Go, Diageo!
It’s rare for investors to agree, but a strong consensus seems to be developing around global drinks giant Diageo plc (LON:DGE), which owns Guinness, Johnnie Walker, Baileys, and many other top brands. It’s a great company, but the shares are expensive. So are they too expensive?
Outgoing chief executive Paul Walsh has transformed Diageo since taking over 13 years ago, creating the world’s biggest premium-drinks company. His acquisition-driven growth strategy tripled the company’s share price in that time, but he’s calling last orders from July, and that will worry many investors. Will Diageo plc (LON:DGE) miss Walsh as much as Tesco misses Sir Terry Leahy?
Following an inspirational leader is never easy. Cynics often say that good leaders move on because they can see trouble coming. That’s another worry, especially given April’s disappointing interim management statement, which admitted that Western European sales had dropped 4%, with peripheral eurozone troubles giving Diageo plc (LON:DGE) a nasty hangover. However, that performance was offset by 6% growth in North America.
Ivan can?
So what will new chief executive Ivan Menezes do to keep the growth party going? The same as almost every other FTSE 100 boss right now: target emerging markets.
Menezes reckons Diageo can hit its target of generating 50% of its profit in the developing world within just three years, up from 40% today. The firm’s recent statement showed 14% growth in Latin America and the Caribbean, as well as 9% growth in Africa, Eastern Europe, and Turkey, plus 4% in Asia-Pacific. There was, however, slippage in Brazil, Korea, and Nigeria.
I bought Diageo plc (LON:DGE) in May 2010 at £11.27. Today, it trades at £19.57 — a rise of 74%. Its share price is up 23% over the past 12 months, versus 18% for the FTSE 100, but the figure that catches everybody’s attention is its pricey P/E ratio of 20.8 times earnings, versus 12.5 times for the index. The PEG ratio of 1.6 is on the higher side as well.
Diageo is forecast to post earnings-per-share growth of 12% for the year to June 30, 2014, but living up to that valuation is still a tall order. The yield has dipped to a disappointing 2.2% (compared to 3.5% for the index as a whole), although the payout is covered a healthy 2.2 times, and the income is forecast to hit 2.7% next year.
Drink up!
With a 22% operating margin and a 43% return on capital employed, Diageo plc (LON:DGE) is a smooth operator. That said, it is heavily geared, with net borrowings hitting a hefty £8.43 billion in March, up from £7.89 billion in December.
I last took the firm’s measure in September, when it traded at 17.4 times earnings and yielded 2.6%. I decided then that it looked expensive, and it looks even pricier today. With markets looking a little shaky right now, I’m tempted to drink some of my profits.
The article Should I Buy Diageo? originally appeared on Fool.com and is written by Harvey Jones.
Fool contributor Harvey Jones owns shares in Diageo. The Motley Fool recommends Diageo (ADR).
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