The world’s largest spirits group Diageo generated 1.3% organic volume growth and 2.8% organic net sales growth in the year to June 2016. This follows on from a fall in volume in the previous year with flat organic net sales. Daigeo’s three strategic priorities in the current year are Scotch, US spirits and India.
Diageo’s latest trading update stated that the financial year to June 2017 has started well. The momentum in place in the last fiscal year appears to e flowing through to a stronger top line performance.
The objective through to fiscal 2019 is for mid-single net sales growth with this a marked increase on the 2.8% generated last year. Diageo is also looking to achieve a 100bps organic operating margin improvement by fiscal 2019.
If these targets can be achieved then Diageo is set to deliver robust profit growth over the next three years. Diageo is already a very profitable business with the organic operating margin in fiscal 2016 coming in at 27.1%.
Diageo’s six “global giants” generated 40% of net sales last year
Source: Diageo Factsheet
Diageo’s three priorities in the current fiscal year to June 2017 are Scotch, US spirits and India. In fiscal 2016 Scotch made up 24% of net sales while North America is Diageo’s most important market at nearly half of operating profit.
India is a key growth market for Diageo with the group owning a 55% controlling stake in India-listed United Spirits Limited (USL). This exposure positions will allow Diageo to benefit from the growth in India’s middle class.
North America returned to organic volume growth for Diageo in fiscal 2016 at 1.1% versus a 2.9% decline in fiscal 2015. In Asia Pacific the pace of organic volume decline slowed to 0.1% from 3.4% decline in fiscal 2015.
Diageo turns around in fiscal 2016: year to June.
Source: Diageo Factsheet
Diageo’s three priorities in the current fiscal year to June 2017 are Scotch, US spirits and India. In fiscal 2016 Scotch made up 24% of net sales while North America is Diageo’
s most important market at nearly half of operating profit.
India is a key growth market for Diageo with the group owning a 55% controlling stake in India-listed United Spirits Limited (USL). This exposure positions will allow Diageo to benefit from the growth in India’s middle class.
North America returned to organic volume growth for Diageo in fiscal 2016 at 1.1% versus a 2.9% decline in fiscal 2015. In Asia Pacific the pace of organic volume decline slowed to 0.1% from 3.4% decline in fiscal 2015.
Diageo turns around in fiscal 2016: year to June
Source: Diageo investor presentation
Turning to India and United Spirits Limited has a number of the leading brands in the country. McDowell’s is described as “India’s largest consumer goods brand” and is USL’s flagship offering in the fast-growing local Scotch market.
USL also has the second largest Scotch brand in India, Black Dog, and the fastest growing Scotch brand in the country, Black & White. With a diversified portfolio USL should inevitably benefit from the forecast growth in India’s spirit market.
Source: Diageo investor presentation
Summary
Diageo appears to be back in good form after a difficult 2015 when organic volume declined 1.3%. The fall in the value of the pound will also provide a currency tailwind for the current year.
If the targets for top line growth and margin expansion through to 2019 are achieved we will see solid medium-term profit growth. The key is for Diageo to continue to improve its position in the larger North American market.
Emerging markets appear to be driving a turnaround in demand for Scotch with volumes stabilising. India holds significant potential for Diageo as it owns a majority stake in the country’s leading spirits group.
Given a very high operating profit margin it is no surprise that Diageo does not appear cheap at 21.6X forecast earnings for fiscal 2017. However, the forecast yield is attractive at nearly 3% and the group has a strong track record.
Looking out to 2020 and the forecast P/E falls to 18X while the forecast dividend yield edges up to 3.2% (1.8X covered). With a range of strong brands the shares offer an attractive core portfolio holding.
This report was produced by Fat Prophets Senior Research Analyst, Andrew Latto
Disclosure: Interests associated with Fat Prophets declare a holding in Diageo.