3 Things I Learned From Reading Diageo plc’s Annual Report

G A Chester digs down into drinks giant Diageo plc (LON:DGE)’s business.

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I’m working my way through the latest annual reports of your favourite FTSE 100 companies, looking for insights into their businesses. Today, it’s the turn of drinks giant Diageo (LSE: DGE) (NYSE: DEO.US).

Made of more

Diageo’s stable of alcoholic drinks brands is second to none. Its world bestsellers include Johnnie Walker whisky, Smirnoff vodka and Guinness stout.

You’ll hear consumer goods firms talking about “investing behind our brands”. That means spending money on marketing — sponsorship, TV advertising and all the rest — with the aim of getting their brands to the top of the tree and keeping them there.

Diageo actually spends more money on marketing each year than it pays out in dividends! From the annual report I was able to work out the marketing spend per £1 of sales for the last three years.

Year Sales Marketing spend Marketing spend per £1 of sales
2012/13 £11.43bn £1.79bn 15.63p
2011/12 £10.76bn £1.69bn 15.71p
2010/11 £9.94bn £1.54bn 15.48p

I was encouraged to learn that while Diageo’s marketing costs have been increasing, so have sales. Furthermore, those additional sales have been won without a disproportionate increase in marketing. As the table shows, the marketing spend per £1 of sales has been fairly constant year on year.

An unfortunate legacy

Probably all of you reading this article will know that the financial implications for BP arising from the Gulf of Mexico oil spill of 2010 will drag on for years. What you may not know is that Diageo has an unfortunate legacy issue that stretches back to the late 1950s and for which the company will continue to pay until at least 2037.

Distillers, a company that came into the Diageo fold via an acquisition by Guinness, was the distributor in the UK and Australia of thalidomide, the morning-sickness drug that caused death and deformities among many children whose mothers used it.

I learned from Diageo’s annual report that the company makes annual payments to the Thalidomide Trust in the UK (this year £8.1m) and the Thalidomide Foundation in Australia (this year £1.7m); and has a current provision of £164m for future payments.

A number of beneficiaries have publicly praised Diageo — and slammed German manufacturer Grunenthal, which only issued an apology for the drug as recently as last year, and reportedly continues to maintain it has “no legal responsibility to compensate individuals affected”.

Whisky in the pension pot

Many companies are currently struggling with pension deficits. During 2011, Diageo transferred whisky inventory with a book value of £535m into a funding partnership with its UK pension scheme. The pension scheme is entitled to a distribution from the profits of the partnership each year for 14 years, which is running at £25m per annum. The current book value of the inventory is £695m.

It’s a measure of great companies that they’re able to find imaginative and innovative solutions to problems!

Overall, the things I’ve learned from Diageo’s annual report are positive. However, with the shares trading at a lofty 18 times earnings and a lowly 2.5% dividend yield, there may be better opportunities to invest than at the current price of 2,025p.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> G A Chester does not own any shares mentioned in this article.

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