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Liberum pours cold water on Johnnie Walker-owner Diageo

Published: 09:39 30 Jan 2017 GMT

Johnnie Walker whisky
Johnnie Walker is a key brand in the US for Diageo

Diageo plc (LON:DGE) shareholders, it’s time to settle the bar bill and go home, according to Liberum Capital Markets.

The broker has downgraded the booze brands giant to ‘sell’ from ‘hold’ following a strong run in the share price.

Results announced last week were good, especially the improvement in performance of the Johnnie Walker whisky brand, but Liberum reckons the current share price of £22 or thereabouts already factors in a successful turnaround.

Liberum values the shares at £20, up from £19 following upbeat results last week.

Diageo is the only spirits company in Liberum’s coverage universe that trades at a premium to its fair value, which has been calculated using a discounted cash flow model.

If you must have a tipple in the drinks sector, Liberum recommends Heineken.

The broker pours cold water on the prospect of new chairman Javier Ferran, with his private equity background, accelerating brands portfolio action and maybe swinging the axe on costs.

“However, there are no obvious major deals to be done, at least not in international style spirits. The most attractive targets are all under the control of their major shareholders, and none are facing significant challenges at the present time. Jose Cuervo, which Diageo allegedly attempted to buy back in 2012, is only floating a minority stake in its planned IPO next month,” the broker noted.

Some shareholders are hoping the company will offload its flagship beer brand – Guinness – and use the cash to buy back stock.

“A simplified back of the envelope analysis shows that doing so might boost Diageo’s EPS [earnings per share] by only 2%, though we would expect a slight re-rating as the business mix shifts closer to 100% spirits (worth c. 1 PE [price/earnings] multiple point to Diageo at current Beer and Spirits multiples). So, the combined effect of a re-rating and the buyback may only be a mid-single digit uplift to the share price,” according to Liberum.

The high level conclusion is that selling Guinness would not provide much tangible benefit to Diageo’s shareholders.

The company has enjoyed some benefit from sterling’s slide following the Brexit vote, but this is showing some signs of reversing a little, which could put Diageo’s share price under some pressure.

Across the pond, the US accounts for around 45% of Diageo’s earnings before interest and tax, and it could suffer if the Trump administration introduces protectionist tax reforms and tariffs.

“While Trump’s proposed tax policies remain unclear at this time, information will start to drip out over the coming months. His protectionist stance to date does not bode well for importers, although spirits may suffer less regulation than other goods. It is clear that importers are in the cross-hairs, whatever their product may be, and it is unlikely that the situation will become more favourable than it is currently expected to be over the next four years.

“On the positive side, Diageo produces many of its US products locally and a lower corporate tax rate would be helpful; however, we think there is very little allowance in the Diageo price for a disappointing trade policy or import tariffs,” Liberum concluded.

Shares in Diageo were down 1.7% at 2,207.5p in mid-morning trade.

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