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Why Diageo plc’s Investment Plans Should Ferment A Fortune

Today I am looking at why I believe Diageo‘s (LSE: DGE) (NYSE: DEO.US) expenditure plans should underpin robust long-term growth.

diageo

Acquisition activity set to continue

Diageo has been a major player on the M&A scene, as it seeks to turbocharge its global presence. The drinks ace forked out a huge £604m in the 12 months ending June 2013, up more than a third from the previous year, and has racked up a number of additional acquisitions since then.

In particular, the business has dedicated this massive investment to lucrative emerging markets across the globe, from which it generates around 45% of net sales (and rising rapidly). Diageo paid £233m last July to gain total control of ShuiJingFang, a major producer of China’s national drink, baijiu. It is also steadily building its stake in India’s United Spirits, and took its share up to more than 28% with additional share purchases in recent weeks.

Diageo also forked out £300m last year to acquire Brazilian cachaça manufacturer Ypióca. The move underlines Diageo’s intention to expand its presence in the premium drinks segment — Ypióca is one of Brazil’s biggest premium cachaça producers.

Ivan Menezes, chief executive of the world’s biggest spirits company, commented recently that “our goal is very much to widen our leadership position in the industry so we will stay active on [this] front.” With organic sales across the globe continuing to struggle, I expect Diageo to continue chucking cash at prospective takeover targets.

The drinks giant has undergone a significant boardroom revamp in recent weeks, illustrating the importance the firm is placing on developing regions. Sales growth in these markets rose just 1.3% during July-December, prompting Diageo to hive off its two biggest growth markets — India and China — from the rest of Asia-Pacific and place them under the stewardship of Gilbert Ghostine.

Drinks giant set to hurdle earnings dip

Current difficulties in emerging markets are expected to weigh on performance in the immediate term, however, and City analysts expect earnings to dip 2% in the 12 months concluding June 2014. But Diageo is expected to rebound strongly in the following year, with a 9% earnings increase currently pencilled in.

These projections leave the drinks giant dealing on a P/E multiple of 18.3 for this year, marginally below a forward average of 18.4 for the entire beverages sector, and which falls to 16.8 for 2015.

In my opinion Diageo is an excellent choice for investors seeking access to strong growth rates in emerging markets, a situation set to be bolstered by further M&A activity. Although recent macroeconomic turbulence has caused revenues to slow in recent times, I believe that rising disposable income levels in these territories bode well for Diageo’s stable of industry-leading brands.

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> Royston does not own shares in Diageo.