Diageo PLC (LON: DGE) – Leveraging E-commerce Capabilities to Drive Sales

Diageo PLC is a UK based alcoholic beverage company. The Company has more than 200 brands that are sold in over 180 countries. The Company has categorized the brands as Global giants, which includes six of the Company's most prominent brands such as Johnnie Walker, Smirnoff, Baileys, Captain Morgan, Tanqueray and Guinness. The other two brand categories are Local stars and Reserve; Local stars include drinks that can be individual to any one market and it is the growth category segment and includes drinks such as Crown Royal, McDowell's No.1, J&B, Windsor. Reserve category includes exceptional spirits brands that are sold at a premium price to cater to the luxury market and includes drinks such as Blue Label, DonJulio, Tanqueray, Talisker, Singleton, Ciroc and Lagavulin.

Diageo generates its largest sale from North America, which constitutes close to 39.5% of the total sales followed by Europe & Turkey, that constitutes around 21.9% to the total sales. Asia Pacific, Africa, Latin America and the Caribbean are the other key regions. Diageo is included in the FTSE-100 index.          

 (Source: Company website)

Growth Prospects and Risk Assessment

The markets and growth of the Company are highly dependent on long-term consumer trends, cultural & social trends and regulatory environment. Diageo focuses on growth through its industry-leading portfolio of Reserve brands, which it uses to influence the evolution of mass luxury spirits in different categories, including scotch & tequila. It is focusing on innovation of new brands to serve the customers, and an extensive portfolio of brands with different price points allows the customers to choose alcohol based on the occasion and the disposable income of the consumer. Adjacently, the Company is also developing lower price point options, which will help to drive growth in the developing market.

The strategy of the Company includes sustainable quality growth, promotion of positive drinking and pioneer grain-to-glass sustainability. To promote growth, the Company has set an online platform to help consumers make cocktails at home. The consumers will continue to be the focal point for all decisions, and the Company will focus on any factor that captures consumers choice.  The Company is concentrating on multiple sales channels, and e-commerce is the focus area.  In 2021, Diageo will further enhance e-commerce and intelligence automation, improve capabilities and develop marketing data and analytical tools.  The Company would continue to promote positive drinking and reduce underage drinking.

(Source: Company website)

Meanwhile, Diageo is exposed to regulatory restrictions and indirect taxes, as the regulators in various markets impose an increase in indirect taxes, trade barriers or conditions in the marketing activity of alcohol. If the Company is not able to identify and cater to the changing demands of the consumers, it could lose business and also threaten the position in the market. Theft, loss and misappropriation of digital assets can disrupt operations. The unsafe counterfeit products supplied to the markets can cause harm to the customers, destroy the reputation and can cause financial loss.

Industry Outlook Dynamics

The alcoholic beverage industry is a lucrative domain that is highly supported by occasion drinking and practices of local culture & tradition. The higher-priced spirits grow faster than the spirits in the lower tier. The lifestyle choice and diet have driven the interest in no-and low alcohol drinks that are differentiated through natural ingredients and craft production. The demand for spirits such as gin on occasions has become more popular than wine or beer. In 2019, the retail sales volume of the global alcohol market was £854 billion and close to 6 billion equivalent units of alcohol is sold each year. By 2030, close to 600 million new legal purchase age consumers are expected to enter the market. The alcoholic beverage industry is experiencing a change as people in the developed markets are shifting from late-night occasions to more informal and food-related occasions, and the pandemic has led to socializing at home.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Diageo Plc.

Recent Developments

On 1 October 2020: The Company announced the appointment of Ireena Vittal as a Non-Executive Director. She will also join the Audit, Nomination and Remuneration Committees.

On 30 September 2020: Diageo announced the completion of acquisition with Aviation Gin LLC and Davos Brands LLC.

On 24 September 2020: The Company launched and priced €700 million of fixed-rate Euro (due September 2028) and £400 million of fixed-rate Sterling denominated bonds (due March 2033) under the European Debt Issuance Programme.

Key Performance Indicators (FY20)

(Source: Company Website)

A Glimpse of Business Segments (FY20)

Trading Update (as on 28 September 2020)

• The Company issued a trading commentary ahead of AGM (Annual General Meeting) 2020, with a good start to the financial year 2021.
• It witnessed sequential improvement in the performance across all regions, with the gradual re-opening of the on-trade channel in most markets, strong execution and robust demand in the off-trade channel.
• In the US business, the Company was ahead of expectations and also performing strongly, driven by resilient consumer demand.
• In Europe business, DGE has shown a robust demand in the off-trade channel.
• The on-trade channel continues to recover in China market.
• In Africa, India, Latin America and the Caribbean, the on-trade channel has also begun to re-open and expects the pace of recovery to be more gradual.
• The Company expects a sequential improvement in organic net sales and operating profit as compared with the second half of 2020. However, it still anticipates lower organic net sales and margin dilution as compared with the first half of 2020.

Financial Highlights (for the year ended 30 June 2020 (FY20), as on 4 August 2020)

(Source: Company Website)

• The organic net sales for FY20 decreased by 8.4% year-on-year, with growth in North America and a decrease in all other regions. In FY20, the organic volumes reduced by 11.2%.
• The reported net sales declined by 8.7% year-on-year to £11.8 billion in FY20, driven by organic declines.
• Led by exceptional operating items and organic net sales, the reported operating profit declined 47.1% year-on-year to £2.1 billion.
• While the organic operating profit was down by 14.4% year-on-year, ahead of organic net sales, driven by cost inflation, volume declines and unabsorbed fixed costs.
• ROIC (Return on average invested capital) decreased by 267bps against the same period last year, driven mainly by organic operating profit decline.
• The Group delivered solid cash flow, with net cash from operating activities of £2.3 billion and free cash flow of £1.6 billion.
• The Board has proposed a final dividend per share of 42.47 pence. This brings the full-year dividend per share for the financial year 2020 to 69.88 pence, an increase of 2% from 68.6 pence in FY19.
• DGE anticipates that they will deliver the return of up to 4.5 billion pounds of capital to investors from FY2020 to FY2022.

Financial Ratios (FY2020)

Share Price Performance Analysis

On 23 November 2020, at the time of writing (before the market close, at 8:15 AM GMT), Diageo Plc shares were trading at GBX 2,944.50, down by 0.25% against the previous day closing price. Stock 52-week High was GBX 3,297.00 and Low of GBX 2,050.60, respectively.

From a technical standpoint, we could see a positive movement in the share price based on the 20-day SMA (2,787.15). Based on 2-year performance, Diageo outperformed the FTSE 100 index and the FTSE All-Share Beverage index. Diageo generated a return of around 5.34%, whereas the FTSE All-Share Beverage index generated a return of 4.51% and FTSE 100 index return was close to -8.29%. MACD line is placed above the central line, indicating a bullish setup.

The Company’s stock has delivered a positive return of around 16% and 14%, respectively in the last month and three months. In the last five years, Diageo Plc share price has delivered around 53% return as compared to the approximately 0.27% return of FTSE 100 index, which shows that the stock has outperformed the index during the last five years.

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Peers used in the valuation methodology (Price/ NTM Earnings)

Business Outlook Scenario

The performance of the Company was impacted in FY20, which was severely affected due to the pandemic and sales volumes and margins declined. The Company highlighted that it expects the market's conditions to remain volatile in FY2021 and its primary focus is to emerge from the covid-19 situation as a more vital organization. Diageo will invest in growth opportunities once the consumer demand revives. The recovery of the business will be highly dependent on the ease in lockdown, government rules and regulations, international travel and uninterrupted operations of restaurants and pubs. The Company did not provide the financial guidance for FY21; however, organic net revenue in H1 FY21 is expected to improve sequentially, as on-trade reopens and consumer demand recovers. In H1 FY21, the Company expects the operating margin to be better than H2 FY20. The Company will keep the dividend under review for FY21, and it will allocate funds to generate attractive returns on capital.

The long-term outlook of the alcoholic beverage is highly lucrative, and investments made by the Company over the last six years have positioned it well to deliver growth in a sustainable manner. The Company has an extensive portfolio of brands, strong global presence, and a healthy balance sheet.

 (Source: Company website)

Considering the recent acquisition, sequential improvement in the performance across all regions, strong execution, robust demand in the off-trade channel, the pace of recovery from the Covid-19 pandemic, sound balance sheet, decent operating & financial performance, high level of cash generation capabilities, and support from the valuation as done using the above method, we have given a “Buy” recommendation on Diageo at the current price of GBX 2,944.50 (as on 23 November 2020, before the market close at 8:15 AM GMT), with lower-double digit upside potential based on 30.59x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.). 

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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