Is Diageo A Buy?

<%= article.AuthorDisplayName %>

By

Royston Wild

Published in Company Comment on 29 January 2013

Should you buy shares in Diageo plc (LON: DGE)?

I believe that Diageo (LSE: DGE) (NYSE: DEO.US) should remain a top target for investors seeking safety against current macroeconomic uncertainty through quality, defensive stocks. I also reckon the company's track record of earnings growth is set to continue through forays into exciting new geographies. 

Get ready to bottle gains

Alcohol producers are a classic safety play against a difficult economic backcloth, and Diageo is no exception. Analysts expect earnings per share (EPS) to rise 9% during the financial year ended June 2013 to 102.6p, slowing from growth of 13% in 2012 but still representing a healthy return. EPS growth is expected to return to double digits in 2014, up 11% to 113.7p.

In my view, the firm's earnings dependability justifies a high P/E ratio of 18.1 for June 2013, and is cheaper than a number of its peers -- SABMiller's P/E ratio for 2013 stands at 20.7, for example.

Meanwhile, Diageo's decent, progressive dividend policy helps to offset the lofty multiple, offering investors a yield of 2.6% for 2013 and which is predicted to rise to 2.8% in 2014.

Emerging markets to drive growth

Diageo continues to make huge inroads into new regions across the globe, mitigating the prospect of lingering weakness in its established Western markets. On an organic basis, the company saw operating profit from Latin America and the Caribbean rise 19% during 2012, with Africa rising 16% and Asia-Pacific increasing 10% on an annual basis. In comparison, profit from North America and Europe rose just 7% and 1% respectively.

The company has remained committed to investing to improve its footprint in these new markets in recent years. It acquired Ethiopia's Meta Abo in January 2012, the country's second-largest beer company, taking total spend in the African continent over the past five years to £1 billion. Diageo also increased its stake in giant Vietnamese spirits producer Halico to more than 45% in June last year.

Excellent brand strength

The firm's catalogue of premium brands -- comprising the likes of Guinness, Smirnoff, Johnnie Walker and Baileys -- gives it supreme pricing power, giving licence to increase prices to boost earnings and maintain margin improvement.

The Scottish National Party earlier this month floated the idea of placing a £1 tax on the production of every bottle of Scotch produced, a move that could potentially have a huge effect on Diageo's bottom line -- more than a quarter of the firm's sales emanate from its Scotch products. However, Diageo's products lie at the higher-end of the market, and thus it should be able to pass these costs effectively onto its customers.

Cigarettes & alcohol

Tobacco and booze specialists are trusted deliverers of growth in both the good and bad times, and market expert Neil Woodward -- veteran fund manager at Invesco Perpetual -- has picked out a handful of similar stocks that are primed to explode. He has also selected promising contenders in the pharmaceutical and telecoms sectors, all of which can be seen by clicking here to view the report -- it's 100% free!

> Royston Wild does not own shares in Diageo.

Share & subscribe

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Pinchthepennies 29 Jan 2013 , 1:07pm

2.6% yield is less than than current inflation and even 2.8% yield is only 0.1% ahead of current inflation - nothing to really boost about and the latter won't be coming until next year.

So from an income point of view I won't buy it at present.

ANuvver 29 Jan 2013 , 3:14pm

Since Royston gives the US tick for DGE, I suspect this is a repost from Fool US. American markets are culturally more about cap appreciation than income, so there is a different attitude to dividends.

eccyman 29 Jan 2013 , 10:02pm

#pinchthepennies

To compare yield to rpi, you should compare the GROWTH in the dividend to rpi rather than the yield.

eg say rpi is 5%. A 1% yield growing at 6% is actually beating inflation

Not the easiest concept to explain, but hope you understand what I'm trying to say!

jrr774 29 Jan 2013 , 10:41pm

I think you're confused Eccyman - 1% growing at 6% would give a yield of 2% after 12 years. In which time presumably RPI has ticking up at 5% pa.

eccyman 30 Jan 2013 , 9:31am

#jrr774 - can assure you I'm not confused, or maybe I got the maths degree by accident.

When looking for a way to keep your income ahead of inflation, you should be looking for a dividend that grows faster than RPI rather than a share initially yielding more than RPI.

Take an extreme example. Alpha ltd yields 20%, but the divi is growing at 1% while RPI is 10%. Beta ltd yields 2% but the divi is growing at 10% while inflation is 1%. - which company would you say is the inflation buster?

eccyman 30 Jan 2013 , 9:43am

Regarding inflation, to clarify I'm talking about having an income that beats inflation - which is my objective anyway!

I would agree that in a scenario where capital growth plus yield is less than inflation then the value of capital will indeed be eroded.

jrr774 30 Jan 2013 , 5:18pm

Yes I understand, I think maybe the example you gave was a little too extreme. If it's income you wish to protect it might be worth having a look at the 'Sturdy Seventeen' analysis of Luniversal on the High Yield boards. He and Valuemargin have done a great deal of regression analysis of large cap stocks and the 17 stocks mentioned have strong and lengthy inflation-beating payout records. If you buy into a yield at, near (or ideally above) the RPI (circa 3%) where those dividends grow consistently at say 6%pa you should be laughing. All being equal the capital value should tick slowly upwards too.

Join the conversation

Please take note - some tags have changed.

Line breaks are converted automatically.

You may use the following tags in your post: [b]bolded text[/b], [i]italicised text[/i]. All other tags will be removed from your post.

If you want to add a link, please ensure you type it as http://www.fool.co.uk as opposed to www.fool.co.uk.

Hello stranger

To add your own comment, please login.

Not yet registered? Register now.

Get straightforward advice on what’s really happening with the stock markets, direct to your inbox. Help yourself with The Motley Fool Collective, a FREE email newsletter designed to help you protect and grow your portfolio wealth.

By submitting your email address, you consent to us keeping you informed about updates to our website and about other products and services that we think might interest you. The Motley Fool respects your privacy. Please read our Privacy Statement and Terms & Conditions.

For all queries please email CustomerServices@Fool.co.uk or call The Motley Fool on 020 7462 4300 between 9am – 5pm, Monday – Friday.

More articles in this section

Beta

Tags for this article

This article hasn't been tagged yet. Be the first to add a tag below.

Login or register to add tags.

Beta

Related content