Diageo plc (ADR) (DEO): Buy, Sell, or Hold?

LONDON — I’m always searching for shares that can help ordinary investors like you make money from the stock market.

Right now, I am trawling through the FTSE 100 and giving my verdict on every member of the blue-chip index.

I hope to pinpoint the very best buying opportunities in today’s uncertain market as well as highlight those shares I feel you should hold… and those I feel you should sell.

I’m assessing every share on five different measures. Here’s what I’m looking for in each company:

1. Financial strength: low levels of debt and other liabilities
2. Profitability: consistent earnings and high profit margins
3. Management: competent executives creating shareholder value
4. Long-term prospects: a solid competitive position and respectable growth prospects
5. Valuation: an underrated share price.

A look at Diageo plc (ADR) (NYSE:DEO)
Today, I’m evaluating Diageo, a company engaged in producing, distributing, and selling premium drinks beers, wines, and spirits, which currently trades at 1,974 pence. Here are my thoughts:

1. Financial strength: Diageo plc (ADR) (NYSE:DEO) is in solid financial position with net debt less than three times its three-year average operating profit and interest payments covered a comfortable eight times. The company also has generated positive free cash flow each year for the last 10 years and converts an average of 14% of its revenues into cash.

2. Profitability: Revenues per share and earnings-per-share growth have been very good, increasing by 8% annually, while dividend growth has been strong, compounding by 6% per year over the past decade. Operating margins have been consistently around 21% while the 10-year average return on equity (ROE) has been excellent at 42%.

3. Management: Paul Walsh has been one of the FTSE’s 100 longest-serving CEOs, having been with Diageo for 12 years. He is responsible for streamlining Diageo plc (ADR) (NYSE:DEO)’s operations — shedding such non-core business units as Burger King and Pillsbury — and steering the company to become the leader in premium drinks.

4. Long-term prospects: Diageo is the world leader in premium drinks, with products sold in 180 markets around the world and owning a broad portfolio of leading brand names such as Johnnie Walker, J&B, Smirnoff, Baileys, Guinness, and Jose Cuervo. These brands are responsible for two-thirds of net sales.

North America continues to be the company’s leading market, generating one-third of the group’s total revenues in 2012 and earning operating margins of 35%. Meanwhile, revenues from emerging markets — Russia, Eastern Europe, Turkey, Latin America, Africa, and Asia-Pacific — have enjoyed tremendous growth, increasing by 33% since 2010. They now account for the 40% of the company’s total revenues. However, performance from the Southern European region continues to be a problem. Due to austerity measures and ongoing economic uncertainty, sales and volume decreased by 9% and 6%, respectively, in 2012.