Une analyse en profondeur de Diageo – Diageo plc (NYSE: DEO)


Source de l'image: Images commerciales gratuites de Freerangestock

Veuillez sauter l’introduction suivante si vous avez lu mes articles précédents. Veuillez également noter qu'il s'agit d'un article très long et détaillé couvrant beaucoup de terrain: vous avez été averti.

introduction

"Il est de loin préférable d’acheter une entreprise merveilleuse à un prix équitable plutôt qu’une entreprise équitable à un prix exceptionnel. "

"Qu'il s'agisse de chaussettes ou de chaussures, j'aime acheter des produits de qualité lorsqu'ils sont démarqués. "

– Warren Buffett

Qu'est-ce qu'une entreprise formidable et qu'est-ce qu'une "marchandise de qualité" du point de vue de l'investissement? La définition la plus constructive pour répondre à cette question est le concept de "fossé économique" de Warren Buffett, un avantage concurrentiel durable qui permet à une entreprise donnée de générer des rendements supérieurs à la moyenne de son capital, même face à des ralentissements économiques ou à des concurrents puissants.

Une stratégie d'investissement de qualité devrait donc refléter la nature fondamentale de la philosophie de Buffett. L’objectif est ici d’identifier des actions de haute qualité, appelées «sociétés de financement», négociées à des prix raisonnables en calculant un niveau de qualité simple, basé sur 12 facteurs fondamentaux liés aux activités réelles et à leurs caractéristiques économiques intrinsèques. Ce sont (probablement) les facteurs qualitatifs et quantitatifs qui capturent le mieux la «dimension qualité» insaisissable d’une entreprise donnée, du moins d’après Buffett et d’autres investisseurs dans ces entreprises renommées telles que Charlie Munger, Chuck Akre et Joel. Greenblatt. L’intention n’est pas de discuter des résultats trimestriels fugaces (loin de là), mais plutôt de trouver et d’analyser des entreprises et des modèles commerciaux de qualité supérieure capables de cumuler de la valeur pour de nombreuses années à venir. Pour calculer le niveau de qualité, nous tenterons de répondre aux questions portant sur les aspects suivants:

1) Présence d’avantages concurrentiels forts et durables; 2) dynamique de marché favorable et positionnement relatif; 3) présence de générateurs de trésorerie multiples et complémentaires; 4) la résilience à la perturbation technologique et à l'obsolescence; 5) présence de leadership sur le marché; 6) présence d'un pouvoir de fixation des prix; 7) la présence de rendements en espèces élevés et persistants sur le capital investi; 8) forte capacité de génération de trésorerie; 9) présence d'une rentabilité brute supérieure; 10) présence d'une croissance supérieure des revenus, accompagnée d'une accélération des ventes; 11) Présence de politiques de gestion des risques solides; 12) Situation financière solide, peu endettée.

Pour calculer le niveau de qualité, un (1) point est attribué lorsque la réponse est fondamentalement positive ("Oui"); moins un (-1) point est soustrait lorsque la réponse est essentiellement négative ("Non"); aucun point n'est ajouté ou soustrait (0) lorsqu'il y a trop d'incertitude ou lorsque des facteurs négatifs et positifs sont essentiellement à l'équilibre. Les «entreprises de haute qualité» sont celles dont le niveau de qualité est égal ou supérieur à «6». Calculons ensuite le niveau de qualité de Diageo plc ().

1. Diageo présente-t-il des avantages concurrentiels solides et durables par rapport à ses concurrents? Oui: 1 point

Le whisky n'est pas simplement le résultat de la distillation de la purée de grains fermentée. C'est aussi une synthèse des saveurs, des traditions, des origines, des talents, des perceptions, de la réputation, des traits culturels et des facteurs chronologiques. Ensemble, tous ces éléments définissent un certain whisky – ou «whisky» – et une certaine marque. La même chose se produit avec pratiquement toutes les autres marques traditionnelles de gin, rhum, vin, bière, vodka, brandy, cognac ou tequila.

En conséquence, dans ce secteur spécifique, la création d’une marque dominante bénéficiant d’une visibilité mondiale requiert maîtrise, efforts continus, légitimité collective et des durées prolongées (souvent mesurées en siècles). Et, sans aucun doute, la société qui détient maintenant le portefeuille le plus vaste et le plus illustre de ces marques est Diageo, qui est elle-même un mélange d'autres sociétés. Bien qu’elle soit relativement jeune – elle est née en 1997 – nombre de ses marques existent depuis des centaines d’années.

Les avantages compétitifs de Diageo | Héritage de marques fortes avec un appel mondial

Comme il a exercé une telle influence sur la position concurrentielle actuelle de la société, le parcours qui a abouti à la création de Diageo ne peut être dissocié de l’histoire de la manière dont le whisky est devenu l’esprit le plus populaire au monde.

Créé par les peuples d'Irlande et d'Écosse, le whisky était une boisson alcoolisée dont la consommation était essentiellement confinée aux îles Britanniques jusqu'aux premières décennies du 19th siècle; bien que de manière plus limitée, il a également été consommé au Canada et aux États-Unis, qui avaient mis au point leurs versions particulières. Puis dans le 19th siècle, plusieurs facteurs ont contribué à faire du whisky une boisson alcoolisée acceptée et appréciée dans le monde entier.

Tout d’abord (et à la recherche d’une noble cause pour tout Irlandais), un inventeur irlandais perspicace nommé Aeneas Coffey a conçu la colonne encore en 1830, qui était une nouvelle technologie plus efficace qui permettait une distillation continue et une production d’alcool beaucoup plus importante.

En plus de mettre de côté la distillation discontinue, l’invention de Coffey a également permis de produire des distillats plus légers et plus agréables au goût que les alambics traditionnels, ce qui a permis d’attirer l’attrait de la boisson sur un marché plus vaste.

Auparavant une industrie artisanale, la production de whisky a explosé par la suite grâce à un contexte fiscal favorable et à la nouvelle technologie. Ceci a marqué à son tour l’ascension des grandes distilleries et des maisons de mélange comme Cardhu, Buchanan et Walker, parmi beaucoup d’autres encore en activité.

Contraintes à la croissance dans les îles britanniques, ces maisons ont été contraintes de porter leur attention sur des rivages plus éloignés. Et leurs objectifs d'expansion étaient réellement réalisables car, contrairement à la bière et au vin, le whisky se déplaçait bien par voie maritime sur de très longues distances.

Heureusement pour eux, ce fut l'époque où la reine Victoria (1819-1901) régna sur une société relativement stable »Empire où le soleil ne se couche jamais”. Pour les producteurs, le marché le plus vaste qui ait jamais existé était à leur portée et, de fait, les vastes voies de navigation et les vastes possessions de l’immense empire britannique étaient deux des principaux facteurs à l’origine de la montée en puissance de la boisson dans le monde. Cela, et aussi un insecte suceur de sève appelé Phylloxera, qui a anéanti la vigne française au cours des dernières décennies du 19th siècle.

La pénurie prolongée de raisins causée par ce ravageur virulent a complètement perturbé la production des eaux-de-vie françaises et en particulier de la production de cognac. Jusque-là l'esprit de choix de l'élite aristocratique, ces eaux-de-vie ont été progressivement remplacées par le whisky sur la plupart des marchés internationaux. À noter: le phylloxéra a été introduit en France lorsque des botanistes de la Grande-Bretagne victorienne, toujours trop enthousiastes, ont importé des spécimens infectés de vignes nord-américaines sur le continent européen…

Et c’est ainsi que le whisky – et en particulier le whisky écossais – a également acquis son statut d’aspirateur parmi les masses dirigées vivant sous la Pax Britannica. Renforcé par l’amélioration des normes de qualité et par un marketing intelligent, le «whisky» est enfin devenu la catégorie de référence pour toutes les autres catégories de spiritueux; involontairement, les efforts de commercialisation des producteurs ont été facilités par une certaine mystique associée à la splendide Écosse, à sa culture et à ses paysages *.

* Toujours aussi forte aujourd'hui, cette mystique romantique s'est nourrie à la fois de 19th chefs-d'œuvre du siècle, comme The Bride of Lammermoor, de l'écrivain génial Sir Walter Scott et de la prédilection de la reine Victoria pour les Highlands et ses habitants (Victoria était l'une des souveraines les plus populaires et les plus influentes qui ait jamais existé, et elle était également un buveur notoire du whisky) .

D'anciens territoires britanniques, tels que l'Inde, l'Australie, Singapour, l'Afrique du Sud et la Nouvelle-Zélande, comptent encore aujourd'hui parmi les plus grands marchés de whisky par habitant. Marché colossal, l’Inde consomme à présent près de la moitié de l’ensemble du whisky produit dans le monde; La France, cependant, occupe la première place mondiale en matière de consommation de whisky par habitant, ce qui est curieux pour le seul pays producteur de cognac qui soit.

Cependant, comme il provient d'une très petite région entourant la Charente dans le sud-ouest de la France, la production de cognac a souvent été confrontée à des contraintes de capacité tout au long de sa noble histoire. De telles situations sont presque idéales pour maintenir le pouvoir de fixation des prix mais sont loin d’être idéales lorsque l’objectif est d’accroître les volumes.

Le whisky, bien que moins sévèrement que le cognac, a également été confronté à ses propres contraintes de capacité, à une industrie fragmentée et à des prix des produits de base très volatils (ainsi qu'à des problèmes de surapprovisionnement occasionnel). Pour contrer ces problèmes chroniques, un grand cartel commercial fut formé dès 1877 par certaines des maisons principales: nommé Distillers Company Ltd. (DCL), ce conglomérat influencerait le secteur pendant de nombreuses décennies sans jamais détenir un monopole total sur le marché. production de whisky.

DCL exerçait une certaine influence, mais elle était également plutôt dysfonctionnelle: bien que les maisons fassent partie du même conglomérat, elles étaient toujours gérées par des propriétaires qui considéraient toujours les collègues administrateurs de DCL comme leur principal concurrent. Pour aggraver les choses, DCL exploitait également une entreprise pharmaceutique qui a par la suite été impliquée dans le scandale au début des années 1960.

En raison de l'attrition constante, de la confusion et de la mauvaise gestion au sein de DCL, les ventes de ses whiskies ont fortement diminué au cours des années 1970 et 1980. Argyll Foods – maintenant Safeway UK – a découvert une opportunité de prendre le contrôle d’une entreprise précieuse mais en dérive, puis a lancé une offre hostile sur le DCL malade. Effrayé par ce coup du tonnerre, DCL a alors fait appel au brasseur irlandais Guinness PLC pour qu’il serve de «chevalier blanc». Guinness a fait une offre concurrente, d'accord, mais ce chevalier n'était pas à la hauteur des normes de la chevalerie victorienne.

Dirigé par Ernest Saunders et par trois autres associés, Guinness a frauduleusement financé sa contre-proposition en manipulant le cours de ses propres actions. L'offre incluait également une promesse que la nouvelle entité fusionnée aurait son siège mondial à Édimbourg, comme l'exigent à juste titre les intérêts écossais. Cependant, après avoir remporté le combat pour DCL, cette promesse fut rapidement oubliée par Guinness; de son côté, Saunders a par la suite été inculpé, condamné à une amende et incarcéré (mais n'a été libéré que 10 mois plus tard, car il était supposé être atteint de la maladie d'Alzheimer. Après sa libération, il avait récupéré de façon miraculeuse).

Après une série d'initiatives de réduction des coûts et de prises de contrôle, Guinness et DCL ont finalement fusionné avec Grand Metropolitan pour former Diageo, basé à Londres. Qu'est-ce qui a résulté de ce gâchis? Une société qui a hérité d’une position concurrentielle véritablement exceptionnelle sur des marchés vastes et en croissance, d’un réseau de distribution massif et bien établi et d’un portefeuille enviable de marques de premier plan. Après plusieurs acquisitions, Diageo a pris possession de deux des cinq plus grandes marques de spiritueux de qualité supérieure au monde et de 22 des 100 plus grandes marques de spiritueux de qualité supérieure dans le monde.

En particulier, la société contrôle certaines des marques de vodka les plus puissantes au monde (Cîroc, Smirnoff et Ketel One), de gin (Gordon's et Tanqueray), de whisky (J & B et Crown Royal), de rhum (Captain Morgan), de tequila (Don Julio), liqueur (Baileys) et bière brune (Guinness). En partenariat avec LVMH (), Diageo contrôle également 37% de Moët Hennessy, propriétaire de Hennessy (la marque de cognac la plus vendue), ainsi que de Veuve Clicquot et de Moët & Chandon, qui sont les marques les plus vendues de champagne premium. Johnnie Walker demeure toutefois le joyau de la couronne grâce à ses multiples «étiquettes».

Le whisky écossais mélangé le plus répandu sur Terre, cette marque a été fabriquée à Kilmarnock par John Walker et son fils Alec entre 1820 et 1865. Les compétences extraordinaires du père en matière de mélange ont permis d'obtenir un whisky de grande qualité, plus léger et plus lisse, le rendre commercialisable à un public beaucoup plus large; De son côté, Alec a créé la bouteille carrée et l'étiquette inclinée typiques de la marque, qui permettaient d'installer davantage de bouteilles dans le même espace et offraient une meilleure visibilité à une distance plus grande, respectivement.

Cette conjonction de facteurs a produit une marque de whisky archétypale et a transformé le Striding Man de Johnnie Walker en une des représentations les plus emblématiques de la boisson écossaise. Selon le classement Spirits 50 (2018) de Brand Finance, Johnnie Walker est désormais la quatrième marque de spiritueux la plus précieuse au monde après une triade de baijius dirigée par Moutai *. Cependant, la consommation de baijiu est largement limitée au marché chinois, alors que Johnnie Walker est vendu dans plus de 180 pays à travers le monde.

*Le principal esprit national de la Chine, c'est une boisson à base de céréales brûlante qui a poussé Henry Kissinger à dire à Deng Xiaoping que «si nous buvons assez de Moutai, nous pourrons résoudre n'importe quoi»: une quantité abondante de Moutai peut-elle être la clé pour résoudre les problèmes commerciaux entre Trump et les administrations chinoises?

Malgré son omniprésence, Johnnie Walker a été confronté à des vents contraires. Par exemple, la reprise de la consommation de bourbon sur le grand marché américain a eu un impact négatif sur les ventes de scotch et a permis à Brown-Forman’s () Jack Daniel’s d’augmenter considérablement la valeur de la marque.

De plus, après la répression du président Xi Jinping contre la corruption, les réductions de la consommation ostentatoire en Chine ont entraîné une baisse significative des ventes de whisky de qualité supérieure depuis 2013. Malgré cela, Johnnie Walker conserve toujours sa réputation de marque de whisky de la plus grande valeur le monde, qui témoigne de sa puissance et de son patrimoine exceptionnel. Au total, et compte tenu de la stabilité de ses marques, il serait très difficile de déloger le positionnement enviable de Diageo dans les plus grandes catégories de spiritueux.

Les avantages compétitifs de Diageo | Accès privilégié à des ressources rares

Dans le monde entier, la production de boissons distillées repose sur certains produits de base pouvant être cultivés localement – comme le sorgho ou Ugni Blanc raisins – et qui sont adaptés aux conditions de sol et climatiques spécifiques d’un lieu. Les méthodes de distillation varient également selon les influences culturelles et les connaissances accumulées au fil de nombreuses générations.

Ensemble, ces facteurs ont donné naissance aux produits dits "à appellation d'origine protégée", qui constituent des cadres juridiques et des accords commerciaux distincts destinés à protéger la réputation, les normes de qualité et les racines culturelles d'un produit, par exemple pour être commercialisés tels quels. , Le «whiskey du Tennessee» ne peut être fabriqué que dans l'État homonyme et la «tequila» mexicaine ne peut être produite qu'avec le Weber Blue variété d'agave. L’accès à ces ressources rares est donc limité par des contraintes juridiques et géographiques, ce qui est directement acquis à une entreprise dominante comme Diageo.

Directement ou indirectement, parmi ses pairs, la société basée au Royaume-Uni contrôle maintenant le plus grand nombre d'actifs portant des appellations d'origine protégées, tels que des distilleries écossaises ou des plantations d'agave bleu; La société entretient également des relations privilégiées avec les producteurs, les agriculteurs et les cueilleurs de diverses régions géographiques, comme par exemple les associations de Diageo avec les cueilleurs qui récoltent des baies de genièvre sauvages en Toscane, en Italie. Sans ces actifs corporels et incorporels, Diageo ne serait pas en mesure de produire du gin de qualité supérieure tel que le Tanqueray Nº Ten ou un whisky écossais de qualité supérieure comme Talisker.

En examinant simplement le bilan de la société, il est possible de vérifier que les immobilisations corporelles nettes de Diageo sont évaluées à environ 5300 millions USD, un chiffre qui dépasse de loin les immobilisations corporelles de Pernod Ricard et de Brown-Forman à 2740 millions et 780 millions, respectivement). Même un concurrent aussi important que Pernod Ricard () ne peut rivaliser avec la profusion de distilleries et d'installations de stockage et de production appartenant à Diageo. Encore une fois, de tels biens – qui ont été laborieusement accumulés pendant plusieurs siècles, dans de nombreux cas – ne peuvent être dupliqués sans effort par aucun autre concurrent ayant des ambitions mondiales.

Les exigences de temps et de fonds de roulement sont également très exigeantes: par exemple, un whisky doit être affiné pendant au moins trois ans et un jour pour être classé dans la catégorie des Scotch, et tous les single malts premium nécessitent une maturation de 10 ans, voire plus. . L’ensemble de l’inventaire doit être planifié, financé et produit à l’avance; ensuite, après avoir été distillé, il doit rester tranquille en attendant que la magie se produise à l'intérieur de fûts de chêne.

En raison de ces délais, relativement peu d’entreprises ont la volonté ou les moyens d’investir dans un produit qui ne portera ses fruits que dans 10, 20 voire 50 ans. La même corrélation entre la qualité et la maturation de l’esprit se retrouve également avec des produits tels que le cognac et le bourbon – ainsi que certains rhums et téquilas – rendant extrêmement difficile pour les nouveaux producteurs d’être concurrentiels sur le segment de prime le plus crucial du marché.

Ce n’est pas un obstacle aussi fort pour les spiritueux blancs tels que la vodka et le gin: la vodka ordinaire peut être produite le lundi, expédiée le mardi et consommée le mercredi; de son côté, et contrairement à ce que certaines initiatives de marketing semblent impliquer, le gin ordinaire (qui est essentiellement de la vodka sans plantes médicinales) n’a pas besoin d’être béni par un druide celte maigre, il y a plusieurs siècles, pour être commercialisé comme tel. un produit premium.

Quoi qu’il en soit, les obstacles à l’entrée dans cette industrie restent élevés et stables, même pour la production de spiritueux blancs. En plus de devoir faire face au difficile accès à des ressources limitées, les distillateurs doivent également faire face aux complications imposées par l’intensité capitalistique de l’industrie. exigences et défis de la distribution.

Les avantages compétitifs de Diageo | Distribution mondiale et relations privilégiées

Tous les actifs de la société sont soutenus par un réseau de distribution massif construit sur des connexions privilégiées (directes et indirectes) avec des bars, des clubs, des grossistes, des casinos, des restaurants, des hôtels et des points de vente, entre autres. Soutenue par son solide portefeuille, la segmentation minutieuse de Diageo garantit que les offres de la société bénéficient d’une rotation des stocks élevée, que ce soit sur site ou hors site; en garantissant des ventes rapides et prévisibles, cela fait également de Diageo un partenaire précieux pour les fournisseurs qui ne souhaitent pas parier sur des produits non éprouvés.

En fait, Diageo (via DCL et Guinness) entretient depuis des décennies des relations étroites avec les intermédiaires et avec ses clients finaux. En conséquence, son réseau de distribution comprend désormais une vaste force de vente et un nombre inégalé de sites dispersés sur toute la planète, ce qui crée un autre obstacle à l'entrée pour les petites marques. En effet, une pénétration efficace sur des marchés nationaux vastes et complexes – tels que la Chine, la Russie ou le Brésil – nécessite invariablement des réseaux d'approvisionnement et de distribution sophistiqués.

Les avantages compétitifs de Diageo | Économies d'échelle

Comme ils opèrent dans un secteur à forte intensité de capital, les plus gros producteurs de spiritueux sont bien mieux placés pour réaliser des économies d’échelle que les distillateurs plus petits ou artisanaux. Bien entendu, l’ampleur de l’échelle est un objectif souhaitable dans l’industrie des boissons alcoolisées, car la production de volumes plus importants conduit à une efficacité beaucoup plus grande et à une réduction des coûts fixes unitaires. Naturellement, cela se produit parce que les coûts peuvent être dilués sur un plus grand volume de marchandises liquides. Et aucun autre distillateur ne peut égaler le volume de production de Diageo: pour mettre la production de l’entreprise en perspective, Diageo a vendu environ deux fois plus en 2018 que Pernod Ricard, son concurrent le plus proche.

Une autre raison de ses fortes économies d’échelle tient au fait que de nombreuses marques de Diageo partagent la même infrastructure de distribution et que, par conséquent, les coûts cumulés sont encore réduits. La maîtrise de Diageo sur ses principaux marchés modère la complexité de la fabrication et tire à nouveau parti de la base de coûts fixes élevés de la société. Les acteurs les plus importants bénéficient également d’une plus grande intégration verticale.

Bien entendu, l’échelle n’est pas un avantage concurrentiel en soi. Cependant, cela devient important quand il interagit avec d’autres facteurs: d’une part, la taille et l’empreinte géographique de Diageo lui confèrent la capacité d’obtenir des matières premières telles que l’orge, le maïs et le raisin à un prix avantageux par rapport à la plupart des concurrents, ce qui génère de fortes économies de les achats via des achats en gros (pour la seule année 2018, Diageo a acheté 1,6 million de tonnes de matières premières et 1,4 million de tonnes de matériaux d'emballage); D’autre part, et en fonction du contexte du marché, l’utilisation supérieure de la capacité de Diageo peut également permettre à la société de vendre moins cher que ses concurrents (si nécessaire) ou de générer des marges bénéficiaires supérieures à celles de ses concurrents.

De plus, la taille de Diageo lui permet de mieux absorber les coûts de mise en conformité juridique et fiscale généralement élevés. Dans la plupart des cas, ces coûts sont générés par les licences, les taxes d'accise et les dépenses administratives. Les boissons alcoolisées sont également soumises à une multitude d'autres coûts d'attrition, notamment les taxes de vente et à la valeur ajoutée, les droits d'importation et d'exportation et les droits de douane, pour n'en citer que quelques-uns.

Compte tenu de ce contexte, il ne fait guère de doute qu’un nouveau concurrent aurait du mal à imiter les atouts et les capacités de Diageo. À quelques exceptions près, la plupart des autres entreprises ne sont tout simplement pas en mesure de produire suffisamment de tequila ou d'égrené de qualité supérieure pour être concurrentielles sur un théâtre d'opérations véritablement mondial.

2. Diageo est-il présent sur des marchés attrayants offrant des pistes de croissance claires? Oui: 1 point

Un signe révélateur d'un marché très attractif est la présence, sur ce marché, de très grandes entreprises privées: en opérant dans une arène structurellement rentable, ces entreprises privées n'ont tout simplement pas vu la nécessité d'émettre des actions au public afin de financer leurs activités. croissance à travers l'histoire. Certains exemples proviennent du marché des fournitures de nettoyage ménager (qui compte un acteur privé important dans SC Johnson), du marché de la comptabilité (avec des sociétés telles que PwC et Deloitte) et du marché de la confiserie (avec Mars Inc., par exemple).

Sur le marché des spiritueux, les principaux exemples sont fournis par Beam Suntory et par Bacardi Limited, qui sont les troisième et quatrième producteurs de spiritueux au monde en termes de revenus. Sans aucun doute, grâce à ses caractéristiques convaincantes, le marché des spiritueux est plus que capable de soutenir ces grandes entreprises privées; néanmoins, et en raison de ses barrières à l'entrée imposantes, il n'est pas en mesure de soutenir plus de quelques entreprises véritablement mondiales.

Entre autres facteurs, ce marché est attrayant car il a tendance à bénéficier d’une cyclicité relativement faible et d’une croissance lente mais régulière; en fait, la demande de spiritueux a généralement suivi une tendance à la hausse constante, la volonté des consommateurs d’acquérir des articles discrétionnaires ayant augmenté avec l’augmentation du PIB mondial, ce qui a entraîné une faible volatilité des revenus. C’est l’une des raisons pour lesquelles le marché des spiritueux a connu une croissance d’environ 3% à 4%. par an au cours des dernières décennies en termes de valeur.

À l'instar des marchés de la bière et des sodas, le marché des spiritueux bénéficie également d'un très grand marché total adressable dans lequel la plupart des consommateurs ont tendance à faire preuve d'une certaine fidélité à la marque; d'autre part, et contrairement aux marchés des sodas et de la bière, le marché des spiritueux est beaucoup plus propice à la mise en œuvre de stratégies de prix très gratifiantes: en fait, une marque haut de gamme de cognac ou de whisky ressemble à un Produit de luxe à prix avantageux que toute personne disposant d'un minimum de revenu disponible peut se permettre d'acheter plusieurs fois par saison (ce qui génère également des ventes fréquentes et relativement prévisibles).

Johnnie Walker, par exemple, est proposé dans une variété d’étiquettes de signature qui s'adressent à des publics variés avec des goûts et des sensibilités de prix différents. Une telle flexibilité peut être explorée à travers différentes marques ou variations au sein d'une marque, allant de mélanges accessibles – comme Johnnie Walker Red Label, le scotch le plus vendu dans le monde depuis 1945 – à des éditions limitées de whiskeys de luxe d'une qualité exceptionnelle – comme Johnnie Walker. Étiquette bleu. Ce fait élargit considérablement son marché potentiel sans pour autant diluer l’équité durement acquise de la marque.

Les éditions limitées sont particulièrement gratifiantes pour les distillateurs de premier plan comme Diageo, car ils possèdent les mérites de produits de luxe emblématiques, tels que les voitures de sport Ferrari () ou les sacs Hermès () Birkin: ils sont presque intemporels et voient souvent leur valeur augmenter avec le temps (ce qui contraste fortement avec la dépréciation rapide d'une voiture Chrysler ou d'un sac Zara); leur cycle de production est long et leur vulnérabilité à l'obsolescence ou aux perturbations technologiques est faible; ils sont antirecessionnistes et largement protégés des récessions économiques; leur production et leur distribution sont rigoureusement contrôlées, ce qui permet de remédier aux dérapages opérationnels, au surinvestissement et à la surreprésentation; et ils bénéficient de patrimoines uniques avec une grande visibilité.

Bien entendu, la population visée par l’industrie est limitée par les contraintes d’âge – communément appelées «l’âge légal de consommation», qui varient d’un pays à l’autre. Mais heureusement pour Diageo et ses pairs, on s'attend à ce que la population en âge de boire augmente au cours des prochaines années en raison de la durée de vie moyenne plus longue et d'une meilleure pénétration dans les grandes zones géographiques.

Souvent négligé par certains investisseurs, l’arène mondiale des spiritueux de qualité supérieure présente une autre caractéristique convaincante qui l’isole partiellement des défis auxquels sont confrontés d’autres produits destinés aux consommateurs: contrairement aux produits de consommation courante comme le café instantané, le dentifrice ou les couches, trop dépendantes de détaillants géants du marché de masse comme Walmart (), Amazon () ou Tesco () au Royaume-Uni pour générer leurs ventes et leurs bénéfices.

En fait, parce qu’ils sont vendus et consommés sur place et sur place dans une grande variété d’occasions et de lieux (bars, clubs, restaurants, casinos, conventions, anniversaires, etc.), les spiritueux ne sont pas touchés de manière disproportionnée par les guerres de prix bouleversantes menées par ces détaillants dominants – pour être sûr, il est maintenant plus facile pour Walmart de réduire les marges de sociétés comme Kraft Heinz () que de réduire les marges de Diageo ou de Brown-Forman (); de plus, les spiritueux haut de gamme ne deviennent pas banalisés et ne sont pas confrontés à la concurrence croissante des produits de marque maison.

Cependant, ce marché présente également un grave point de fragilité, les esprits internationaux étant très dépendants du libre-échange et des marchés ouverts. La croissance dans ce domaine peut également être freinée par des facteurs tels que des restrictions en matière de publicité, des règles et réglementations plus strictes, une fiscalité lourde et tous les esprits contrefaits qui continuent de toucher certains pays en développement.

Malgré les guerres commerciales en cours, le marché mondial des spiritueux devrait croître d'environ 2% à 4% d'ici 2023-2024. Les taux de croissance seront toutefois asymétriques, car les marchés émergents devraient connaître une croissance pouvant aller de 6% à 8% au cours des prochaines années, tandis que les marchés développés ne devraient se dilater que de 1% à 3% au cours de la même période. Il convient de noter que la pénétration des spiritueux internationaux dans de nombreux marchés en développement reste assez faible (moins de 2% à 3%), en particulier en Inde, en Chine et dans l’ensemble de l’Afrique; par conséquent, lorsque l'on compare ce faible niveau de pénétration à celui des marchés développés (où il atteint souvent la barre des 50%), le potentiel de croissance soutenue semble assez élevé.

Les principaux facteurs à l'origine de l'expansion du marché mondial sont la prééminence croissante des voyages internationaux (les ventes hors taxes sont d'importantes sources de revenus, près de 20% des touristes rentrant chez eux avec jusqu'à 2 litres d'alcool), ainsi que l'urbanisation rapide et la hausse du nombre de touristes. revenu disponible dans plusieurs zones géographiques émergentes clés. Dans les pays développés, la demande sera principalement stimulée par les modifications des habitudes de consommation et les tendances en matière de premiumisation.

Pour les producteurs, la mégatendance des primes a été l’élément principal de l’élargissement des marges bénéficiaires et est particulièrement importante dans les zones géographiques où les niveaux de consommation sont stationnaires ou en baisse, comme en Australie ou en Europe occidentale. Mais la premiumisation fait également partie intégrante de l'équation de la croissance dans les plus grandes économies émergentes: l'Inde et la Chine.

Le tiers de la population mondiale est énorme, mais ces marchés en plein essor restent difficiles à conquérir grâce à la force des marques locales (la Chine avec ses prestigieuses marques baijiu) et à la disponibilité de marques à bas prix. spiritueux domestiques *. Etant donné qu’ils ne peuvent pas rivaliser uniquement sur des prix bas et des volumes élevés, certains grands acteurs internationaux tels que Diageo et Pernod Ricard ont ciblé les classes moyennes en expansion dans la région afin d’obtenir des marges plus importantes d’acheteurs moins sensibles aux prix.

* C'est le cas en Inde: en plus d'être parfois mélangé avec des distillats de mélasse moins chers, le whisky indien mûrit beaucoup plus rapidement que le scotch grâce au climat plus chaud du sous-continent. En pratique, un whisky indien de 3 ans a une maturité similaire à celle d'un whisky. whisky écossais âgé de plus de 25 ans, ce qui génère un chiffre d'affaires beaucoup plus élevé.

Diageo en Inde

Introduit en Inde pendant la période du Raj britannique (1858-1947), le whisky reste l’esprit le plus populaire du pays, tant parmi les classes les plus aisées que les classes moyennes (mais curieusement, bien qu’il vive dans le plus grand marché du whisky sur la planète, la grande majorité des Indiens sont sobres); Cependant, pour protéger les recettes fiscales et les emplois locaux, l'industrie nationale des spiritueux est farouchement défendue en supprimant 150% des droits de douane sur l'alcool importé.

Diageo a contourné cette contrainte sur les distillats étrangers en acquérant une participation de 55% dans la société indienne United Spirits Limited (), qui, en tant qu'entité autonome, est la deuxième entreprise de spiritueux en importance au monde en volume. Aujourd'hui, fort de 58 usines de fabrication, de marques locales fortes et d'un réseau de distribution sans égal à travers le pays, Diageo semble être bien placé pour tirer parti de la croissance du marché indien prometteur. Cet accord, qui valorisait United Spirits à 20 fois l’EBITDA, n’a pas coûté cher, mais ses possibilités de croissance sont incontestées.

De plus, Diageo a la possibilité d’accroître la rentabilité de USL, car la société avait été mal gérée avant l’acquisition. Cependant, le redressement prendra quelques années à se concrétiser, alors que Diageo assouplit le bilan de USL et met en œuvre de meilleures pratiques de gouvernement d’entreprise. Compte tenu du marché peu développé de l’Inde, ainsi que du potentiel inactif de USL, il n’est pas impossible d’envisager une croissance des bénéfices de Diageo à des taux élevés à un chiffre dans le pays au cours des prochaines années.

Diageo en Chine

Le secteur des spiritueux en Chine est également fortement réglementé et dominé par des distillats produits dans le pays. Fuelled by 20 million new legal-drinking-age consumers entering the market every 12 months, China is now the largest and most dynamic market for alcoholic beverages on the planet; and, despite the fact that imported spirits are not yet as popular as the local brands of baijiu, rising purchasing power in the country is expected to increase even more the demand for alcohol in general and for imported spirits in particular.

Nowadays, even in a slowing economy, more and more Chinese citizens are reaching the USD 10.000 annual income threshold that usually signals a substantial upsurge in discretionary consumption – tellingly, when the average GDP per capita breached that threshold in neighboring Taiwan, demand for imported spirits climbed by about 700% in just a few years.

Combined with the country’s robust urbanization trends, these events are making China’s middle-class consumers more willing to accept imported spirits like gin and whiskey. On their part, both prosperous Hong Kong and boisterous Macau (a rich hotspot where the gambling industry is about 7 times larger than that of Las Vegas) are also instrumental at exposing and converting local consumers to imported premium brands.

Consumers in China are especially brand-conscious, and they prize quality and status above price, convenience, or any other considerations. In a culture where prestige and social standing are highly regarded (hence the concept of ‘face’, a hard-to-translate standard by which Chinese social intercourse is often structured), that’s one of the reasons why premium brands act as highly coveted social cues meant to be consumed frequently and conspicuously.

As a consequence, premium Scotch, which has replaced cognac as the main luxury tipple in China over the last decade, seems to have large sales potential in the country. Diageo, as the world's leading premium spirits company, is positioning itself to become the largest supplier of whisky in China over the next few years; the firm’s long-term purpose is to derive about 5% of its global sales of the Scottish drink from the country over the next decade, which seems to be a feasible goal when the latest rates of sales growth are taken into account.

Diageo in Africa and in Latin America

Despite all its challenges (or because of them), Africa remains an appealing arena for Diageo. With their battered infrastructure, difficult logistics, counterfeit alcohol, political instability, and persistent governance woes, many countries in the continent present a forbidding prospect for most competitors. However, Africa is an immense market full of promise, as attested by the fact that the continent is expected to be the world’s fastest-growing market for alcoholic beverages up to 2021.

Several factors explain the market’s advance, and they include growing populations, higher average incomes, low but increasing consumption of alcoholic beverages, and a generalized move towards the consumption of safer beverages (unfortunately, people in Africa continue to perish after drinking illicit distillates laced with methanol and other deadly substances).

Given Africa’s generalized affordability constraints, Diageo opted to offer consumers a variety of inexpensive beverages, from Senator beer to Black & White whisky, so as to bring them into the fold across the most attractive price points and categories. Diageo also sells premium products in Africa, but that’s not the company’s main focus for now. Hopefully, such a strategy will enable the firm to nurture long-term relationships with the masses of consumers that cannot meet the expense of buying its flagship offerings.

Therefore, Diageo’s approach in Africa is to sacrifice profit margins in favor of higher volumes. But this is a calculated risk because the company has successfully implemented a cost-savings program that took the pressure off the margins while it fostered sales through the continent. The firm’s latest results showed that net sales of beer were up by mid-single digits across Africa, and also that spirits posted double-digit net sales growth.

Like Africa, Latin America is a vast region that presents both great challenges and great opportunities. While the region is socially and economically volatile due to income inequality, to governance issues, and to its reliance on commodities, Diageo still sees great potential in this market – with the probable exception of Venezuela – thanks again to its expanding middle classes and to its young demographics (nearly 6 million people reach Legal Purchasing Age every year throughout the region). Penetration of spirits is also low, particularly of vodka and whisky. Peculiarly, with only half the rate of penetration seen in developed markets, native rum and tequila are also under-represented in the region as a whole.

Diageo in Developed Nations

With their slow growth rates and high levels of profitability, Oceania, North America, and Western Europe are cash cow markets. In Europe, growth has been inhibited by aging populations and by better awareness of the negative health and social effects of alcohol (as in several U.S. states, drinking in public is illegal as a general rule in countries like Norway, Poland, and Finland, for example).

On their part, consumers in the United States downed approximately USD 45 billion worth of whiskey, tequila, rum and more in 2018 alone; however, due to competition from substitute products like wine and beer (and even bottled water), the market for spirits in North America is relatively small compared to its overall economy. This state of affairs has been reinforced by cohorts like the Millennials, which exhibit quite different needs and requirements when paralleled to previous generations.

In particular, Millennials prefer craft, organic and premium products, and are on the whole more concerned about the long-term health implications of alcohol consumption. Many of them are shunning distilled beverages (like vodka) in favor of fermented beverages (like wine).

To respond to their demands, Diageo has launched Ketel One Botanicals in the U.S., which is ‘quasi-vodka’ infused with natural fruit and botanical essences but – more importantly – with no ‘excess’ alcohol, no added sugars, no sweeteners, no GMOs, no fake botanicals, and no artificial flavors. With only 30% alcohol by volume, this beverage does not even meet the legal definition of ‘vodka’ under European and American regulations.

Across the pond, Diageo has also launched Gordon’s Premium Pink Distilled Gin, which quickly became the most successful new spirits launch of the last decade in Europe. Despite these discrete successes, it is still unclear whether or not Diageo will be able to reignite meaningful growth in developed regions.

3. Is Diageo a diversified company, with multiple and complementary cash flow generators? Yes: 1 Point

By controlling 200 different brands marketed throughout the globe, Diageo has indeed diversified sources of cash flow. In 2018, the firm realized over half of its revenues from rum, beer, vodka, and Scotch; however, no single category accounted for more than a third of its aggregated sales.

Nowadays, the company generates about 60% of its profitability from matured spirits whose production entails powerful barriers to entry. In terms of geographical coverage, the company is also reasonably diversified but Latin America (8.8% of net sales) and parts of Africa (12.3% of net sales) remain largely underpenetrated. In contrast, the mature North American market (34% of net sales) represents over a third of Diageo's net sales and nearly half of its operating profits.

Either way, Diageo has greater product and geographic diversity than any other of its global competitors: compared to Suntory and Pernod Ricard, Diageo has a stronger portfolio in top-tier categories like whisky and gin; and contrary to a competitor like Brown-Forman, which is an admirable company, Diageo is not overly dependent on whiskey (a single category) in the United States (a single country).

What Diageo’s diversified portfolio intends to achieve is quite simple to understand but often difficult to execute: first, its purpose is to bring consumers into the company’s fold with affordable beverages tailored to local tastes (such as with its McDowell’s beverages in India); then, as consumers’ disposable income rises over time, the intention is to move them up the value ladder towards the company’s 6 global champions*; and finally, it intends to attract the wealthier fringe through the company’s Reserve portfolio (18% of net sales), which include ‘premium and above’ offerings such as Bulleit American whiskey and Don Julio tequila.

*The Global Champions are Johnnie Walker whisky, Smirnoff vodka, Captain Morgan rum, Baileys liquor, Tanqueray gin, and Guinness beer. These 6 brands account for 41% of Diageo’s net sales.

Showing its strength, Diageo's Reserve portfolio has been named as the best-performing assortment of spirit brands in Drinks International's Brands Report for the third year in a row, a fact that seems to vindicate the company’s approach. Besides providing a hedge against the challenging business environments often seen in more unstable markets, the company’s broad portfolio across distinct geographies also enables Diageo to remain competitive on all price points and to respond more effectively to the ever-changing consumer demands. Furthermore, a wide assortment of spirits generates economies of scope on marketing and distribution.

There’s a downside to such diversity, though, because such wide-ranging collection of beverages is not geared towards realizing the highest of returns on capital employed (more on that later). In essence, the company’s portfolio dampens volatility at the expense of absolute returns – in this case, an analogy can be established with the different results obtained through an investment in a S&P 500 index as opposed to an investment in Mohnish Pabrai’s or Charlie Munger’s ultra-concentrated portfolios, as the latter investments are much more volatile but also, potentially, much more rewarding.

Beer, in particular, is driving down returns in favor of latent growth, as this category generates significantly lower margins than spirits. About 50% of Diageo’s beer sales are generated in the African continent, which is the last growing frontier of the global beer industry; of those sales, approximately half come from its beleaguered Guinness brand. Unfortunately, because Diageo seems to be focusing its efforts on spirits, the firm’s results in Africa have been quite erratic over the last few years.

As demonstrated by the recent underperformance of companies like Anheuser-Busch InBev (), mainstream beer is becoming an increasingly commoditized product just about everywhere, and even an asset like Guinness – which is the only global brand of stout – is feeling the heat as its revenues only posted a CAGR of about 1% over the past decade. Moreover, Guinness does not generate economies of scope with the spirits operations, as spirits and beer distribution is often done through distinct wholesalers. Should Diageo sell its beer assets to focus its efforts on spirits? Peut être. But that would certainly weaken its long-term prospects in Africa.

4. Is Diageo dominant within its core markets? Yes: 1 Point

Diageo is currently the world’s largest producer of spirits. The company dominates approximately 25% of the global premium spirits market in volume terms, well ahead of Pernod Ricard (with 16% share), Bacardi Limited (9% share), Beam Suntory (7% share) and Brown-Forman (6% share). It is also the leading vendor of distillates by total annual revenues, as it captured sales well above Pernod Ricard (the French firm generated revenues of USD 11 billion in 2018 to Diageo’s 15.7 billion).

According to Brand Finance, Diageo now owns 12 of the top 50 global premium brands and 4 of the leading 10 brands, making it the main force to be reckoned with in the worldwide spirits arena. However, at the local level, the spirits market remains largely subjugated to national champions like Korea’s Jinro, Thailand’s Ruang Khao and India’s Officer’s Choice.

The exception to this home-centric logic is Diageo’s Smirnoff, which was the only globally-distributed distillate to integrate the list of the top 10 most-consumed brands in the world during 2017-2018. Locally-made spirits control their respective national markets, but they are also largely confined to them – indeed, together with Thai Beverage (), Diageo is the only other company placing two brands (Smirnoff and McDowell’s) on this list’s top 10, according to International Wine & Spirits Research (IWSR).

With a market share of 35%-37%, Diageo is also the undisputed global leader in the Scotch whisky market, which is one of the most important categories within the industry. And, despite playing second fiddle to companies like Anheuser-Busch and Heineken () in the global market for beer, Diageo also possesses a very strong position in large and expanding beer markets like Ghana and Nigeria (the most populous country in Africa), as well as throughout Eastern Africa.

Although the spirits industry is fragmented, the global premium brands are held almost exclusively by a rather concentrated group of multinational players – in fact, according to some estimates, the industry’s top 5 spirits companies account for 62%-64 of premium drink’s global volumes. These behemoths, which have been consolidating the sector over the past 30 years, now have the assets and the financial muscle to consolidate even further the sector’s ‘long tail’, and to develop, manage and sell a broader assortment of products so as to better offset the high fixed costs incurred by its operations. This bodes well for the industry’s profitability as a whole, but its growth rates will certainly suffer in developed markets.

5. Is Diageo a superior cash-generative business? Neutral: 0 Points

Money doesn't buy happiness, but it calms the nerves.” (Joe E. Lewis): with the “”, and once-mighty companies like GE (), Kraft Heinz () or Anheuser-Busch InBev cutting their dividends, a firm’s capacity to generate cash is becoming even more relevant to calm the nerves of shareholders. Undoubtedly, highly cash-generative companies will fare better during an eventual economic downturn than firms with difficulties at converting their top-line into free cash flow. Here, by scrutinizing the following parameters, the purpose is to assess how well Diageo translates inputs and sales into true liquidity:

Free Cash Flow to Sales (5-year average)

Diageo’s FCF margin has averaged more than 18% over the past 5 years, which is a percentage that translates a very healthy conversion of sales into free cash flow (naturally, companies that are able to transform revenues into plentiful cash are better able to reinvest money into further growth opportunities, or to return funds to shareholders) – from a Quality Investing standpoint, FCF margins above 10% usually denote very profitable businesses. Reaching averages of 16%, 15%, and 12%, respectively, Brown-Forman, Campari (), and Pernod all trail Diageo in this instance.

Cash Conversion Rate (5-year average)

As measured by free cash flow/net income, Diageo's CCR averaged only 81% between 2014 and 2018. When properly contextualized, a CCR above 100% is a suitable indicator of a high-quality business – in fact, despite its apparent weakness, Diageo’s CCR is a reflection of the firm’s hefty past investments as it built up stock to battle Pernod on a global scale. Moreover, and contrary to other businesses like Moody’s () or Microsoft (), for instance, Diageo and its rivals are not paid in advance for its products or services. As a result, free cash flow usually cannot (in most circumstances), be higher than net income in any given year. There are exceptions, though, as attested by Campari’s notable CCR; however, the Italian firm is much more skewed towards drinks that do not require maturing, such as traditional vermouth. On the opposite side of the scale is Brown-Forman with its heavy reliance on matured brown spirits, and an average CCR of only 67%.

Cash Conversion Cycle (5-year average)

The factors discussed above also conspire to prolong the cash conversion cycle of distillers. On average, Diageo required 354 days to transform inputs like water and wheat into cash. In comparison, beverage companies like Coca-Cola () and Boston Beer () only take about 50 days and 26 days, respectively, to do the same. Still, both Pernod and Brown-Forman are even slower than Diageo as they require well over a year (436 and 414 days, correspondingly) to finally see cash enter their coffers. On average, Campari completes its cycle in only 203 days.

Positive Free Cash Flow Generation

Unsurprisingly, the company has always been FCF-positive over the last decade. Diageo’s free cash flow has more than doubled since 2014 (from GBP 1.15 billion to 2.5 billion) but that’s not a great feat, though, because the company’s FCF reached a multiyear nadir at that time. Unfortunately, in 2018, Diageo’s operating profit growth was again offset by larger investments in capex and in maturing stock. According to the company, operating working capital also improved but the benefits on free cash flow were lower than in 2017.

CapEx/Operating Cash Flow (5-year average)

Over the past 5 years, on average, Diageo’s total capital expenses have amounted to just 22% of its operating cash flow. That’s a very reasonable figure for a capital-intensive business, and it places Diageo on par with companies like Coca-Cola and Keurig Dr Pepper (). Despite having substantial working capital requirements – such as the need to frequently sell on credit – the cash requirement for expenditures has been skillfully managed by Diageo; the same goes for capex, which has dropped as a proportion of operating cash flow over the last few years. Still, among its peer group, only Pernod had to reinvest a larger percentage of its cash to keep on functioning. When all these parameters are considered, it seems that Diageo is not the absolute most cash-generative company compared to peers, but it is not too bad either. But, how good is Diageo at transforming invested capital into cash?

6. Has Diageo maintained high average Cash Returns On Invested Capital (>15%) over the last 10 years? Neutral: 0 Points

In 1976, vodka surpassed whiskey as the most popular spirit in the United States, but it has since lost some of its allure; gin gained a lot of ground over the past few years and is expected to perform well as a category up to 2021; bourbon has also seen a notable resurgence, even among those troublesome Millennials; meanwhile, both white rum and alcoholic RTDs (Read-to-Drink) beverages continue to lose share in both value and volume terms.

All this fluctuating demand for distinct categories is also one of the reasons why there’s much to like regarding Diageo’s varied portfolio – a portfolio where certain waning categories of spirits are totally or partially offset by growth in other categories. However, having a presence in both fading and growing categories of spirits is not the optimal strategy to maximize returns and profits because they tend to cancel each other out according to the whims and vagaries of consumers; as long as execution remains on track, though, such varied portfolio is perhaps a safer and more stable bet.

This seems to be one of the main reasons why Diageo’s Cash Returns On Invested Capital* (CROIC) are lower than Brown-Forman’s stellar returns, which averaged 15.2% over the past 10 years. Diageo’s CROIC including goodwill only averaged 9.4% during the same period. Indeed, compared to its British counterpart, the American company has a much narrower portfolio composed mainly of high-return brown spirits like the Woodford Reserve and Jack Daniels brands. Furthermore, given its lower maturing requirements, American whiskey is not as capital-intensive as Scotch, and it also generates higher margins due to its skew to the very profitable North American market.

* Ici, the calculation of returns on invested capital will follow the proposed by Michael Mauboussin; however, Free Cash Flow will be used in the numerator instead of NOPAT. The purpose is to assess how much actual cash Diageo was able to generate based on each pound it invested into its operations. CROIC might be preferable to ROIC in this circumstance.

Diageo’s returns are also negatively impacted by its beer operations (the high-volume, low-value beer business tends to produce weaker returns than the high-value, low-volume premium spirits business) and by the presence of – arguably – too many unproductive intangible assets and too much goodwill on the balance sheet.

Profitability Matrix | Diageo vs. Peers

A profitability matrix shows the returns on capital (using NOPAT this time, to provide a different angle) relative to the amount of free cash flow extracted from sales; companies placed further up and leaning to the right-hand side on the chart below tend to generate abundant cash from sales and they also have the capacity to extract a higher return on it (if current conditions persist over time, of course). As shown, Brown-Forman clearly beats Diageo in this instance, as it generates much higher returns and just slightly less cash flow from sales when compared against its British counterpart. This means that the American company has more excess profits to reinvest productively, which gives it a significant advantage over its less efficient rivals – as investors, we must not forget that “Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return” (Warren Buffett). Concerning this matter, both Pernod and Campari are not playing in the same league as Diageo and Brown-Forman.

Diageo, though, has plenty of room for improvement along this front: unfortunately, not all types of growth create the same amount of returns for shareholders; in reality, the value creation ‘capacity’ of a dollar (or pound) of top-line growth depends on how much invested capital is necessary to drive that growth – in very broad terms, the more invested capital (in acquisitions, for instance), the lower the value creation ‘capacity’, and the lower the cash returns.

And, looking at the numbers, it seems that Diageo has been definitely overpaying for inorganic growth: added together, intangibles and goodwill now account for about 43% of Diageo’s total assets, which seems an excessive amount. No wonder then that Diageo’s cash returns pale in comparison to Brown-Forman’s. Brown-Forman is also a superbly well-run business with a clear and well-executed growth strategy. But, as discussed below, the same cannot always be said about Diageo.

7. Are systemic and company-specific risk factors being well-managed by Diageo? Neutral: 0 Points

As a multinational concern operating within a politically- and ethically-sensitive sector, Diageo is subjected to many risks that obviously include unfavorable currency gyrations, trade barriers, increased fiscal pressures, and rising anti-alcohol sentiment in conservative-leaning countries such as Indonesia or India (a place where drastic measures like ‘dry days’ are frequently held throughout the year). Historically and operationally, all these risks are a given in Diageo’s markets. However, there are other risks that need to be carefully managed by the company so as not to destroy value going forward.

A Baffling Premiumization Agenda

Despite owning a very diverse collection of spirits, Diageo’s portfolio is still incomplete and the company has been compelled to make a series of acquisitions in order to participate in critical consumer- and competitor-led developments. It is known, though, that errors tend to occur when senior executives insist on promoting overly ambitious or poorly planned acquisitions. Indeed, large acquisitions tend to create relatively little value compared to the required level of investment, while adding integration and complexity risks into the mix.

Yet, acquisitions in this sector are a necessity because the spirits market does not lend itself to meaningful innovation. Quite the opposite: besides a certain flavor, what most consumers want in spirits are aspects like excellence, tradition, respectability, and craftsmanship. Being so, it is very difficult to really innovate and to launch a novel, unproven brand. And this is one of the main reasons why Diageo and its global competitors started to absorb brands like Ypióca in 2012 and Belsazar in 2018.

Regrettably, as seen with the acquisition of India’s United Spirits, Diageo has been buying other firms in an overheated and ultracompetitive seller’s market that will certainly punish those companies following a fuzzy strategy – it is an obvious fact that the payback on acquisitions lengthens considerably as their prices increase. Now, it remains to be seen if Diageo’s management can deliver the promised benefits accrued by all its feverish M&A activity against a more challenging economic backdrop.

But, then again, Diageo has some good reasons to pursue this acquisitive strategy, as sales of premium and super-premium products have been outpacing all other categories: only ten years or so ago, mass-market spirits (those defined as costing USD 12 or less per bottle) accounted for about 40%-50% of total sales, whereas premium spirits represented a mere one quarter of total revenue. Nowadays, these figures have been largely inverted and the tendency is accelerating.

However, the company’s premiumization agenda is often baffling (to say the least), as Diageo paid a gargantuan price of USD 1.0 billion for Casamigos, a new tequila company, when it had already bought another premium brand of tequila in 2015 with the acquisition of Don Julio (which is a brand recognized by connaisseurs as the 'champagne of tequilas'). What are the reasons behind these largely overlapping but very expensive acquisitions? Will Diageo be able to truly differentiate the two brands in a value-creating way?

Moreover, some of the money used to acquire Don Julio came from the sale of Bushmills, the world’s oldest distillery (Bushmills has been producing Irish whiskey since 1608). Why was Diageo unable to effectively market this ancient, traditional, exemplary brand of whiskey? Was this an admission that Diageo was unable to profit from such strong heritage? That would be the manifestation of a worrying symptom, as the company would be implicitly acknowledging its ineptitude in the all-important Irish whiskey category. And why did the company announce (soon after the sale) that it was developing a completely new brand of Irish whiskey? It seems nonsensical to discard a brand with 400 years of history supporting it, only to create an unproven product from the ground up afterward.

All in all, Diageo’s scattershot strategy looks especially convoluted when compared to Brown-Forman’s judicious and well-executed capital allocation policies. Contrary to Diageo, the family-led American company has placed its focus on developing its own premium brands instead of pursuing a never-ending string of costly and speculative acquisitions. And that really shows on their contrasting financial and operational parameters.

Counterfeit Spirits are a Persistent Menace in Some Developing Nations

Diageo operates in many problematic markets in which counterfeit spirits are a serious menace to the company’s reputation and public image. This threat was materialized not long ago in Taiwan, a place where Diageo’s sales were impacted by fake, pseudo-whisky beverages. Quite astonishingly, in countries like Brazil, Mexico, or Russia, as much as 30%-60% of total alcohol sales are generated by illicit products. This is not a new phenomenon, of course; however, counterfeiters now operate industrially, and at an unprecedented scale and scope. And that’s a relatively new development. No wonder then that, on a global basis, the world’s illicit alcohol market now accounts for a staggering 25% of alcohol sales. To counteract this persistent menace that places scores of consumers at risk (according to an , even jet fuel is sometimes used in counterfeit beverages), Diageo has established a certification program in brewing and packaging sites, as well as independent audits. The company also undertakes ‘food fraud’ risk assessments on a regular basis. Despite Diageo’s best efforts, industrial counterfeiters will seek to capitalize on the company’s reputation for as long as its sought-after drinks command premium prices.

Brexit

Even with the commotion of Brexit, Diageo should not incur tariffs on its exports to the European Union and should also continue to benefit from zero tariffs in the North American space. However, Diageo can be impacted in many markets such as Peru, South Korea, and South Africa, because the UK will lose access to the EU’s Free Trade Agreements. According to the company, Brexit could cost Diageo ‘tens of millions of pounds’ if the UK fails to reestablish timely trade deals with other countries; similarly, the reintroduction of effective, ‘hard’ borders between Ireland and the UK (through Northern Ireland, a question that has been the source of great angst and acrimony among all the parties involved in the process) would disturb the company’s supply chain and probably affect the production of Guinness and Baileys. In the end, the impact on sales will depend on how swiftly the UK government can negotiate its own agreements. Of course, a weak (or weaker) British Pound can and will have a positive impact on financial results.

8. Is Diageo resilient and adaptable to disruption? Yes: 1 Point

It is clear that this sector is not particularly susceptible to obsolescence or disruption: whiskey today is not vastly different to the whiskey produced 200 years ago, and the way this ancient beverage is consumed is not that distinct either, of course (and, concerning how resilient distillers can actually be, let us not forget that Brown-Forman made it largely unscathed through Prohibition). However, it would be unwise to assume that this defensive sector is somehow invulnerable to disruption in this time of swift, unexpected and unprecedented change – a time when an asset-light online social media service like Facebook () became larger than the largest descendant of John Rockefeller’s colossal oil empire within just 14 years (please check image below).

If a behemoth like ExxonMobil (), with all its massive hard assets, can become less valued than a service created in 2004 in a dorm room, then no company is certainly immune to the forces of free enterprise. Not even a distiller that produces and sells seemingly immutable products. In particular, Diageo and its peers are now facing two major disruptors: craft distilleries, on the one hand, and a new generation of customers, on the other hand.

Diageo’s Crafty Method to Cope with Craft Spirits

In the year 2000, there were only two dozen craft distilleries in the United States but 19 years later that number enlarged to about 1850 distilleries. Indeed, the threat of new competitors entering this industry has markedly increased over the last decades: as elsewhere in the consumer-driven space, there has been a fragmentation at the base of the industry whereby large-scale brands have been partially displaced by local players focused on small-scale production serving niche markets.

This fact is intensifying the attrition in some regional markets, but these much smaller competitors are in general unable to gain much scale and to compete on a wider arena due, as mentioned before, to the capital intensity and lead times required to produce brown spirits. Furthermore, as the giants consolidate, production costs are expected to decline considerably, which will lead, in turn, to a large minimum efficient scale. Being so, craft producers (including the ones distilling white spirits) will probably be hard-pressed to justify their initial investment if average selling prices start to falter.

Apart from these obvious barriers, craft distilleries also face other limiting factors of growth. A few examples: with all its finely-tuned methods, distilling is technically more complex than brewing; however, today there are too few truly knowledgeable distillers and too many small distilleries (between 2017 and 2018, the number of distilleries in the United States grew by almost 16%); moreover, the current legal framework makes it much easier to produce beer than to distill spirits, as every aspiring distiller needs to go through the harshness of local, state, and federal approval before producing a single drop of liquor; and finally, this market is already served by a huge basket of premium and super-premium beverages sold at different price points and with distinct taste profiles, and therefore there’s no evident void to fill like there was for beer in the past.

To eliminate all this (sometimes irrational) competition from the map, Diageo and its global peers will need the help provided by a more severe economic downturn. Such a downturn will probably precipitate a Darwinian process of selection that has been artificially inhibited by the access to cheap money provided by both crowdfunding platforms and by private equity funds specialized in alcoholic beverages.

Diageo is not sitting quiet, though: aware of the way mainstream brewers like Anheuser-Busch InBev were outmaneuvered by craft producers, the company has financed Distill Ventures, which is a “drinks accelerator dedicated to helping founders build, scale and sell the drinks brands of the future” (in reality, this is an investment arm that allows Diageo to control would-be competitors and to learn from their nimbler tactics).

This ‘accelerator’, which has already invested in brands such as Oregon-based Westward Whiskey, will enable Diageo to adopt a ‘craftier’ approach on some products. In fact, by leveraging its expertise, financial muscle and distribution channels, the craft spirits trend can become a real opportunity for Diageo going forward. But, of course, there are no certainties regarding this matter: after all, who would have guessed 20 years ago that craft beer would become such a relevant category?

Oftentimes, Cheap Alcohol Is Not the Poison of Choice Among Younger Consumers

And craft beer became such a relevant beverage because many consumers were demanding more quality, artistry, exclusivity, and authenticity. The same phenomenon is now powering the changes in the spirits sector: regarding their choice of alcoholic beverages, people are generally trading up even among older generations – they are drinking less alcohol but they are also drinking better-quality spirits. Strengthened by health concerns, these trends around craft and premiumization have naturally arrived at the spirits realm and have helped drive a cultural shift in attitudes and in perceptions.

As a consequence, to stay dominant, Diageo needs to anticipate and respond to this shifting consumer behavior in a timely and congruent manner. The company is doing it mainly through its ‘Reserve’ portfolio, which is populated by exclusive, high-quality brands such as Zacapa rum. Diageo is also utilizing data and insights to make ‘real-time’ decisions in order to ensure that its beverages are reaching the right consumers at the right places and at the right times (contrary to microdistillers, Diageo has a wealth of market intelligence to capitalize on consumer trends around the globe).

However, younger generations in developed markets are drinking less alcohol than any other generation. This phenomenon is illustrated by the fact that global alcohol consumption fell for the first time this century during 2017; in the United States specifically, overall alcohol consumption has also declined over the last few years – in 2017, beer consumption dropped by about 1.5% in the country, and while spirits consumption rose, their growth rate is still decelerating. What’s more, close substitutes to spirits (like beer and wine, including fortified wines such as sherry and port wine), remain one of the major factors affecting overall demand.

Besides exhibiting a lower alcoholic content – a fact that attracts the expanding numbers of health-conscious customers – wine and beer have in general fewer regulations placed upon them. More often than not, these fermented beverages are also available at reduced price points. In addition, the spirits sector faces mounting competition from non-alcoholic beverages such as tea, juice, soft drinks and bottled water, particularly among the so-called ‘Clean Lifers’ in developed countries*. Seedlip, the world’s first non-alcoholic spirits firm, and a true growth star, has been financed by Diageo in order to target this cohort. And finally, the future will probably see the widespread acceptance of cannabis-infused beverages; however, this market is still in its embryonic phase, and therefore it is nigh on impossible to estimate its impact on Diageo’s operations.

*Clean Lifers, an emergent cohort, are highly educated young consumers that adopt minimalist, ‘clean-living’ lifestyles – they usually reject alcohol, tobacco, cannabis, and any other recreational drugs; they reject animal-based products, and they reject superfluous and uninformed spending.

9. Has Diageo been able to consistently increase sales over the past 5 years? Neutral: 0 Points

Without some measure of tangible revenue growth, it becomes hard to differentiate between a low-return business and a high-return one – after all, the value of a business is based on the distributable cash it will generate in the future, and the amount of generated cash will depend both on the company’s cash returns and on its sales trajectory.

The ‘quality’ of this growth is also relevant, as earnings originating from organic sales are obviously more valuable than earnings originating from mere cost-cutting initiatives. So, how is Diageo currently producing its earnings and cash flow? As part of an objective to improve efficiency and productivity, Diageo has indeed committed to saving approximately USD 800 million over the next few years; nonetheless, according to the company, about two-thirds of those efficiencies will be plowed back into the business to fuel further growth.

This seems a sensible move, as increasing efficiency is always desirable but slashing sales and marketing costs too abruptly can atrophy the muscle needed to move the company forward, as was recently seen with Kraft Heinz. In fact, aggressive cost-saving targets can be hazardous because they may tempt management to scale back value-creating organic growth initiatives – such as settling new markets – in favor of some sort of inorganic expansion.

Fortunately, Diageo’s latest quarterly results showed that the company was able to grow sales organically and not just through inorganic initiatives. Beating expectations, organic sales grew by 7.5%, helped by price hikes, by larger volumes, and by a favorable mix. In Asia Pacific and in North America – the company’s most important geographies – net sales grew by 8%, which is a notable result for a slow-moving firm. In contrast, Europe and Latin America only posted 2% and 4% growth, respectively.

Africa, in turn, took the middle ground by recording 6% growth. In the United States, the company’s single largest market, net sales dilated by 5% thanks in large part to White Walker, a Johnnie Walker extension. After a period of worrying decline, sales of vodka finally steadied – Cîroc and Smirnoff continued to underperform, but the premium Ketel One brand rose by about 22% on the back of a ‘botanical’ variant that was welcomed by consumers (this ‘botanical’ boost is probably an ephemeral phenomenon, though).

The company also delivered solid performance in gin (up 29%), in beer and in tequila: surprisingly, Guinness posted a 13% improvement, while both Don Julio and Casamigos brought double-digit growth to their superpremium category (but Casamigos is still far from justifying the price paid by Diageo). On their part, net sales of rum declined by 3% due to a sizable drop in Captain Morgan net sales across the North American space; outside the U.S., however, net sales of Captain Morgan were actually up by about 4%.

Now, management continues to envision mid-single-digit growth and expanding margins for the current year. Despite these latest results, the company’s sales trajectory has been somewhat uninspiring during the last decade – without a doubt, the firm has been more cyclical than it should be considering its defensive characteristics: between 2014 and 2016, excess inventory combined with currency devaluations and a downturn in emerging markets deeply affected the business, and in particular the Scotch category. Even though the company has developed price ladders for its Scotch offerings, this area of the business was still hit by the turmoil suffered by emerging economies due, in large measure, to affordability problems (which shows that premiumization comes with risks).

10. Does Diageo exhibit a high degree of pricing power? Yes: 1 Point

Warren Buffett once said that “The single most important decision in evaluating a business is pricing power”. It is indeed, because pricing power is a barometer of a company’s overall health and competitiveness, as well as a crucial aspect of its future performance: without the capacity to raise prices, a firm’s profitability is bound to suffer, and that in turn will impact its ability to grow, to reinvest and to return capital for shareholders. In this regard, and under standard conditions, exhibiting the highest intra-industry gross profit margins typically indicates the company with the highest pricing power within its industry (but not always, of course).

Diageo’s gross margins do not fit this criterion, as they are lower than the margins of Pernod and much lower than the margins of Brown-Forman (but, as mentioned, Diageo’s beer business is decretive to margins); yet, pricing power – a vague concept – cannot be appraised solely through gross margins, as it must also take into account both market share fluctuations (which are roughly reflected on growing or slowing revenues) and returns on invested capital (because no company is able to produce above-normal returns when rivals are eating away profits).

But, as seen before, on the CROIC front Diageo is doing worse than Brown-Forman: when goodwill and other non-operating items are removed from the equation to obtain cash returns on operating capital, Diageo is only able to reach an average 5-year cash return of 13.4%, whereas Brown-Forman reaches returns close to 20%. However, as shown above, the company is now performing more strongly on the sales front, as it was able to increase revenues both through higher prices and through larger volumes (arguably, within the consumer defensive sector, volume expansion is at least as important as price increases).

However, growth boosters such as price hikes aren't something a business normally implements several times per year (and in the periods when price increases take hold there is an outsized and temporary impact on growth); moreover, continuous price increases in isolation are not a sustainable way to promote long-term growth, as the latest performance of companies like Altria () and British American Tobacco (NYSE:) can testify.

But, because volume growth remains constrained in developed countries, this capacity to increase prices is becoming even more crucial for driving sales growth. As consumers move up the quality continuum and choose higher value-added spirits over run-of-the-mill brands, the premiumization trend should then continue to benefit top-tier producers like Diageo – after all, premium brands command significantly higher prices and only marginally higher production costs.

What’s more, as is generally the case, retail prices of spirits are well-known determinants of demand: at lower price points, discounts can enhance the demand for cheaper spirits relative to alternatives like wine and beer but, at premium price points, discounts may diminish the perceived quality (and therefore the demand) of a given brand. Indeed, premium alcoholic beverages often perform as ‘Veblen goods’*. All this seems to favor Diageo, as premium core brands account for roughly two-thirds of its net sales.

* ‘Veblen goods’ are most often luxury products for which the demand increases as their price increases – companies like Richemont (), for example, frequently benefit from this anomaly of the law of demand.

11. Is Diageo highly productive and efficient relative to its assets? No: -1 Point

The ratio between gross profits and total assets can reveal a lot about how efficient and productive a company really is. Since it uses top-line results in the numerator, this parameter is usually regarded as a ‘cleaner’ measure of true economic productivity – and that is one of the reasons why gross profits are used to estimate economic productivity instead of earnings or free cash flow. The second reason is that gross profits are also not impacted by investments (like R&D) incurred to improve a firm's competitive edge.

Indeed, a company that exhibits lower production costs (i.e. higher gross margins) and improving sales should be considered as being more productive than a rival with higher costs and slowing sales; however, the more productive firm can still have lower earnings than this (apparently better) competitor if it is increasing sales through the organic development of superior services and products. So, how productive is then Diageo relative to its assets when compared against its competitors? It is not very productive.

In very general terms, the highest-quality firms tend to exceed a ratio of 1:3 between gross profits and total assets, respectively (but this is not a rule set in stone, though, because different industries tend to display different average ratios: an asset-light software company like Intuit () will always display a higher ratio than an asset-heavy firm like Diageo). However, by this standard, only Brown-Forman breaches comfortably the minimum 33% threshold to be considered a company of the highest quality along the gross profitability dimension.

The same cannot be said regarding Diageo: the company was openly acquisitive as it battled for supremacy over the last decade, and therefore it saw its non-current assets inflate by about 80% between 2009 and 2018. Now, this asset inflation is weighing on the firm’s gross profitability. The same problem is also affecting Campari and Pernod Ricard. Will Diageo ever make a decent return on its investments, or will it incur a write-down just like Kraft Heinz Co incurred?

For Diageo, the situation wouldn’t be so bothersome if cash and cash equivalents made up a sizable portion of total assets. But Diageo is not a particularly cash-rich company, as cash only accounts for 3% of total assets. However, concerning its substantial assets, it is not all bad for Diageo because depreciation in the spirits industry is moderate – while capital investment is high at the beginning, the realization of economies of scale means that the cost of employing this capital is reduced over time.

The company has also invested heavily in maturing stock since 2007, but now these investments are starting to ease. On the dark side, though, capital-intensive companies usually find it harder to grow fast because they need to invest heavily in such assets today in order to generate cash flow tomorrow. And if assets in place generate only moderate cash returns on capital – as in Diageo’s case – the company is more likely to fund its expansion using debt, which seems to be what Diageo has been doing.

12. Is Diageo financially strong? Neutral: 0 Points

Can Diageo easily cover payments on its outstanding corporate debt? According to Moody’s it can, as the credit ratings agency assigns a relatively positive A3 long-term rating to Diageo, with a stable outlook. However, long-term debt and other long-term liabilities account for nearly half (46%) of the company’s total current liabilities. On aggregate, this is translated in a high debt-to-equity ratio of 1.10 and in a rather low cash-to-debt ratio of 0.13, as well as in quick and current ratios of only 0.72 and 1.48, respectively.

Despite these subdued figures, operating income still covers 9.5 times the firm's interest expense. The company's current Altman Z-Score of ‘3.7’ places Diageo inside the 'safe zone’, and shows that the firm is nowhere near bankruptcy; at the present, Diageo also has an adequate if unspectacular Piotroski F-Score of '7' (out of 9) that is being penalized by higher year-over-year leverage and by a lower year-over-year asset turnover.

Diageo is a stable and profitable company operating within a non-volatile sector, and therefore higher levels of debt are not automatically a problem. Of course, in the event of an economic downturn, there is always the possibility that holding such relatively high leverage could create difficulties for Diageo. Moreover, high debt levels can prevent the company from pursuing a countercyclical M&A strategy.

Diageo| Valuation

Relative Valuation: With a free cash yield of only 4% and an earnings yield of 4.33%, Diageo certainly doesn’t seem cheap. The company’s EV/EBITDA is also quite high at 18.2; indeed, Diageo is now exhibiting its highest relative valuation of the past 10 years. Nothing is pointing to favorable mispricing here.

Absolute Valuation (Discounted Cash Flow Analysis)

Estimation of Operating Cash Profits | Main Assumptions

Revenues: On average, the model expects revenues to grow at about 3.6%-4.6% per year over the next 5 years, just slightly ahead of the historical growth rate for the global spirits market (admittedly, this is a somewhat conservative assumption). Reasons: Diageo will probably benefit from its solid and expanding position in premium spirits, from its investments in forthcoming craft brands, and from consumer loyalty among older demographic cohorts. The model assumes that sales expansion will primarily be fuelled by the large and growing Indian and Chinese markets. The North American space will remain Diageo’s main cash cow. However, Pernod and a multitude of craft producers will continue to exert strong competitive pressure on Diageo across the Asia Pacific and North American regions, respectively.

Sales of vodka (which is the beverage generating the highest returns across the business), as well as sales of rum and RTDs, are expected to flatten or to marginally decay but premium gin and tequila will possibly help pick up the slack going forward. The pressure on the all-important vodka sales (particularly on the sales of Smirnoff) will continue unabated thanks to the rise of independent brands like Tito’s Handmade Vodka. Of course, Scotch (which is projected to expand at a CAGR of 3%-5% up to 2022) will remain Diageo’s most important category.

Cost of Goods Sold | Gross Margins: Purchases of raw and packaging materials like glass, wheat and malted barley account for the largest single cost component for distillers. The prices of such commodities can be notoriously volatile and thus virtually impossible to estimate with any accuracy. For instance, the production of soft wheat – which is grown in higher latitude areas – can suffer an outsized impact from rising average global temperatures, which in turn can decrease its yields and augment its prices. For premium spirits, though, such purchases make up a smaller proportion of revenue; in contrast, regarding such higher-priced distillates, marketing costs (see below) become generally higher. Contrary to the past, labor costs are now only moderate and are continuously decreasing throughout the sector thanks to higher levels of efficiency and automation.

Buyers of premium spirits are not overly price-sensitive and therefore Diageo will probably be able to mark up its main goods to obtain roughly the same levels of gross profits. On top of that, Diageo’s cost-savings program will also probably drive margins slightly higher going forward. It should be noted, however, that premium Scotch’s higher pricing power is not always enough to offset the costs imposed by its very long maturing requirements and by its higher working capital intensity; it’s the opposite case concerning regular vodka, a category in which Diageo is losing ground at an upsetting rate (vodka generates lower profit margins but it also benefits from much higher asset turns). Considering all of the above factors, the model assumes gross margins within the 61.5%-62.5% range. A disposal of the entire beer business would improve profitability but such a move seems for now unlikely given its strategic importance for the group.

Sales, General, and Administrative expenses | Operating Margins: SG&A expenses in this industry can be substantial, as distillers often need to reinvest a large chunk of their gross margins into maintaining brand awareness. Without a doubt, the capacity to advertise on a massive scale is perhaps one of the most relevant factors separating the industry's top producers from all of the others. However, with the rise of social media advertising, this barrier is gradually being dismantled by nimbler producers: from Molson Coors () to General Mills () and Campbell Soup (), every incumbent within the consumer staples sector can testify to that.

Being so, renewed advertising campaigns are a necessity to keep the existing customer base and to appeal to prospective new buyers, which in turn means that marketing costs won’t abate anytime soon. In fact, up to 60% of younger buyers do not have a specific brand in mind when they are looking to buy liquor. Selling and administrative outlays are also significant for distillers, and include costs like promotions, discounts to retailers, and legal expenses. On average, over the past 5 years, Diageo has spent about 33% of its revenues on SG&A and related expenses. Considering all of the above, as well as the necessity to boost its marketing efforts in order to restore vodka to growth, the model assumes an uptick in SG&A expenses equivalent to 34%-35% of sales, which means that operating margins will fall largely within the 29.5%-30.5% range.

Estimation of Operating Cash Investments | Main Assumptions: The model assumes that the sum of capital expenditures investments with the changes in working capital will reach a level equivalent to 16%-23% of operating income, on average, per year. Diageo’s capex as a percentage of operating income has been trending down since 2014, which is in large part a reflection of past investments. Diageo now holds Scotch inventory levels roughly equivalent to 8-10 years of demand (which are higher than competitors’ levels), and so it won’t need to invest as much in inventory as it did during the recent past. This will probably facilitate asset turns in the medium term, as well. On their part, working capital requirements are still high but they are not increasing. Diageo’s reinvestment rate – including the investments in acquisitions – over the last decade has also been high (averaging 62% of the cumulative free cash flow generated between 2009 and 2018) but this rate should decrease as the industry consolidates. The model expects a reinvestment rate equivalent to 45%-55% of free cash flow over the next 5 years.

Terminal Growth Rate, Estimation of Cost of Capital and Fair Value: To keep assumptions conservative, the DCF model assumes a WACC within the 7.0% + (± 1.5%) range. The model also assumes a terminal growth rate between 2% and 3%. Subsequent to a sensitivity analysis, the valuation model conveys a present-day fair value estimate range between USD 128 and 140 per share (for the American Depositary Receipts), implying that Diageo is currently overvalued.

Conclusion

The final Quality Score for Diageo is 5 hors de 12 possible points. Diageo is a good company overall, but it could be much better. From age-old iconic brands to countless distilleries, and to a gigantic global distribution network, Diageo possesses a wealth of enviable assets. Diageo is also the most dominant company in an established and lucrative arena, it operates within a defensive industry largely insulated from the hardships faced by other consumer-facing businesses, and it has broad exposure to fast-growing emerging markets.

However, despite its undeniable strengths, the company’s performance over the past 10 years has been somewhat unremarkable. For instance, Diageo’s revenue per share only increased by 31% over the last decade, whereas Brown-Forman and Campari were able to grow their revenues per share by 54% and 67% during the same period, respectively. Only Pernod did worse, as revenues on a per share basis only grew by a meager 13% between 2009 and 2018.

Of course, the firm’s dividends, earnings, and cash flow can expand faster than sales for a few years but, ultimately, sales growth is what determines the faith of any business. Will Diageo be able to maintain its newfound sales momentum over the next few years? And will it be able to extract higher profits and returns from those sales? The tailwind provided by sterling’s weakness against most major currencies won’t last forever. Currently, Diageo’s combination of relatively high levels of debt, very acquisitive nature, and middling cash returns on capital do not make the most compelling of investment cases.

It looks as though Diageo knows what to do to stay ahead of competitors, but it doesn’t know how to do it properly (it is a problem of execution, then: as one author puts it “distilling is like composing music…the notes are the same, but how you play them makes all the difference”).

Above all, the company needs to start executing more effectively against its ambitious premiumization strategy – indeed, Diageo should know that, besides good execution, it also takes a brilliant (or perverse) mind to think of mixing gin, rum, soda, vodka, tequila and triple sec to come up with a delicious & harmonious Long Island Ice Tea. An equally adventurous mix of distinct premium brands is presently being assembled by Diageo: will the company’s concoction finally delight long-term shareholders? As it stands now, and to paraphrase whisky-loving Queen Victoria, “We are not amused” with Diageo.

Divulgation: I am/we are long DEO, BF.B. J'ai écrit cet article moi-même et il exprime mes propres opinions. Je ne reçois pas de compensation pour cela (autre que de Seeking Alpha). Je n'ai aucune relation d'affaires avec une société dont les actions sont mentionnées dans cet article.