Diageo

Stock price: p1089
Conclusion: Notwithstanding stronger sales in Q3, Diageo reconfirmed low organic growth guidance, implying that its key markets (Europe and the US) remain pretty flat. We think the stock is close to its fair price, based on our valuation range of p1100-p1200.

Q3 sales up 9% reported (+12% organic). 9m up 4% (+2% organic). Guidance FY10 unchanged: low single digit organic profit growth.

Recovery could take longer for Diageo
-Q3, up 12%, not really significant, was largely driven by easy comps, early Easter and front loading ahead of tax increases.
-Geographic mix skewed towards mature markets. North America and Europe account for 33% and 30% of sales respectively. Signs of recovery in these markets remain fragile owing to unemployment and fiscal tightening. The outlook is clearly better for International sales (Latam and Africa 45% sales each) and Asia Pacific which account for a smaller part of the business.
-Price/mix could remain slightly negative due to faster growth in the off trade, combined with continuing promotional activity, notably in the US but also in Europe.
-Full year growth should remain in line with 9m trend (+2%).

Bottom line: small organic growth but forex will help
-Profit growth will be held back by slower expansion in mature markets where margins are higher, notably the US.
-We look for 2% organic EBIT growth following -3% decline in H1. Gross margin should remain negatively impacted by pricing/mix, while opex will be impacted by a higher marketing investments. These factors should be offset by £120m of costs savings. In addition, corporate costs are expected to return to normal in H2, following non-recurring charges in H1 (bonus accrual, system investments, M&A and legal costs).
-Reported EBIT numbers will be boosted by forex (+3.5-4% positivie impact), based on current rates, which might continue to fluctuate..
-Our EPS estimate (p72.5 up 9.6%) is adjusted for £180m of one off restructuring charges.

Diageo trades at 15xP/E (in line with Pernod Ricard) based on 2010 calendar estimates, and 11.2xEV/EBITDA (10% cheaper than Pernod Ricard). The stock looks relatively cheap in the spirits sector. Nevertheless, we find the brewers multiples (ABInbev and Heineken) more attractive.

Diageo

Stock price: p962
Conclusion: Both our investment case and valuation (p980-1050) remain unchanged following Q1 trading update. Stock fairly priced.

Q1 sales down 6% like for like. F10 guidance confirmed: low single digit growth in operating profit.

Q1 confirmed what we were expecting: a tough start in spirits due to weak demand, continuing trade destocking and high comparison base. We might have to wait for Q3 and Q4 to see a return to positive numbers. We don’t change our forecast of -1-2% decrease in sales this year.

Bottom line will benefit from costs savings (£120m) added to a positive forex impact (£80m). In addition, Diageo benefited in Q1 from “efficiencies” in marketing spending and media rates, implying a further decline in expenses. As a result, EBIT and EPS could increase by around 4% in F10 despite the negative operating leverage from lower sales.

Diageo trades at 15x and 14x P/E, based on calendarised 2009 and 2010 estimates, which is not expensive compared with brewers or food companies. Nevertheless, we believe Pernod Ricard offers superior long term growth following the acquisition of Absolut. Although, Diageo management confirmed that they would be interested in taking the full control of Moet-Hennessy, we doubt that LVMH would sell at the bottom of the cycle.

Diageo

Stock Price: p975
Conclusion: Good resistance in tough markets but stock looks fairly priced in light of our valuation range of p980-1050.

FY2010: Paul Walsh “F10 will be challenging, we expect to deliver low single digit organic operating profit growth”.

In spite of a probable further decline in organic growth (-1-2%), we expect Diageo to post a slight increase in adjusted EPS this year (3.9% to 69p).
-Top line growth will be challenging, with a tough comparison base in Q1 and H1. Key markets such as Spain, Ireland remain very difficult, while the US are impacted by downtrading. As a result, we expect global priority brands to be more affected than local brands. Guinness will also be faced with a tough comparison in Africa and weak demand for higher priced imported beer in the US. The second half of the year should be helped by easier comparison, as organic sales fell by around 4% during the corresponding period of last year.
-Operating profit could increase by around 4% thanks to £120m savings expected from restructuring initiatives in F10, coupled with £80m forex gains based on current exchange rates, partly offset by negative operating leverage.
-Management might also adjust marketing budget depending on results. However, we think that spending will also be function of the competitive environment. Pernod Ricard made it clear that it will increase spending this year, which might force Diageo to increase its budget, at least in the second half of the year.
-Operating profit will include £190m of restructuring charges compared with £170m reported in fiscal 2009.
-Net profit growth will be held back by lower contribution from Moet Hennessy, notably in H1.

We expect net debt to fall to £6.8bn by the end of June 2010, representing 2.4x EBITDA, which gives Diageo some room for maneuver. Management confirmed that they would buy Moet Hennessy and Souza Tequila if these businesses were for sale.

Diageo trades at 15.2x and 14.2x P/E based on our calendarised 09 and 10 estimates. Our valuation range p980-1050 based on multiple and DCF leads us to conclude that the stock is fairly priced.

Diageo

Stock price: p871
Conclusion: Fairly priced

Interim management statement 9 months ended 31 March 2009
Sales declined by 7% like for like in Q3, increased by 11% reported helped by forex. Management confirmed 4% to 6% organic operating profit growth for the year and double digit growth in eps.

Diageo performed better than Pernod Ricard in Q3 with sales down 7% vs -12% for Pernod Ricard. Inventory destocking in the US, coupled with lower demand in Russia and a depressed travel retail business were mainly responsible for the lower revenues. We believe that Q4 could remain slightly negative, which makes us wonder about the reiterated guidance for the year. We think that Diageo will have to cut marketing spending to reach the bottom end of the organic target. EPS growth should be helped by the depreciation of the sterling and the relative strength of the dollar.

Diageo trades at 13,3x our 2009 estimates. Our DCF valuation leads to 900p, which implies that the stock is fairly priced.