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Wealth Accumulated

Wealth Accumulated

By D J Thomas, a large-cap stock market value investor and financial writer

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Diageo

Diageo: the world’s greatest boozer

January 31, 2023 by D J Thomas

Diageo and it's suite of branded premium drinks
If you like boozing premium brands, Diageo’s your best friend

Wealth Accumulated is long Diageo (LSE: DGE) after an extremely positive half-year report from the firm.

Diageo is a London-listed owner of over 200 premium drinks brands that sell to over 180 countries.

Jonnie Walker, Guinness, Baileys, Smirnoff, Captain Morgan, and a suite of Scotch Whiskey Diageo brands itself as the world’s foremost premium drinks brand builder.

Let’s take a look at the latest numbers:

  • net sales of £9.4 billion, up 18.4%
  • organic net sales grew 9.4%, with growth in all regions
  • operating profit of £3.2 billion, up by 15.2%
  • basic earnings per share of 100.9 pence, up by 19.7%
  • Free cash flow of £817 million, down by 48%

Free cash flow tanked, here’s what the firm offered as a reason for the fall in FCF (emphasis mine):

… a higher year-on-year working capital outflow, higher cash tax and interest paid, and increased capital investment. The higher year-on-year working capital outflow was due to the normalisation of creditors relative to the first half of fiscal 22, as our growth rate began to moderate in the first half of fiscal 23…

Diageo half-year report, 26th January 2023

In other words, as sales began to slow interest payments became more expensive.

More cheerfully, growth in revenues and operating profits were attributed to ‘premiumisation’ – consumers turned to premium drinks brands despite the high cost of living to treat themselves, even though they cut spending in other areas of their lives.

Diageo also noted that ‘price increases and supply productivity savings more than offset the impact of absolute cost inflation on gross margin.’

Scotch, tequila, and beer accounted for the most favoured drinks from consumers and the most growth in sales.

All-in, a good set of numbers for a global brand navigating the fall-out of covid.

The Diageo balance sheet

Specifically the debt.

In the highly upbeat report, there was little mention of the debt by management so it pays to dig a little deeper into how strong the balance sheet actually is.

Diageo has always carried a lot of debt relative to its equity but the firm touted a ‘strong balance sheet’ on the basis that its leverage ratio (adjusted net borrowing to adjusted EBITDA) is 2.5x as of 31 December 2022, the lower end of its target range.

It was able to remain within the lower end of its target range by adding back increased finance charges, an exceptional intangible impairment, and an exceptional operating item to the calculation of EBITDA.

This had the effect of masking the increased indebtedness Diageo had undertaken in the period.

This financial manipulation is not new and attempts to curve fit a firm’s financial strength into the false safety of a ratio that does little except to hoodwink investors.

A much better look at Diageo’s financial strength is as follows for the six months to 31st December 2022:

  • Market cap: £76.88 billion
  • Net debt: £15.16 billion
  • Revenue: £9.4 billion
  • Pre-tax profit: £3 billion

No doubt there are disposals in the pipeline for Diageo as it seeks to strengthen it’s brand offering by acquiring premium brands around the world which could be used to pay down debt.

But from a cash flow and financial strength perspective, I wouldn’t like to see net debt go much higher than it is already since its assets (and liabilities) held for sale, including Guinness Cameroon S.A., amount to only £106 million.

Can Diageo handle the debt?

CEO Ivan Menezes was confident about Diageo’s future prospects:

As we look to the second half of fiscal 23, whilst the operating environment remains challenging, I remain confident in the resilience of our business and our ability to navigate volatility. We believe we are well-positioned to deliver our medium-term guidance of consistent organic net sales growth in the range of 5% to 7% and sustainable organic operating profit growth in the range of 6% to 9% for fiscal 23 to fiscal 25.

Ivan Menezes, CEO, Diageo

These growth targets are already being met and the challenge for Diageo is to continue to meet them for the rest of 2023 and beyond. A target they have set themselves.

From a section entitled ‘fiscal 2023 outlook’:

In North America, organic net sales grew 3% in the first half of fiscal 23. We expect organic net sales growth to continue to normalise through the second half of fiscal 23, compared to the double-digit growth in the prior period. In Europe, we expect organic net sales growth to moderate in the second half of fiscal 23 as we lap on-trade re-opening recovery. In Asia Pacific, Latin America and Caribbean and Africa, we expect continued growth through the second half of fiscal 23, albeit at a moderated pace relative to the strong growth in fiscal 22.

So slower growth, but growth is forecast nonetheless and it’s fair to say that the strength of their brands and the continued investments in ad spend and premium brand acquisitions should help them achieve their targets.

Why I didn’t buy this stock when it was £25 – £30 a share is beyond me, but I’m in at an elevated price so Diageo represents a smaller percentage of the overall portfolio for now.

Why lower interest rate rises are less toxic for your portfolio

January 23, 2023 by D J Thomas

Image by Elliot Alderson

0.25 or 0.50? These are the numbers getting everyone’s knickers in a twist. The numerical obsession with interest rates is tied to the fact that stocks like low interest rates. The next FOMC meeting is in a few weeks’ time starting 31st January and Federal Reserve Governor Christopher Waller said last Friday “there appears to be little turbulence ahead, so I currently favor a 25-basis point increase at the FOMC’s next meeting.” And it’s not just Waller. Philadelphia Fed President Patrick Harker said in his view “hikes of 25 basis points will be appropriate going forward”. The expectation has been set.

Machine learns like lightening, very very frightening

Google and Alphabet CEO Sundar Pichai is frightened of future internet users turning to AI rather than using its search engine. It’s clear why: Sridhar Ramaswamy from Google’s ad team between 2013 and 2018, said that ChatGPT could prevent ChatGPT users from clicking on links with ads. Ads that generated approximately $208 billion dollars (81% of 2021 revenue). The recent lawsuit filed against Google by a coalition of 8 US states and the Department of Justice accusing them of ‘destroying competition in the ad tech industry’, may prove to be an untimely distraction. The demo version of Google Search with AI chatbot that Google promised by the firm later this year can’t come soon enough for shareholders.

Google needs a lawyer

The US Department of Justice along with eight states is suing Google. But before we get into that, let’s remind ourselves about the staggering worldwide backlash against Google’s dominance: a $2.73 billion fine by the EC in 2017, a $4.3 billion fine by the EU in 2018, a $1.49 billion fine by the EC once again – all for antitrust issues. Historical fines for Google in the US have been nowhere near these figures. This time around, the lawsuit is seeking to divest its advertising businesses as a way of opening up competition in the ad space. Are we about to see the US admonish one of its own corporate children?

Microsoft’s layoffs cost it a packet

Microsoft earned $2.32 per share. The market was expecting $2.29. All good in the hood. Microsoft said it recorded a charge of $1.2 billion for the quarter, $800 million of which related to the job cuts. Oh, there’s also a slowdown in its cloud and business software divisions for 2023 according to the company. “During the pandemic, there was rapid acceleration. I think we’re going to go through a phase today where there is some amount of normalization in demand,” Chief Executive Officer Satya Nadella. Microsoft earnings are important because it’s seen as an example of the wider tech sector, which also happens to have a major influence on the tech-heavy S&P 500. Its slowdown in December coupled with an acknowledgment of a general slowdown in PC sales forecasted for 2023 looks as though the recession is starting to influence forward earnings “In our commercial business we expect business trends that we saw at the end of December to continue” – Amy Hood, Cheif Financial Officer, Microsoft.

UK government likes debt

From £16.7 billion in December 2021, to £27.4 billion in December 2022, the UK government hits record borrowing. Way above expectations of £17.8 billion. Inflation, household energy bills assistance, student loans, and April’s national insurance policy reversal is to blame. A significant proportion of student loans will never be repaid and the government is forced to recognise this under new accounting rules adding to the indebtedness.

Recession in the UK

Two data points: 1) the S&P global CIPS UK flash composite purchasing managers’ index saw the ‘sharpest drop in business activity for two years’. January data highlighted a sustained downturn in UK private sector business activity. The overall rate of decline accelerated to its fastest for two years. “Weaker than expected PMI numbers in January underscore the risk of the UK slipping into recession”, Chris Williamson, chief business economist at S&P Global Market Intelligence. 2) Anna Leach, CBI Deputy Chief Economist, said: there are signs that demand is easing too, with order books weakening sharply, spare capacity in the manufacturing sector rising and the share of firms citing the strength of sales or orders as a potential constraint on output rising to its highest in almost two years.” If the patient is the UK economy, it’s like two doctors coming to more or less the same conclusion.

Boeing’s flying low

A $663 million loss for the fourth quarter and a $5 billion loss for the full year with a loss per share of £1.75 v expected earnings per share of 26 cents. It’s the sixth quarterly loss in a row. “While we have made meaningful progress, challenges remain and we have more work ahead to drive stability in our operations and within the supply chain,” Chief Executive Officer Dave Calhoun. Boeing is betting on a full re-opening in China and the easing of supply-chain issues that slowed the production of aircraft, especially jet engines. As an old-school value investor, I can’t help thinking back to the massive losses Warren Buffett suffered when he went full ham on airline stocks only to sustain huge losses. No thanks.

Tesla’s earnings turn south

You’ll see the headlines: record revenue at Tesla. What you won’t see, at least not as clearly, are earnings of $1.19 per share v $2.52 in the same quarter last year. Or that gross margins are the lowest in five years and operating cash flow is down 29% from last year. Tesla has already begun well-publicised price cuts on its vehicles which helped ramp up orders. Musk is upbeat about Tesla and thinks he can make up to 2 million vehicles this year which he says will all be sold if they can make them fast enough. ‘Twitter is actually an incredibly powerful tool for driving demand for Tesla’ Musk responded when asked if his political rants hurt the firm. He even had the gall to encourage other automakers to make use of Twitter for marketing their own brands. Elon is a well-received businessman here at Wealth Accumulated.

US Fourth quarter GDP down

A weakening housing market and a slowdown in corporate spending reduced fourth quarter GDP to 2.9% from 3.2% in the third quarter. Consumer spending (68% of GDP) increased 2.1%, fuelled largely by consumer debt, even as retail sales declined in December by 1.1%. Are consumers maxed out? Most commentators believe a recession is coming, albeit a mild one despite these numbers.

Diageo

Earnings per share shot up 20% for the firm this week to 100.9p at the half-year stage. The company owns the most enviable portfolio of drinks brands in the world. Baileys, Johnnie Walker, Guinness, Smirnoff, and a suite of Scotch Whiskeys to name a few. Price rises for its products and an increase in consumers drinking its premium brands helped to boost revenue. It, like a lot of the large caps that sell to China, is betting on increased revenue in 2023 when China re-opens.

Intel

Just 10 cents per share and a $664 million net loss in the fourth quarter of 2022. Intel is predicting a net loss of $15 cents per share in the first quarter of 2023. Intel elected not to give full-year guidance for 2023 but did indicate $11 billion in sales in the March quarter, a 40% year-over-year decline. Their customers have a deluge of chips already and need to work through their supply before buying Intel chips again, at least that’s what analysts are saying.

Chevron pumps profits

Putin’s invasion of Ukraine has prompted what will no doubt be eye-watering earnings from the energy sector. Chevron made a record $36.5 billion profit for 2022, more than double the previous year. The $75 billion share buyback program it announced has President Biden calling it a ‘slap in the face’ for Americans coping with the ravages of flooding in California.

Rolls Royce is a burning platform

The CEO of Rolls Royce, Tufan Erginbilgic gave his employees an analogy: when an oil platform in the North Sea is on fire, you need to jump into the volatile and freezing water to survive. That’s what he meant when referring to the firm as a ‘burning platform’. Covid was dismissed as no more than an excuse for what he called the firm’s chronic underperformance. He will likely announce a brutal restructuring following up his tough words with tough action.

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