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.