Should I Buy Diageo?

Published in Company Comment on 14 September 2012

Harvey Jones weighs up Diageo (LSE: DGE).

It's time to go shopping for shares again, but where to start? Bombed-out bank RBS (LSE: RBS)? Merger maniacs BAE Systems (LSE: BA)? Or maybe out-of-favour fashion giant Burberry (LSE: BRBY)?

There are plenty of great stocks to choose from, and I'm enjoying doing some window shopping. So here's the question I'm asking right now. Should I buy Diageo (LSE: DGE) (NYSE: DEO.US)?

Drink up!

I first bought Diageo in May 2010, but it took me time to acquire a taste for this international spirits and brewing company. Despite serving up a small measure of growth with a modest 3% dividend chaser, I still couldn't get excited about it. Still, I held on, thinking the odd drink can't do you any harm -- and I'm delighted I did. While other FTSE 100 (UKX) stocks have had their weak moments, this well-run company has gone from strength to strength. It is up 50% over the last 12 months, while the FTSE 100 has grown less than 20%. I'll drink to that kind of success; the question now is, do I want a top up?

Alcoprofits

Diageo packs quite a punch. It is truly a global company, operating in 180 countries, with a whole barrel of famous brands, including Johnnie Walker, Smirnoff, Baileys, Tanqueray, Captain Morgan and Guinness. That's quite a drinks list.

2012 has gone very smoothly. Diageo posted pre-tax profits £3.12 billion in the 12 months to 30 June, a rise of 32%, with revenue up 10% to £14.6 billion.

That's good news for chief executive Paul Walsh. His performance-linked pay shot up to £11.2 million this year, from a mere £4.4 million last year, but unlike some executives, he is being rewarded for success rather than failure. Diageo is also the first major company to comply with the Coalition's demands for disclosing executive pay.

Thirsty work

European sales may have soured but this has been more than offset by thirsty emerging markets in Asia, Africa and Latin America, which now make up 40% of Diageo's business. Net emerging market sales rose 15% and operating profits increased by more than 20%. By 2015, the company expects emerging markets to make up more than 50% of its business.

As I reported yesterday, the Chinese may be thinking twice about splashing out on luxury brands such as Burberry, but in good times or bad, most people will still pay for one of life's little luxuries: alcohol.

This cash-rich company is also investing in its future. It is investing more than £1 billion in the Scotch whisky renaissance, while Johnnie Walker is going down a treat in the US, where Diageo is nicely placed to benefit from a QE3-fuelled recovery. Europe, where it still generates roughly one-third of its profits, is more of a worry.

A pricey round

It isn't all fun, fun, fun. The rising cost of raw materials, such as wheat and barley, could prove a downer, as could further gloom in Europe. The company also has significant foreign exchange exposure, a worry in this turbulent time for currencies.

My biggest concern is that Diageo is getting expensive. It now trades on a price-to-earnings ratio of 17.4 times earnings. Despite its progressive dividend policy, which included an 8% hike this year, the surging share price means that you are buying a modest yield of 2.6% (covered 2.2 times).

I'm delighted I ordered a slug of Diageo in 2010. But at these prices, I'm in no hurry to order another round.

Yield to the yield

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> Harvey holds Diageo. He doesn't own any other shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

richjfool 14 Sep 2012 , 2:07pm

Harvey,

I take it you don't plan to take any profits either though?

goodlifer 16 Sep 2012 , 12:24pm

If I held any, which I don't, I wouldn't consider selling unless they climbed to 20 or more times earnings.

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