Diving Into Diageos Preliminary Results
Jul. 28, 2018 10:41 AM•DEO
Summary
Alcohol titan Diageo released its preliminary results for fiscal year 2018 ended June 30th. Results include growth, a dividend raise, and a buyback program.
Diageo's massive size and scale give it the ability to generate a high return on acquisitions that are then scaled up. Diageo is also seeing growth in key markets.
Alcohol has long been sought after as an investment for its high margins, steady consumption across the world, and tendency to generate wealth for its investors. Industry giant Diageo plc (DEO) closed out its fiscal 2018 with an earnings release full of positive tidbits. We review the year Diageo had, and look at where Diageo can find growth moving forward.
Diageo is one of the largest alcohol companies in the world. With leading brands in the spirits and beer space such as Guinness, Smirnoff, Johnny Walker, and Captain Morgan, the brand portfolio is packed with high market share options for consumers. The company maintains a diverse global presence with sales in just about every notable market in the world.
Diageo wrapped up fiscal 2018 with several highlights considering the massive size and scale of the company. Sales grew 5% year over year at 12.163B British pounds (approximately $15.9B USD). This was organic growth, and pretty evenly split between volume growth and price/mix.
Diageo continued its highly profitable ways by expanding its operating margin by 78 basis points and converting approximately 2.5B pounds worth of revenue into free cash flows. This is a conversion rate of 20.55%. I typically look for companies that convert at least 10% of revenue into free cash flow. When you have a high degree of FCF conversion, the company is able to "do more on less revenue". The excess cash can be distributed to shareholders, or reinvested back into the company for growth. Diageo's ability to convert more than 20 cents of every dollar give it a lot of financial flexibility.
The company's bottom line grew 9.3% year over year, which is in line with the long term 7-10% EPS that Diageo will achieve simply by growing sales in the low to mid single digits, and buying back a ton of shares every year.
Speaking of which, the company spent 1.5B pounds in fiscal year 2018 on share buybacks, and will buyback another 2B pounds worth of stock in fiscal year 2019. The dividend - which due to FX fluctuations doesn't qualify for status as a dividend growth stock, yet is steadily increased in local currency - was raised another 5% by management.
The company is facing some great opportunities for growth that will be reviewed further down in the article. All in all, 2018 was a steady year for Diageo (Diageo is never going to grow at a spectacular pace because the company is so large relative to its market). High free cash flow production fueling acquisitions, dividends, and buybacks are how it has been such a consistent wealth producer over the years.
Growth Strategies
Despite Diageo's immense size, there are a lot of opportunities for growth. This is partially due to the immense global presence, and resulting scale of Diageo's operations. Diageo is consistently looking for bolt-on acquisitions that the company can buy, and grow with its distribution network.
A great example of this has been Diageo's more aggressive play on the tequila market. After failing to acquire Jose Cuervo in 2012, Diageo has acquired Don Julio brand tequila in 2015 and Casamigos Tequila last year.
Since the acquisition, Don Julio has seen strongly accelerating sales growth in the three consecutive fiscal years since the acquisition. Casamigos tequila has yet to play out, but it is likely that it will follow a similar trajectory.
Overall growth strategies that touch the entire brand portfolio are centered around key growth markets.
Despite already being a core market for Diageo, the United States continues to be an area of growth for liquor producers.
Despite being its largest contributor to total revenues, it is the third fastest growing market for Diageo (going by sales growth in 2018). Tequila is an especially fast growing product category in the United States, and helps provide further logic behind recent acquisitions.
With a population of 1.3 billion people, India's growing attraction to alcohol is a massive opportunity that distillers are fighting over. Diageo owns subsidiary United Spirits Limited which is the largest umbrella spirits company in the world. The flagship brand is McDowell's No. 1, which has given Diageo a huge market presence in India. In all, 10 million people per year turn of legal drinking age in India. This expanding market will continue to play a larger role for Diageo moving forward.
Another highly populated market is China (1.4 billion people). China can be a tough market for various industries because there is often times a culture clash between Chinese traditions and western brands. Diageo has tapped into the tradition aspect with its brand Shui Jing Fang. A parital stake in Chinese distillery Sichuan Chengdu Shuijingfang Group Company in 2011, Diageo circled back and was able to buy 100% ownership of the brand in 2013. Shui Jing Fang is a brand of baijiu (a type of Chinese spirit distilled from grain). Baijiu is the leading type of spirit consumed in China.
The effort is so far paying off handsomely, with robust sales growth each of the past two years. This growth should continue in the years to come. India and China currently make up a minor stake in Diageo's revenues despite the oversized consumer base.
Wrapping Up
Diageo faces opportunity in key emerging markets such as India and China, while continuing growth in the United States. Earnings will fluctuate because of the high degree of FX fluctuation, but long term averages will be in the 7-10% EPS growth every year.
Converting 20% of revenues into cash is extremely strong, and will give Diageo the ability to continue rewarding us shareholders with dividends and buybacks. Meanwhile, management has openly stated that strategic acquisitions are always on the table to fuel growth. While Diageo won't make you rich overnight, this is one to work your way into and let it distill wealth over a period of decades.
Diving Into Diageo's Preliminary Results - Diageo plc (NYSE:DEO) | Seeking Alpha
