What Will Drive Diageo’s Valuation?

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Diageo

Diageo (NYSE:DEO) reported organic sales growth of 4.2% in the first half of FY 2018 (six months ended December 2017), beating consensus estimates of a 3.7% rise, stirred on by volume growth and a strong price mix, with broad-based growth across categories and regions, particularly of baiju white spirits in China. The company was also able to deliver 81 basis points of organic operating margin expansion, again ahead of expectations, as a result of the productivity work undertaken. These factors, together with lower finance charges, helped in the rise of pre-exceptional EPS by 9.4%. However, the pound, which had been weak since the 2016 Brexit vote — helping provide a boost to British companies that derived a big chunk of their sales from the US, including Diageo — has been resurgent of late, which has, in turn, dampened the earnings. The adverse exchange rate had a negative impact on sales by £134 million, and on operating profit by £15 million. For the full financial year, the company expects a hit of £460 million to its sales and £60 million to the operating profit. On the other hand, the company received a one-time tax benefit of £360 million from the tax cuts implemented by the Trump administration. The impressive sales growth is expected to continue through its financial year, leading us to have a price estimate of $159 for Diageo, higher than the current market price.

We have also created an interactive dashboard which shows the forecast trends; you can modify the key value drivers to see how they impact the company’s revenues, bottom-line, and valuation.

Higher volumes of premium and standard brands would make the price mix favorable for Diageo, driving growth in North America Revenue Per Unit. Diageo also leads the U.S. spirits market, with the company’s strong brand positioning mainly a result of its dominance in the vodka and whiskey category, as well as growing market share in rum. These factors would result in higher North American revenues.

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Diageo’s premium and ultra-premium brands have been well positioned in Europe for a long time. Higher sales of premium brands should ensure continued growth in the region.

The scope for growth in the beer market is enormous in the African continent, as long as the companies are able to persuade the consumers to drink more beer. While Africans drink nine liters of beer per head per year, the global average is 45. With an increase in disposable incomes, the rate of beer consumption is set to grow significantly. Africa also displays significant potential because of the rate at which it is developing, as well as the increasing levels of urbanization.

We expect the demographic landscape in Latin America to prove advantageous for the sale of premium lager with younger individuals developing more sophisticated tastes. Moreover, an increasing popularity of premium and standard brands in Paraguay, Uruguay, Brazil, and Western Latin America could help drive volume growth.

The stellar performance of Chinese White Spirits is expected to continue going forward. Moreover, India is considered a key growth market by the company, and the company’s strategy in the country is to grow its Prestige and above brands, which should result not only in higher revenues, but also improving margins.

The aforementioned factor should result in a 5% growth in revenues for FY 2018 (year ended June 2018). Meanwhile, higher sales of premium products, as well as the implementation of cost saving initiatives, should drive margin expansion, resulting in a 6% growth in EBITDA.

We have used a P/E ratio of 26 for our valuation estimate, but you can modify the multiple in order to come up with your own valuation estimate for the company.

See Our Complete Analysis For Diageo Here

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