James Moore: In Diageo's world it's always drinks time somewhere

Investment View: Diageo's global reach means that it is exposed to some very attractive markets where growth still exists
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The Independent Online


Our view: Take profits

Share price: 1,523.5p (+7p)

Alcohol is one of the first things many people decide to sacrifice when they give something up for Lent. Which means they will be preparing to enjoy their first tipple in some time.

That being the case, it seems like a good time to look at another of those quality investments you'll be asked to pay a high price for: the drinks giant Diageo.

The question, however, is whether Diageo is like Rolls-Royce – buy despite the price – or more like Arm Holdings – a great company but the earnings multiple the shares trade on is just too extreme. Actually, it might be somewhere in between.

As an investment proposition Diageo has a number of attractions. For a start it boasts some genuinely iconic global brands, none more so than Guinness. But that's just the start of an embarrassment of riches that includes Smirnoff vodka, Johnnie Walker whisky, Captain Morgan rum and so on.

Even if one of those brands goes out of fashion in one market, there's a good chance it will be seen as the "in" thing in another. That is the benefit of operating a truly global business. Diageo has 180 markets (right now) to chose from with offices in 80 countries.

Currently there's some excitement in the City over the company's attempt to secure full control of Jose Cuervo, the tequila brand it has the rights to distribute outside Mexico.

Happily for investors, Diageo's global reach means that it is exposed to some very attractive markets where growth still exists. In February, for example, it unveiled first-half sales growth of 23 per cent in Latin America, which generated an increase in profits of 19 per cent.

Then there is the Asia Pacific where sales grew by a healthy 10 per cent, while profits surged by twice that.

In beer-thirsty Africa sales increased 12 per cent with profits again up 20 per cent. While beer was the driver, spirits are beginning to grow nicely (although from a low base) helped by the company's attempts to, for example, sell Johnnie Walker as an "aspirational" brand to people having something not commonly associated with much of Africa: disposable income. The numbers of the latter are actually growing quite nicely.

In Britain the darling, demon drink is in poor odour, largely because of the way it turns town centres up and down the country into virtual war zones on Friday and Saturday nights. Minimum pricing and ever higher taxes mean that the company could be said to face some challenging headwinds.

In fact, across the "developed" world growth was (unsurprisingly) relatively slow. But growth there still is.

Paul Walsh, the chief executive, has a strong following, although he has been cautious about the outlook, given that the world is yet to fully emerge from its economic stew.

I'd also be a shade concerned about debt. Net debt was £1.8bn higher at the full year at £8.3bn, driven by £1.5bn worth of acquisitions. Charles Stanley, the broker, notes that Diageo's balance sheet policy is "to maintain an A band credit rating, although management would consider modifying policy to make strategic acquisitions".

When companies gush about "strategic" deals it is often code for "look, we're over-paying, but this will be great, honest".

Which brings us to valuation. Diageo sits on a pricey rating. Since those results (well received in the main), the shares have continued to power ahead. They now sit on a multiple of just over 16.5 times 2012 forecast earnings, with a prospective yield of just under 3 per cent. So while the company's emerging markets operations offer some very good growth prospects you will have to pay a pretty price for it.

Over the past 20 years the shares have traded at between 12 and 18 times forecast earnings. They are nearly at the top of that range. At the very least, it is hard to see them growing much from their current level. It is more likely, in the absence of an expectations- busting trading update, that they will show some retrenchment.

While I'd want long-term exposure to this stock, right now there's a strong argument for taking some profits. But look to buy again when they hit a more realistic multiple.