Diageo (LSE: DGE) (NYSE: DEO.US) shareholders have enjoyed an average annual total return of 11.3% over the last ten years — 40% more than the FTSE 100 average of 8.1%.
Last week’s news that Diageo-controlled United Spirits has agreed to sell its Whyte & Mackay whisky business, to satisfy Office of Fair Trading concerns about the firm’s pricing power, highlights how dominant Diageo’s spirit brands have become.
Diageo shares have now fallen 14% from their 52-week high of 2,152p, and I believe that the current slowdown in the firm’s growth could continue for longer than expected. Here’s why.
1. -2%
Diageo has delivered average sales growth of 7.2% since 2008, while adjusted earnings per share have risen by an average of 10.4% per year.
However, Diageo’s growth has come to a full stop this year: sales volumes fell by 2% during the first nine months of the year, while revenues rose by just 0.3% during the same period (Diageo’s financial year ends on June 30).
Diageo bulls — including most City analysts — seem to believe this is a temporary glitch, caused by factors outside Diageo’s control, such as the Chinese corruption crackdown. Current consensus forecasts are for an 8% rise in earnings in 2014/15.
However, I reckon that many of the factors behind this year’s slowdown may persist next year, and I expect more modest growth.
2. 127%
Diageo’s 30% operating margin means that its business is strongly cash generative and should be able to afford above-average levels of debt.
That’s just as well: Diageo’s net debt has risen by an average of 5.7% per year since 2008, and has climbed by 12% so far this year, leaving the firm with gearing of 127%, which is higher than I like to see.
The explanation is simple — acquisitions have absorbed much of Diageo’s spare cash, most recently through its efforts to gain control of India’s United Spirits. This deal may yet cost another £1.1bn, if the firm’s current tender offer for 26% of United’s shares is successful.
3. 7.7%
Diageo’s dividend has grown by an average of 5% per year since 1998. The firm has ramped up dividend growth since 2011, and this year’s forecast is for a 7.7% increase to 51.1p, giving a prospective yield of 2.8%.
Any sign of slowing dividend growth would be a serious concern, in my view, as Diageo wouldn’t take such a decision lightly.