Diageo plc & Reckitt Benckiser Group Plc Prove Why They Are Core Holdings For Investors

Consumer giants Diageo (LSE: DGE) and Reckitt Benckiser (LSE: RB) are great additions to any portfolio. The two companies have proved this fact over the past few days. 

Indeed, this week Reckitt and Diageo have released first-half figures that beat City expectations. 

Diageo’s first-half numbers were released today. The company reported pre-tax profits of £2.9bn, which beat expectations and ended two years of declining profits for the group. However, organic sales fell 1% during the period. 

Nevertheless, including the contribution from United Spirits revenue increased 5% during the first half of 2015. Basic earnings per share increased 6%, and free cash flow — a crucial measure of business performance — grew by 54% to £2bn. 

Underlying figures 

Diageo’s performance during the first-half is mildly disappointing. While profits jumped, the group’s lacklustre sales growth took a shine off the results. 

That being said, it’s difficult for me to describe a company that’s growing profits and generating billions in cash as “struggling”. In fact, Diageo is preparing to embark on a growth trajectory over the next few years, and it has spent the two years preparing the foundations for growth. 

Over the past two years Diago has cut costs, streamlined its supply chain, sold off non-core assets and acquired new brands for its beverage portfolio. 

After these changes, management expects Diageo’s top line to begin expanding again during 2017. The company’s operating profit margin increased by 0.24% year on year during the first half of this year, and further margin growth is expected going forwards.  From 2017 onwards, the group is planning to unlock another £500m from cost savings to reinvest in the business. 

So, when Diageo’s sales do return to growth, the company’s earnings should charge higher as changes made over the past three years pay off. City analysts are expecting earnings growth of 7% next year. Diageo currently trades a forward P/E of 19.6 and supports a dividend yield of 3.1%. 

Boring but upbeat 

Reckitt released its first-half results at the beginning of this week, and the company surprised the City with numbers that beat even its own expectations. 

Reckitt’s net profit jumped by 10% during the first half as its three-year cost cutting programme reaped rewards. And just like Diageo, Reckitt now has a strong base from which to grow. While the group’s legacy business ticks along, management is now on the hunt for large acquisitions to complement Reckitt’s healthcare offering. 

Last year the company was outbid for Merck’s $14.2bn consumer health business, which sells items such as hayfever remedies. Still, the size of the deal with Merck Reckitt was chasing shows how aggressive the company is being. Taking on a $14.2bn deal would transform Reckitt’s product portfolio and catapult sales higher.

As Reckitt’s net debt to equity ratio is only 30%, the company certainly has room on its balance sheet to take on extra debt for acquisitions. The market seems to believe that Reckitt will strike a deal sometime soon. The company trades at a forward P/E of 25, a premium valuation that implies rapid earnings growth is just around the corner.