Diageo Expects Return to Sales Growth After Two-Year Slump
Comment of the Day

July 31 2015

Commentary by Eoin Treacy

Diageo Expects Return to Sales Growth After Two-Year Slump

This article by Thomas Buckley for Bloomberg may be of interest to subscribers. Here is a section:

The outlook reflects the prospect of stronger growth in selling volumes in the 12 months through June 2016, Chief Executive Officer Ivan Menezes said in a statement Thursday. He forecast “mid-single-digit” organic sales growth in the following financial years and a 1 percentage-point improvement in the operating margin within three years.

The guidance is “conservative and undemanding,” said Eddy Hargreaves, an analyst at Canaccord Genuity in London. “It’s below what we already have in our model and it’s a positive that they have reinstated guidance.”

As he starts his third year as CEO, Menezes has tried to gain more control over his sprawling liquor empire and restore sales growth after a two-year slump. He’s bought out India’s United Spirits Ltd., taken full ownership of Don Julio tequila and dissolved a South African joint venture. Diageo is also shifting to a model focused on purchases by consumers, rather than the amount of bottles it ships to distributors.

Eoin Treacy's view

Premium distillers such as Diageo trended higher in 2010 and 2011 as Chinese demand surged not least on the back of Communist Party cadre largesse. They have subsequently had a more difficult time repeating those growth figures following Xi Jinping’s anti-corruption drive, contraction of the European economy and stagnant North American sales. Diageo is betting that India and Africa will represent its primary growth engines in future but it will take time to generate results large enough to move the needle in terms of earnings growth. 

The share (Est P/E 19.04, DY 3.5%) has been ranging mostly below 2000p for more than two years and has pulled back from that area again over the last couple of weeks. A sustained move above that level will be required to signal a return to dominance beyond potential for some steadying above 1700p. 

Today’s news that Merck’s Ebola vaccine is effective is great news for companies hoping to benefit from the rise of an African middle class. HIV/AIDS, malaria and, more recently, Ebola represent major headwinds to development potential. Any progress on these fronts improves the chances Africa’s burgeoning population may be able to reach its productive potential. 

Merck (Est P/E 16.96, DY 3.05%) has been ranging mostly below $60 since early 2014 and firmed this week from the lower boundary. A sustained move above that level would confirm a return to demand dominance.


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