- No further profit warning from drinks giant and no change in medium-term targets
- Interim dividend up 5%
- Modest improvement in momentum seen in next fiscal year but no margin expansion until fiscal 2025
“Shares in LVMH and Rémy Cointreau rallied on the Paris exchange after their latest updates last week, but Diageo has not offered enough in its first-half results to stoke gains in its shares, even though they have already lost one fifth of their value in the past twelve months,” says AJ Bell investment director Russ Mould. “The absence of any further shocks after November’s profit warning is welcome, as are the increase in the interim dividend and a reaffirmation of the company’s medium-term sales and profit growth goals. Some investors may still be disappointed, however, by forecasts of another year-on-year drop in profit in the second half of this fiscal year and no real profit margin improvement in the fiscal year to June 2025.
“After their sharp fall over the past year, shares in Diageo are now back to where they were in February 2019, five years ago. It is almost as if Covid-19 and the pandemic never happened and perhaps one of the issues with which the company is wrestling now is a normalisation in demand and customers’ appetite – and ability to pay – for premium-priced products, as lockdowns, interest rate cuts, furlough schemes and fiscal stimulus give way to the return to more regular working patterns, tax hikes, higher interest rates and the squeeze on spending power inflicted by inflation.
Source: LSEG Datastream data
“The FTSE 100 firm is also wrestling with excess inventory, which trade clients may have built up during the pandemic and lockdowns.
“This process will impact production output and thus overhead recovery to the detriment of profit margins. The Latin American and Caribbean markets remain particularly challenging, even after weakness here already prompted the release of last November’s profit warning, and it seems as if this process could take some time.
“Even after a sharp drop in profit margins in this fiscal year to June 2024, Diageo expects operating profit growth to match sales growth in the twelve months to June 2025, to imply no margin improvement. Only in fiscal 2026 will the firm get on track with regard to its medium-term goals, whereby underlying sales rise by 5% to 7% a year and profits increase faster still, thanks to higher profit margins.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“Diageo does still generate impressive margins, at around 30%, and such lofty returns on sales help to drive cash flow that funds dividends and buybacks.
“A 5% increase in the interim distribution to $0.4050 equates to a 3.5% increase in sterling terms, at current exchange rates (Diageo has switched to reporting in dollars). That sets the company on track for another increase in its annual dividend to extend a growth streak in the full-year payment that runs back to 1999.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts. Fiscal year to June.
“That streak is testimony to the power of Diageo’s brand range and at some stage investors may well start to ask the question as to why the share price is getting too low, especially as they are now down by a third from their 2021 all-time high and thus rooted firmly in bear market territory.
“That slide means the shares have de-rated from more than thirty times forward earnings to around eighteen times, based on analysts’ consensus estimates for fiscal 2024. Investors may have mistaken reliability for safety, and by overpaying for the former removed some element of the latter from the stock.
“The premium rating relative to the wider UK market is still there, since the FTSE 100 trades on eleven to twelve times forward earnings, but some form of premium is surely deserved, given Diageo’s brands, lofty margins and dividend growth record. The issue is simply when the premium gets too low, or perhaps when investors decide it would not be possible to go and buy a portfolio of brands to match that of Diageo for a price tag equal to its market capitalisation, which is currently some £63 billion.”
Source: Marketscreener, consensus analysts’ forecasts. Rémy Cointreau fiscal year to March. Brown-Forman fiscal year to April. Diageo, Pernod Ricard fiscal year to June.
