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Diageo: A market leader with room to grow.

Opdateret: 27. jan.


I like companies that are market leaders, companies that have plenty of growth ahead, and companies that are gaining market share. Diageo is a company that fulfills all of the above criteria, and it also possesses a strong competitive advantage, which should enable it to perform well even in times of economic downturn. Is now the right time to add Diageo to your portfolio? This is what I will investigate in this analysis.


This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.


For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Diageo. If you would like to copy my portfolio or view the stocks in my portfolio, you can find instructions on how to do so here. I don't own shares in any of their direct competitors either. I should also mention that Diageo has been on my watchlist for years, so it is a company that I like. Nonetheless, I will keep this analysis unbiased. Diageo is listed in both the United States and the United Kingdom. In this analysis, the numbers and calculations will be in U.S. dollars because that is the currency used by eToro the platform where I buy shares. Should I buy the shares, I will opt for UK-listed shares instead, as they are not subject to withholding tax on dividends. You can purchase both U.S. listed and U.K. listed shares or fractional shares on eToro. eToro is a highly user-friendly platform that allows you to get started with as little as $50.



Diageo was founded in 1997 through the merger of Guinness plc and Grand Metropolitan. It is headquartered in London, England, United Kingdom. It is a global leader in the beverage alcohol industry, boasting over 200 brands encompassing spirits and beer. Their products are sold in over 180 countries worldwide. Their largest market is North America, accounting for 39% of total net sales, followed by Europe at 21%, Asia Pacific at 19%, Latin America & the Caribbean at 11%, and Africa at 10%. Diageo also has a joint venture with LVMH Moët Hennessy - Louis Vuitton, in which they own a 34% share of the Moët Hennessy joint venture. This joint venture contributed 10% of Diageo's profits before taxes. Diageo has a strong brand moat, as evidenced by its ownership of two of the world's largest international spirits brands, Johnnie Walker and Smirnoff, in terms of retail sales value. Diageo also owns brands such as Guinness, Baileys, Tanqueray, and Don Julio.


Their CEO is Debra Crew. She joined Diageo in 2020, initially serving as the President of Diageo North America. She later assumed the role of COO before being appointed as the CEO in June 2023. Prior to joining Diageo, she worked in various roles at companies such as Mars, Nestle, Kraft Foods, PepsiCo, and Reynolds American. She is also serving on the Board of Directors at Stanley Black & Decker. She has an MBA from the University of Chicago Booth School of Business. She was appointed as the CEO of Diageo due to her impressive track record, extensive expertise in the consumer industry, proven strategic capabilities, strong operational performance, and her evident ability to build and lead teams. In her first letter to shareholders, Debra Crew wrote that she will focus on continuing to gain market share through premiumization and active portfolio management. Thus, it seems like she wants to continue with Diageo's winning formula, which is encouraging. While it is too early to judge Debra Crew, I am encouraged by her extensive experience and her commitment to continuing the successful strategy that has been effective for Diageo recently.


I believe that Diageo has a strong brand moat. I have confidence in the management as well, despite the uncertainty that always accompanies a new CEO. Now, let us investigate the numbers to determine if Diageo meets our criteria for a strong moat. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first number I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a return on invested capital (ROIC) above 10% in all years. Diageo has consistently achieved a solid return on invested capital (ROIC) above 10% in all years except for 2020, which coincided with the peak of the pandemic. It is encouraging to see that ROIC has now reached pre-pandemic levels above 15% again. Another aspect that I appreciate is the fact that the Chairman of the Board, Javier Ferran, mentioned ROIC in his letter to shareholders. He explained that their investment philosophy may sometimes have a short-term impact on ROIC. It is very evident when looking at the Return on Equity (ROE), which I will share later in the analysis. Personally, I am very happy to see numbers like these when investing in a company.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The equity has decreased since 2018, but it isn't something I'm worried about. The decrease since 2018 is because Diageo sold 19 brands to the Sazerac Company. Besides that, we have also experienced a pandemic that has had a significant impact on equity. I'm encouraged that Diageo seems to be growing their equity year over year post-pandemic.



Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use margins to enhance clarity and improve understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. What comes to mind is that the free cash flow is positive in all years, which is always pleasing to see. Free cash flow reached record levels in 2021 and 2022 but decreased in fiscal 2023 due to the inflationary environment. Levered free cash flow margin and free cash flow yield also reached lows in 2023 due to the challenging macroeconomic environment. If macroeconomics improve, so should Diageo's free cash flow. Thus, I'm not concerned about the numbers in fiscal 2023, as I expect macroeconomics to improve at some point.



Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a 3-year period. This can be assessed by calculating the ratio of long-term debt to earnings. Doing the calculation on Diageo, I can see that Diageo has a debt-to-earnings ratio of 3,96 years, which exceeds the limit of 3 years. It is slightly higher than I would like to see, and although it is not yet alarming, it is something that needs to be monitored. The high debt affects the return on invested capital (ROIC) of Diageo. Below, you can see the Return on Equity (ROE) in the last 10 years, which will give you an idea of how debt has impacted the Return on Invested Capital (ROIC).




Like every other investment, there are risks associated with investing in Diageo. One risk is macroeconomics. Management has previously mentioned that macroeconomic factors, such as major economies facing inflation, compounding costs of living pressures, and geopolitical uncertainty, bring some short-term challenges for consumer goods companies like Diageo. It is evident when looking at the free cash flow from 2023 that it has been affected by higher input costs for Diageo. Another risk is competition. In their annual report, Diageo mentions that they are facing substantial competition from various international companies, as well as regional and local companies. They particularly mention that there has been a recent increase in competition for distribution channels, especially e-commerce channels. These trends may lead to stronger competition and could have a negative impact on Diageo's distribution network. Regulations. Diageo operates in the alcoholic beverages industry, which is a sector that is constantly exposed to potential regulations. At Diageo's risk management, they mention that "public health concerns may lead regulators in major markets to ban or restrict the marketing or sale of alcohol." If new regulations on alcohol are implemented, Diageo could potentially experience financial losses.


There is also a lot of potential for Diageo moving forward. A growing addressable market. Diageo expects that by 2032, an additional 600 million consumers will come of age to purchase their products. Furthermore, according to Diageo, the growth of the middle class and higher income bracket should enable an additional 600 million customers to purchase their brands by 2032. Finally, penetration of spirits among current customers remains low. In the United States, which is their largest market, only 50% of households purchase spirits every year. A higher penetration rate, a growing middle class, and a larger population should significantly increase Diageo's addressable market. Winning Market Shares. Diageo is growing larger than the alcoholic beverage market in both developed and emerging markets. It is due to the premiumization trend, with the highest price tiers growing more than double the overall international spirits market. Diageo has the largest premium-plus business in the international spirits industry, and this segment now accounts for over half of their net sales. Currently, Diageo holds a 4,7% market share of the global alcohol beverage industry. The management has set a goal to increase the market share to 6% by 2030. Should do fine during inflation. Diageo should perform relatively well during periods of inflation due to their strong pricing power. With its strong brand recognition, Diageo should be able to pass on extra costs to its consumers. Hence, higher costs can be passed on to the consumers, allowing Diageo to maintain their high margins and profitability.



Now it is time to calculate the price of shares in Diageo. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 2,09, which is from fiscal 2023. I have selected a projected future EPS growth rate of 13%. (Finbox estimates EPS to grow by 5,3%, but EPS has grown at 16,7% in the last 5 years). Additionally, I have chosen a projected future P/E ratio of 26, which is twice the growth rate. This decision is based on the fact that Diageo has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $45,60. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Diageo at a price of $22,80 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment (remember that the numbers are in British Pounds). The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 3.024 and capital expenditures were 1.180. I attempted to review their annual report to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 826 in our calculations. The tax provision was 970. We have 2.244 outstanding shares. Hence, the calculation will be as follows: (3.024 – 826 + 970) / 2.244 x 10 = £14,12 ($17,28) in Ten Cap price.


The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Diageo's Free Cash Flow Per Share at $1,04 and a growth rate of 13%, if you want to recoup your investment in 8 years, the Payback Time price is $14,99.


Diageo is an interesting company. They have a high moat and are winning market shares, and their addressable market seems to be growing much larger. They are facing some short-term risks in terms of macroeconomics. I believe that competition poses a long-term risk in the beer segment, as I don't see the trend of craft beer reversing. The beer segment accounts for 15% of their net sales. Nonetheless, I would love to add Diageo to my portfolio, as I believe it could be a long-term compounder that I would feel comfortable holding for many years. I don't think it will be realistic to ever buy Diageo at a 50% discount to its intrinsic value. The calculations used in this analysis are based on a challenging year for Diageo, which means they are lower than what you would pay for a high-quality company like Diageo. For instance, if we use the average EPS growth over the last 5 years of 16,7%, the margin of safety price would be $40,42, meaning that the intrinsic value would be $80,84. Hence, I would be interested in adding Diageo to the portfolio if it reaches $80, which is unfortunately significantly below the current trading price. Nonetheless, I will keep Diageo on the watchlist and continue to make new calculations when we receive updated figures. So, remember to subscribe so you can be notified when I have made new calculations.


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