Diageo is in an arguably stronger market position than multinational peer SAB Miller due to its core exposure to spirits rather than beer, according to one City analyst who covers the firm.
In a lengthy note released today on the UK-based plc., Shore Capital analyst Phil Carroll compared Diageo to SAB Miller and noted the former’s “arguably stronger position” in the current market.
Carroll said Diageo had the potential to close its narrow ratings gap with the world’s second-largest brewer, and become a 20x price to earnings ratio (PER) stock (the company delivers 18.4x today).
“This is because its core exposure is to spirits rather than beer. Therefore, it should be more resilient to a rise in unemployment, should it become an issue in developed countries again,” Carroll said.
“We also believe that the spirits category, which Diageo has many leading international brands in, is well positioned for growth, as it is widely expected to continue to take share from beer in the total beverage alcohol market.”
Sweet spirits category
Carroll attributed this to, firstly, demographic changes driving demand for sweeter-tasting products: for instance, the growing Latin American and Afro-Caribbean population in the US.
Secondly, there had been greater innovation in spirits in recent years, Carroll said, coupled with poor innovation in beer, despite some recent signs of improvement.
Lastly, spirits – top Diageo brands include Johnnie Walker, Crown Royal, J&B, Smirnoff, Captain Morgan – offered greater brand strength and were more aspirational, the analyst added.
Greater emerging market exposure (now circa. 42% of group sales) that would rise 4-5% if Diageo secured its majority holding in United Spirits was another big positive, Carroll said.
“An additional point we would highlight is that Diageo has reached critical mass in many of its emerging markets and is now making real returns from those markets, rather than just laying down infrastructure for the future,” the analyst said.
“This is particularly evident in Latin America and Africa, where the profit margin profiles in these divisions are very healthy.”
Despite Diageo’s strong share performance – which compared well with its peers – Carroll said that Shore Capital believed its stock had further upside potential.
“If anything, we believe the premium valuation of SAB Miller suggests that rating expansion for Diageo remains a possibility,” he wrote.
Structural growth potential
Assuming CCL approval for Diageo’s United Spirits stake purchase, Carroll said the deal should boost its stock rating, upon the basis of market reaction to Heineken’s takeover of Asia Pacific Breweries and SAB Miller’s Kingway Brewery Holdings purchase in China.
Reaffirming Shore Capital’s ‘buy’ recommendation for Diageo, Carroll said that the company’s capital returns were robust – driven by efficient growth and solid margin expansion.
“Diageo also has a portfolio of leading brands operating in a market where there is structural growth, both from a consumer perspective and market perspective,” he said.
Carroll added: “Finally, it has significant and growing emerging markets exposure with balance sheet flexibility to accelerate its strategy going forward.”