Diageo Plc DEO has been benefiting from its diversified footprint, advantaged portfolio, strong brands and favorable industry trends of premiumization. The company has been witnessing a solid business momentum, strong consumer demand and market share gains, which have been boosting its performance. Effective marketing and exceptional commercial execution bode well.
Robust sales growth, organic operating margin expansion, productivity savings and favorable currency impact aided Diageo’s fiscal 2023 results. The price/mix gained from a positive mix due to robust growth in super-premium-plus brands, particularly scotch, tequila and beer.
The Zacks Consensus Estimate for DEO’s fiscal 2024 sales and earnings suggests growth of 9.9% and 1.2%, respectively, from the year-ago period’s reported numbers.
However, continued inflationary pressures from increased glass, paper, metal, and transportation costs have been headwinds. Also, currency headwinds are concerning.
Shares of the Zacks Rank #3 (Hold) company have lost 4.1% in the past year against the industry’s growth of 2.8%.
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What Keeps Diageo Strong?
DEO is anticipated to retain the strength in its business through constant premiumization efforts, recovery across markets, pricing actions and supply productivity savings. The company’s premium-plus brands contributed 63% to reported sales growth and 57% to total organic sales growth for fiscal 2023.
Diageo is confident about the long-term growth potential of the beverage alcohol sector. It expects to expand its value share by 50% in the sector to 6% by 2030. DEO is on track to deliver on its medium-term guidance for fiscal 2023-2025 of 5-7% organic sales growth and 6-9% organic operating profit growth. Diageo expects to invest strongly in marketing and innovation, and leverage its revenue growth management capabilities, including strategic pricing actions.
Although the company predicts a challenging operating environment for fiscal 2024, it predicts a gradual improvement in year-over-year comparisons in the second half of fiscal 2024. The company expects net sales to improve in the first half of fiscal 2024 from the second half of fiscal 2023. It also expects accelerated sales growth in the second half of fiscal 2024 due to easy comparisons from fiscal 2023.
DEO is well-poised for growth from effective marketing and extraordinary commercial execution. It is likely to invest strongly in marketing and innovation, and leverage its revenue growth management capabilities, including strategic pricing actions. This is likely to support DEO in the near and long terms.
DEO’s margin trends were favorable in fiscal 2023, thanks to its premiumization efforts, recovery in markets, pricing actions and supply productivity savings, which mostly offset the cost inflation. Organic operating profit benefited from strong sales growth, revenue management initiatives, disciplined cost management and productivity savings. Productivity initiatives delivered £450 million of cost savings in fiscal 2023. Gains from price increases more than offset the impacts of cost inflation on the gross margin.
The company expects the operating margin in fiscal 2024 to benefit from a moderating inflationary environment and continued focus on revenue management initiatives, including improved pricing. Moreover, the organic operating margin is likely to benefit from premiumization trends and operating leverage with strong marketing investments.
Our model predicts a 5% rise in operating profit in the first half of fiscal 2024, with 7% growth in fiscal 2024. The operating margin is estimated to expand 50 basis points (bps) in the first half and 100 bps in fiscal 2024.
Hurdles to Overcome
Diageo suffers from persistent inflationary pressures from higher commodity costs, particularly agave, energy expenses and supply disruptions. The company’s organic gross margin declined 97 bps in fiscal 2023 mainly due to the cost pressures.
Price increases and supply productivity savings more than offset the absolute impact of cost inflation. The significant cost pressure in fiscal 2023 mainly came from increased glass, paper, metal and transportation costs. Additionally, the gross margin was impacted by lower beer volumes in Africa.
DEO expects to continue its revenue management initiatives, including pricing actions, throughout fiscal 2024 to overcome the challenging inflationary environment. In fiscal 2024, the company expects cost inflation pressure to persist and is committed to investing in its brands to deliver sustainable growth.
We expect its cost of sales to increase 1.5% in the first half of fiscal 2024, owing to continued cost inflation. Our model estimates marketing investments to increase 4% year over year in the first half of fiscal 2024, with a 20-bps increase as a percentage of sales.
As a substantial portion of the company’s business comes from international operations, exchange rate fluctuations have been hampering its sales for a while.
Stocks to Consider
We have highlighted three better-ranked stocks from the Consumer Staple sector, namely Fomento Economico Mexicano FMX, Ambev ABEV and PepsiCo Inc. PEP.
Fomento Economico Mexicano, alias FEMSA, currently sports a Zacks Rank #1 (Strong Buy). The company has an expected EPS growth rate of 22.4% for three to five years. Shares of FMX have rallied 89.3% in the past year. You can see the complete list of today's Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for FEMSA’s current financial year’s sales and earnings per share suggests growth of 31.9% and 58.3%, respectively, from the year-ago period’s reported figures. FMX has a trailing four-quarter earnings surprise of 6.1%, on average.
Ambev has a trailing four-quarter earnings surprise of 20.8%, on average. It currently carries a Zacks Rank #2 (Buy). Shares of ABEV have gained 6.4% in the year-to-date period.
The Zacks Consensus Estimate for Ambev’s current financial-year sales suggests growth of 4.5% from the year-ago period's reported figure. Meanwhile, the consensus estimate for earnings indicates a decline of 5.6% from the year-ago quarter’s reported figure. ABEV has an expected EPS growth rate of 7% for three to five years.
PepsiCo has a trailing four-quarter earnings surprise of 6.3%, on average. It currently carries a Zacks Rank #2. Shares of PEP have gained 5.1% in the past year.
The Zacks Consensus Estimate for PepsiCo’s current financial-year sales and earnings suggests growth of 6.7% and 10.2%, respectively, from the year-ago period's reported figures. PEP has an expected EPS growth rate of 8.1% for three to five years.
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