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Diageo Gains on Innovation, Expansion Efforts: Can It Sustain?

Zacks Equity Research

Diageo plc DEO stock has been resilient in a tough industry, courtesy of strong fundamentals, continuous innovation and focus on expansion. The company remains focused on expanding the fastest-growing premium spirits brands by resource optimization, which should drive growth and boost shareholder value.

These actions largely fueled its results in recent years. The company reported strong results in fiscal 2019, wherein sales and earnings improved year over year. Earnings gained from strong organic operating profit growth, lower finance charges, positive impact of share buybacks and favorable currency. Meanwhile, the top-line improvement was backed by solid organic growth, benefiting from broad-based sales gains across all regions and categories.

Backed by favorable trends and ongoing plans, shares of the London-based company have advanced 22.8% in the past year compared with the industry’s growth of 5.7%.

 



Let’s delve deeper and find out reasons behind the Zacks Rank #3 (Hold) stock’s outperformance.

Factors Aiding Stock Growth

Diageo continuously explores opportunities to expand geographically through acquisitions to further strengthen its exposure in the fast-growing categories. In sync with this strategy, the company increased its shareholding in Shui Jing Fang from 40% to just over 63% in fiscal 2019. This enhanced its presence in the premium Baijiu segment. Further, the company acquired the fastest-growing premium tequila brand in the United States, Casamigos, in August 2017, which boosted its market share in the tequila category.

Further, the company enhanced its portfolio with the acquisition of 26% stake in India’s leading brewer, United Spirits Limited (in July 2014) and the premium brand, De Leon Comb Wine & Spirits (in fiscal 2014). Additionally, Diageo’s distribution deal with Minnesota-based broker, United Brokerage, Inc., in 2013 solidifies its position in traditional markets.

Meanwhile, the company has been divesting assets to enhance its portfolio — including the recent divestiture of 19 brands to Sazerac. This divestiture will enable Diageo to focus on the premium and above-premium brands, with stronger growth and profit opportunities.

Concurrently, the company, like most other multinationals, is turning its attention to the emerging markets. It is the leading international spirits company in the emerging markets of Africa, Latin America and Asia. Moreover, Diageo caters to the local tastes of the regions. Its products like Johnnie Walker Blue Label bottle, which was designed through a series of exclusive private tasting in China, India, Thailand, Vietnam, Brazil and Mexico with local cultural relevance, testify this strategy.

Moreover, the acquisition of United Spirits extended its reach to one of the most populous countries, with growing middle-class population and beer consumption trends. With the opening of the first Johnnie Walker House in Seoul in October 2013, Diageo was able to boost sales in Korea.

We believe the company’s expansion and innovation efforts along with robust organic growth trend instill confidence in reaching its medium-term targets. Notably, its organic operating margin expanded 83 basis points (bps) in fiscal 2019, marking a 198-bps organic operating margin expansion over the last three years. This expansion was above the company’s long-term organic operating margin guidance of 175-bps improvement from fiscal 2017 through 2019.

Backed by the better-than-expected performance over the last three years, Diageo reiterated its medium-term guidance for the period between fiscal 2020 and 2022, which was announced in May 2019. The company continues to expect organic net sales growth in a mid-single digit between fiscal 2020 and 2022. Further, it expects to sustainably grow organic operating profit by 5-7%, suggesting growth of about 1% ahead of net sales.

Wrapping Up

Though the aforementioned factors keep us optimistic about the stock’s potential, there remain some hurdles in its growth path. The most prominent among these is the persistent pressure from cost inflation and higher marketing expenses.

Marketing spends increased 8% in fiscal 2019, reflecting a 22-bps rise as a percentage of sales. This resulted from increased marketing investment in all regions, with the largest investments in US Spirits. Notably, the company’s overall rate of marketing investments over the past two years has risen nearly 50 bps, owing to increased investments in marketing and new technology to build a sustainable growth platform.

Moreover, it expects an increase in marketing investment rate in fiscal 2020, focused on sustaining gains witnessed in the US Spirits segment through investments in new brands.

Additionally, while Diageo reiterated its medium-term view, it expects a slowdown in sales growth in fiscal 2020, owing to the lapping of several successful innovation launches in fiscal 2019. For fiscal 2020, the company anticipates net sales growth at the mid-point of 4-6%, whereas it recorded 5.8% gain in fiscal 2019.

Nonetheless, we believe that there is momentum left in the stock of this leading alcohol company as it has a long-term impressive earnings growth rate of 8.1% and a Growth Score of A.

3 Better-Ranked Beverage Stocks

Carlsberg AS CABGY has a long-term earnings growth rate of 5%. It currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Boston Beer Company, Inc. SAM presently has an expected long-term earnings growth rate of 10% and a Zacks Rank #2.

The Coca-Cola Company KO has an expected long-term earnings growth rate of 6.8% and a Zacks Rank #2 at present.

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