Diageo (DEO) Rises 22% in a Year: Will It Sustain Momentum?

Diageo plc DEO is benefiting from strong fundamentals, continuous innovation and focus on expansion despite soft industry trends. The company’s focus on achieving growth via acquisitions is also yielding results. Further, Diageo remains focused on expanding the fastest-growing premium spirits brands by resource optimization, which should drive growth and boost shareholder value.

These factors largely drove the company’s results in recent years. Consequently, the Diageo stock has rallied 22% in the past year compared with the industry’s growth of 21.6%.

Moreover, the Zacks Rank #3 (Hold) company has been benefiting from strong organic growth, driven by broad-based sales gains across all regions and categories.

Factors Narrating Diageo’s Growth Story

The company continuously explores opportunities to expand geographically through acquisitions to further strengthen its exposure in the fast-growing categories. In sync with this strategy, it increased its shareholding in Shui Jing Fang from 40% to just over 63% in fiscal 2019. This enhanced its presence in the premium Baijiu segment. Further, the company acquired the fastest-growing premium tequila brand in the United States, Casamigos, in August 2017, which boosted its market share in the tequila category.

Prior to this, Diageo enhanced its portfolio with the acquisition of a 26% stake in India’s leading brewer, United Spirits Limited (in July 2014), and the premium brand, De Leon Comb Wine & Spirits (in fiscal 2014). Additionally, Diageo’s distribution deal with Minnesota-based broker, United Brokerage, Inc., in 2013 solidifies its position in traditional markets.

Meanwhile, Diageo has been divesting assets to enhance its portfolio — including the recent divestiture of 19 brands to Sazerac. The divestiture will enable Diageo to focus on the premium and above-premium brands, with stronger growth and profit opportunities.

We believe that the company’s expansion and innovation efforts along with robust organic growth trend instill confidence in reaching its medium-term targets. Notably, its organic operating margin expanded 83 basis points (bps) in fiscal 2019, marking a 198-bps organic operating margin expansion over the last three years. The expansion was above the company’s long-term organic operating margin guidance of a 175-bps improvement from fiscal 2017 through 2019.

Backed by better-than-expected performances over the last three years, Diageo reiterated its medium-term guidance for fiscal 2020-2022, which was announced in May 2019. The company continues to expect mid-single-digit organic net sales growth between fiscal 2020 and 2022. Further, it expects to sustainably grow organic operating profit by 5-7%, suggesting growth of 1% ahead of net sales.

Apart from these, the company, like most other multinationals, is turning its attention to the emerging markets. It is the leading international spirits company in the emerging markets of Africa, Latin America and Asia. Moreover, Diageo caters to the local tastes of the regions. Its products like Johnnie Walker Blue Label bottle, which was designed through a series of exclusive private tasting in China, India, Thailand, Vietnam, Brazil and Mexico along with local cultural relevance, testify this strategy.

Moreover, the acquisition of United Spirits extended Diageo’s reach to one of the most populous countries, with growing middle-class population and beer consumption trends. With the opening of the first Johnnie Walker House in Seoul in October 2013, Diageo was able to boost sales in Korea.

Possible Deterrents

The company is witnessing pressures from cost inflation and higher marketing expenses. In fiscal 2019, marketing spends increased 8%, reflecting a 22-bps increase as a percentage of sales. This resulted from increased marketing investment in all regions, with the largest investments in US Spirits.

Notably, the company’s overall rate of marketing investments over the past two years has risen nearly 50 bps, owing to increased investments in marketing and new technology to build a sustainable growth platform. Moreover, it expects an increase in marketing investment rate in fiscal 2020 on sustaining gains witnessed in the US Spirits segment through investments in new brands.

In addition, while Diageo reiterated its medium-term view, it expects a slowdown in sales growth in fiscal 2020, owing to the lapping of several successful innovation launches in fiscal 2019. For fiscal 2020, the company anticipates net sales growth at the mid-point of 4-6%, whereas it recorded 5.8% gain in fiscal 2019.

We believe that the aforementioned factors will offset these hurdles and help the stock sustain momentum. Currently, the company has a Momentum Score of A.

3 Better-Ranked Beverage Stocks

Coca-Cola FEMSA, S.A.B. de C.V. KOF has a long-term earnings growth rate of 9.1%. It currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Keurig Dr Pepper Inc KDP presently has an expected long-term earnings growth rate of 15.2% and a Zacks Rank #2.

Luckin Coffee Inc LK delivered a positive earnings surprise of 13.5% in the last reported quarter. Currently, it carries a Zacks Rank #2.

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