Diageo plc May Have Just Dug Itself A Huge Hole, But Will SABMiller plc Benefit?

Is Diageo plc (LON:DGE) drunk with power? Find out what this Fool thinks of the brewer’s latest move, and why SABMiller plc (LON:SAB)’s worth another look.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

The UK economy is doing okay, but it’s not going ‘gangbusters’…

The latest data shows that the economy expanded by 0.5% in the three months to the end of December, following growth of 0.7% in the third quarter, according to the Office for National Statistics.

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It’s the usual story: the services sector is holding up quite well but there’s been a sharp fall in construction output. Industrial production also shrank by 0.1%, while the manufacturing sector was basically flat. Britain’s economic recovery remains patchy.

That may all be quite manageable except for the fact that real wages remain a sticking point for consumers. So “the risks”, as they say, to the economy are on the downside, in this Fool’s humble opinion.

Taking matters into your own hands

Top FTSE 100 companies know things could go pear-shaped at the drop of a hat, which is why many of them are starting to resort to somewhat under-handed tactics to stay afloat… too many cliches??

Take Diageo (LSE: DGE) (NYSE: DEO.US), for example. According to The Telegraph, it has made the unusual move of extending payments to suppliers out to 90 days. The reason for the move is obvious — healing a margin squeeze. It’s an unfortunate move, though. Why? Because its margin squeeze ain’t that bad, and because it’s taking advantage of its market position.

Diageo insists that it needs to improve its cash flow and drive out costs. So just how injured is the brewer’s balance sheet? Not that much as it turns out.

Diageo has a debt to equity ratio of 1.35. There’s more evidence that it’s got its finances under control with an interest cover of 5.74. It’s no surprise then to see that the company has a healthy profit margin of 12%.

So what’s really going on? Well, as part of the information made available to the press, Diageo was reported as saying that it has “significant investment projects under way across our operations in Scotland and Ireland and like any business, to support our investments we need to improve our cash flow and drive out costs”.

In other words, Diageo is using its suppliers to help cushion the potential cash-flow headwinds that could come from its increased investments. Not cool!

Is this the catalyst to switch to SABMiller?

So I guess the question then is whether you should consider switching to SABMiller (LSE: SAB) (NASDAQOTH: SBMRY.US). Both Diageo and SABMiller have very similar fundamentals. To cover some of the basics, SABMiller has a price-to-earnings multiple of 25 times, and a dividend yield of 1.94%. Diageo’s price-to-earnings multiple is around 22 times, with a dividend yield of 2.63%. It’s a tough call.

One way Diageo has chosen to ‘grease the wheels’ is to make life a little more difficult for its suppliers. SABMiller, on the other hand, has chosen to reach out for synergies (joining up with Coca-Cola in Africa).

Based purely on the more sustainable approach, it seems to this Fool that the wiser investment decision is SABMiller, but it too has its challenges. In its latest accounts, SABMiller said net producer revenue rose 4% in the fourth quarter. That’s on par with last year. The company said, however, that volumes in China fell 9% during the quarter. Sales in North America also fell 1% as many Americans upgraded to more premium brews.

Both companies have their challenges, especially with regard to achieving growth, but I think it’s worth pointing out the different strategies these companies have employed to gain an advantage. Which stock do you think now has the most potential?

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