Why We Increased Our Stock Price Estimate For Diageo By 10 Percent

May 29th, 2019 by Trefis Team
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Trefis has increased the stock price estimate for Diageo (NYSE: DEO) by 10% to $170 per share on the back of improving fundamentals, strong revenue growth, and increasing shareholder returns. DEO remains a long-term favorite in the alcoholic beverages industry due to its consistently high margins, dominant market position, excellent cash conversion ratio, rising revenues across all its major segments, robust portfolio of top brands, and management’s focus on enhancing shareholder returns through steadily increasing dividends and share buybacks.

We have summarized our expectations for Diageo’s financial performance over the next two years in our interactive dashboard – What makes Diageo attractive for investors? In addition, here is more Consumer Staples data.

Revenue Growth Across All Segments

  • North America: This continues to be the largest market for Diageo with revenues rising in 2018 after being flat in 2017. Future revenue growth is expected to be driven by an increase in the share of scotch and growth in both Diageo Beer Company USA (DBC USA) and Canada.
  • Europe: Revenue growth would be driven by strong performance in Turkey, Great Britain, Ireland, and Continental Europe. Gin is expected to be the best performing product, with Tanqueray gaining share in the fastest growing category and Gordon’s benefiting from the launch of its Pink variant.
  • Africa: In the recent past growth has been sluggish due to the impact of the uncertainty following the presidential election in Kenya. Future growth would be led by rising beer sales with strong growth of Dubic in Nigeria and the successful launch of Serengeti Lite in Tanzania.
  • Latin America: Revenue growth to be driven by strong performances in Mexico, PUB, and PEBAC. Additionally, scotch, gin, and Smirnoff continue to gain market share in the region.
  • APAC (Asia-Pacific): Sales were lower in 2016 and 2017 due to regulatory uncertainty in India and lower sales in Korea. However, favorable regulatory ruling from courts in India related to alcohol sales in proximity to highways has come as a breather for Diageo. APAC would be the fastest growing region for the company in the near term. APAC revenue growth is expected to be led by India and China as beer sales along with higher scotch demand would be the main growth drivers.
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Increasing Profitability and Strong Cash Conversion

  • Margins have been rising due to benefits from the company’s ongoing productivity program. FY 2018 also saw a  reduction in tax expense due to the Tax Cuts and Jobs Act.
  • Going forward we expect margins to continue the upward trend driven by lower marketing expenditure and with DEO’s premium brands increasing their market share.
  • FY 2019 is expected to witness 60 basis points of organic operating profit improvement based solely on productivity gains.
  • Diageo has consistently been able to record strong free cash flow over the years.
  • Its cash conversion ratio, which has consistently exceeded 60% over the recent years in spite of heavy share buy backs, is one of the best in the industry. We expect Diageo to maintain its excellent conversion rate in the near term.

Source: Diageo’s Investor Presentation

Increasing Shareholder Returns

  • EPS is expected to continue to increase driven by higher profitability and margins, further boosted with expectation of lower share count as the company has undertaken an aggressive share-repurchase program with an aim to return 3 billion pounds to shareholders in FY 2019.
  • Along with share buy-backs, DEO has consistently increased its dividends, with the dividend per share steadily rising over recent years and we expect the trend to continue in the near term.
  • Due to management’s consistent focus on enhancing returns, DEO continues to remain one of investors’ long term favorites in the industry.

Stock Performance

Diageo has the ability to outperform the larger index, as DEO has been able to beat the S&P 500 index’s annual return in thirteen of the last twenty years. The company’s stock has also been able to outperform its competitor Anheuser-Busch InBev in the last three years. Diageo is expected to maintain its uptrend for revenues, margins, and profitability, along with a strong competitive edge vis-à-vis its peers due to its dominant market position, which would likely provide an upside to the company’s stock over the long term.

Trefis has a stock price estimate of $170 per share for Diageo’s stock, based on expected EPS of $7.08 in 2019 and a forward P/E multiple of 24x.

 

 

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