco has achieved double digit sales growth in every one of the past 18 years. Yesterday, the support services group assured the City that this will continue for the foreseeable future due to increasing public spending and a tendency for governments around the world to outsource the provision of services to the private sector.

More than 90 per cent of Serco's business comes from this line of work. In the UK, it operates London's Docklands Light Railway, the country's nuclear warning systems and a number of young offender institutions. According to the company, governments in the UK and abroad need to improve public services in a cost-efficient way. For that they need the private sector and that is where Serco comes in.

This trend towards rolling back the frontiers of the state was pioneered by the Conservatives under Margaret Thatcher in the 1980s. Her successor, John Major, extended it as has Tony Blair's Labour administration. In fact, Serco says it secured more business from the Labour government than from the Tories. The fact that this type of government outsourcing is catching on abroad is an added bonus for the group.

Yesterday's interim results saw Serco boast a record £13.5bn forward order book. The group also said it is at the preferred bidder stage on contracts worth £3.6bn. In terms of the pure numbers, Serco unveiled a 20 per cent rise in first half pre-tax profits to £45m. Although the stock trades at 20 times forward earnings, it is worth buying.

Avis Europe

Our view: Sell

Share price: 65p (-3p)

Avis Europe was being touted as a recovery play in 2004. Two years on, there seems to be little sign of a meaningful renaissance at the car rental firm. Yesterday, Avis posted widening first-half losses, prompting the company's broker to downgrade its earnings forecasts for the years ahead.

The group is suffering from a tough pricing environment and the travel disruption caused by August's security alerts will not have helped. Although management expects an upturn during the second half, and further down the line the costs savings programme Avis unveiled in February should start feeding through, the shares look thoroughly unappealing given the company pays no dividend and carries a hefty debt burden.