Diageo plc (ADR) (NYSE:DEO) maintains a lot of debt on its balance sheet relative to its cash on hand, but the strong and stable nature of its cash flow mitigates much of this risk. Morningstar and Fitch have given the company an A- credit rating.
Source: Simply Safe Dividends
All things considered, we believe DEO’s dividend is very safe.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
DEO’s dividend Growth Score of 55 is slightly above average. The company’s low payout ratio and strong cash flow generation support its score.
DEO has increased its dividend for more than 10 consecutive years (excluding foreign currency fluctuations) and hiked its dividend by 9% during its last fiscal year. While DEO is not a member of the S&P 500, disqualifying it from ever being included on the list of U.S. dividend aristocrats, we think the company can continue raising its dividend by at least 3-6% per year over the long term.
As seen below, the company’s historical dividend growth rate in U.S. dollars has been in the mid-single digits.
Source: Simply Safe Dividends
Valuation
DEO trades at about 20x forward earnings, which is a meaningful discount compared to beverage companies Brown-Forman (Forward P/E 28.8x), Molson Coors Brewing Co. (24.6x), and Anheuser Busch (25x). The stock’s dividend yield is also 3.2%, which is meaningfully above its five year average dividend yield of 2.8%.
DEO clearly needs to show improving growth trends in its most profitable region (North America) to close the valuation gap.
If the company can get back on track, it looks cheap. A high-single digit earnings growth rate wouldn’t be out of the question (DEO’s 5-year earnings per share compound annual growth rate is 7.5%) and would potentially result in an annual total return of about 10%.
Conclusion
Diageo plc (ADR) (NYSE:DEO) is experiencing several challenges at the moment. Some appear to be controllable (e.g. better marketing / innovation / management of North American division), while others are more uncertain (e.g. consumers shifting away from big brands in favor of craft distilleries; flavored vodka losing share to whiskey and bourbon; strong U.S. dollar).
DEO has the marketing budget, brand strength, distribution channels, and global reach to get back on track, but the size of its struggling businesses means that a turnaround could take some time. The SEC’s investigation (DEO might have been shipping excess inventory to distributors to boost results) is another mark against the company, but it doesn’t necessarily impair the company’s long-term earnings and dividend growth potential.
Either way, we don’t see a rush to jump into the stock despite its stable cash flows and 3.2% dividend yield. However, if DEO traded down below $100, it would be hard not to give it more serious consideration for our Top 20 Dividend Stocks portfolio.
Disclosure: None
