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Diageo HY: Still in Need of Recovery

Published 30/01/2024, 08:25
Updated 09/07/2023, 11:32

All is certainly not lost at Diageo (LON:DGE), but the performance in Latin America and the Caribbean has left a bitter taste in the mouth, from which it may take some time to recover.

The profit warning in December was a shock for investors which led to a sharp decline in the share price. Latin America and the Caribbean (LAC) was held up as the main culprit, where net sales declined by 23% in the period. Despite only accounting for 10% of overall sales, the shockwaves for the group were immediate and impactful. Diageo has pointed out that part of the decline arose from strong comparatives, but lower consumption and a tendency among consumers to trade down to cheaper alternatives is the main concern of potential problems to come.

Unsurprisingly, the group has recognised the damage and will take steps in the second half of the year to mitigate the situation. Inventory levels will be reduced to more appropriate levels and although the decline is expected to continue, it should be at a lower rate. Consumer sentiment shows no immediate signs of improvement and so the group will need to cut its cloth accordingly.

Elsewhere, the group’s strength and geographical diversification has been able to pick up some of the slack. The group’s largest region accounting for 37% of net sales is North America, which saw a decline of 2% but where sequential improvement continues, which should help the group back on the growth path. Other regions fared rather better, with Europe contributing sales growth of 3% (responsible for 23% of overall sales), Asia Pacific 6% (20%) and Africa 9% (9%).

Net sales overall fell by 1.4% to $11 billion driven by the LAC performance and an unfavourable foreign exchange impact. By way of comparison, excluding LAC, there was sales growth of 0.7%. Operating profit also fell by 11.1% to $3.3 billion, while the profit margin dipped by 3.29%. Overall, some of the margin loss was offset by passing on price increases, but the salutary lesson of LAC was one of the factors which spooked investors, with customers potentially becoming more selective in their purchases, as has been seen recently to some extent in the luxury goods sector.

Rather more positively, Diageo remains a cash generative giant which will withstand the LAC hit, however painful in the shorter term. Free cash flow of $1.5 billion was helped along by some $335 million of cost savings, with the group’s medium term plan announced of $2 billion dollars of productivity improvement over the three years between 2025 and 2027. Even with these savings, the group plans to maintain its significant marketing presence and to continue with the “premiumisation” of its products, leaning towards higher margin sales.

The cash generation also enabled the completion of $500 million of the intended $1 billion share buyback programme, while the dividend was increased for the umpteenth year by 5%, keeping the group’s progressive policy intact. The yield of 2.8% is not one of the stock’s major attractions, rather it forms part of the wider shareholder returns approach.

Diageo has tended to be a typical core constituent of many portfolios, given the undoubted quality of its brands, diversification in terms of price point and regions, and strong and stable growth which has resulted from its many offerings. The LAC performance has blotted its copybook, with the share price decline all but wiping out any progress made during the pandemic and since. The shares are now down by 17% over the last year, as compared to a dip of 2% for the wider FTSE100 and the initial price reaction to this release reflects the fact that the need for recovery remains live and pressing. Perhaps slightly more positively, the market consensus of the shares as a hold suggests that investors are playing the waiting game for the time being, hoping for some of the current clouds to clear.

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