With the FTSE 100 falling to its lowest level in 2015, now may be the perfect opportunity to buy quality companies on the cheap. The share prices of quality companies may not have fallen as much as commodity-related or cyclical shares, but quality often comes at a premium. Warren Buffett once reportedly said: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Quality companies are ones that benefit from wide economic moats. Diageo (LSE: DGE), SABMiller (LSE: SAB) and Whitbread (LSE: WTB) are three companies that boast broad global exposures, dominant market positions and strong pricing power. These factors give them a competitive advantage over rivals, and this enables them to generate wide profit margins and stable free cash flows.
Shares in Diageo currently trade at a forward P/E of 19.7, with analysts currently predicting underlying EPS will grow 3% to 91.6 pence in 2015/6. Valuations for the company are now less demanding and, in addition, Diageo pays a reasonably attractive prospective dividend yield of 3.3%.
Diageo has already been hit hard by the slowdown in emerging markets and the lack of exposure to the fast-growing bourbon market in North America. But, with long-term branded spirits consumer trends remaining intact and profit margins near 30%, Diageo is still a great company.
The lower valuation multiples for Diageo could bring renewed takeover interest from 3G Capital, a private equity firm owned by Brazilian billionaire, Jorge Paulo Lemann. Lemann could be interested in a possible tie-up of Diageo with AB InBev, to create an enlarged beer and spirits business.
SABMiller has already been affected by the slowdown in China and the weak consumer spending in Europe. In its latest trading update, SABMiller’s total lager volumes declined 1% in the three months leading up to 30 June. But soft drink volumes grew 4% and the company continued to see robust demand from Africa.
SABMiller, with its sizeable exposure to fast growing African consumer markets, is also a potential takeover target for 3G Capital and AB InBev. AB InBev’s focus on higher value beer products has meant that it has made limited strides in the African market, and a combination of the two companies could create a truly globally dominant beverage producer.
With expectations that underlying EPS will fall 2% this year, SABMiller has a forward P/E of 21.8. Analysts expect EPS will bounce back by 8% in the following year though, with forecasts of underlying EPS of 150.0 pence in 2016/7. Thus, its forward P/E based on 2016/7 earnings is expected to be 20.0. Although valuations are still relatively high in today’s market, shares in SABMiller are unlikely to get much cheaper.
Whitbread’s growth strategy remains strong. Its two most popular brands, Premier Inn and Costa, are seeing strong growth in like-for-like sales, and the company continues to invest in new store openings. In the 13 weeks to 28 May, like-for-like sales for the group rose 4.3%, whilst total sales grew 12.5%.
Analysts expect Whitbread’s adjusted EPS will grow by another 14% over the next two years, which gives its shares forward P/E ratios of 21.5 and 18.9, based on the expected earnings of 241.0 pence and 274.2 pence for 2015/6 and 2016/7, respectively.