Tequila and non-alcoholic Guinness doesn’t sound like the most alluring cocktail, but those two drinks are the latest star performers in the Diageo portfolio.
The drinks specialist behind Johnnie Walker whisky, Smirnoff vodka and Tanqueray gin pleased the stock market last week with a sparkling set of first-half results to the end of December. Reported net sales of £8 billion were up 15.8 per cent, with strong underlying growth partly offset by adverse foreign exchange movements. Organic net sales grew by a fifth across all regions, which, with a boost to the margin, translated into a 22.5 per cent rise in operating profit.
According to Ivan Menezes, the company’s chief executive: “We have made a strong start to 2021-22. While we expect near-term volatility to remain, including potential impacts from Covid-19, global supply chain constraints and rising cost inflation, I am confident in our ability to successfully navigate these disruptions through the remainder of the year.”
While supply blockages are likely to continue for a while, the company has learnt to adapt. Switching the taps on and off can be difficult when many of the products take years to mature, but Diageo’s answer is “demand-shaping”. With a combination of advertising and price variation, it switches consumer attention to well-stocked lines while stepping up production of scarcer items. The Johnnie Walker Experience in Edinburgh, which opened last September, has proved a smart move.
All that juggling is possible only because of strong underlying demand for premium alcoholic drinks, but that does not come out of thin air. People are consuming less booze, but the producer’s skill lies in persuading them to pay more for the indefinable feeling of sophistication that goes with an exclusive label. But that also pushed up Diageo’s latest half-year marketing spending by a quarter year-on-year to £1.35 billion. If it were to take its eye off the ball, there are plenty of competitors ready to take advantage.
Drinkers have been willing to upgrade to dearer variations after the lengthy closure of pubs and bars last year. Craft gin distillers have done well and Diageo has sought to capitalise on that trend. But it has also found winners elsewhere, with sales of tequila brands including Casamigos and Don Julio up 56 per cent during the final six months of last year. While the international tequila market is in its infancy, in Menezes’ view, the spirit “is making its way on to drinks and cocktail menus and bartenders are excited about it”.
The company is also alive to the growing demand for alcohol-free alternatives. Sales of the re-released Guinness 0.0 have been a hit during Dry January. Profit margins on alcohol-free items are promising, as consumers seem to take the price of the established alcoholic counterparts as their yardstick.
Menezes expects organic net sales to grow by a consistent 5 per cent to 7 per cent a year from now to June 2025 and organic operating profit to grow sustainably at 6 per cent to 9 per cent. The dividend carries a 2 per cent yield, but a history of increases offers reassuring hope of continued steady growth. At that level, it may not be for those needing high income now, but it is a firm base for investors taking a longer-term view.
The shares have suffered a hangover since reaching a record high of more than £40 at Christmas, as investors have shifted away from highly valued stocks. Diageo shares are not cheap, trading at about 26 times forecast earnings for this year, but versus peers that multiple looks less demanding.
ADVICE Buy
WHY A reliable performer in a competitive industry, and the shares will repay patience as supply constraints recede
Renewi
Renewi seems to be suffering from a credibility gap. A third-quarter update showed its commercial waste division performing “very well”, while the specialities and minerals and water businesses were in line with expectations, all of which was enough for underlying earnings guidance of €120 million for the year to the end of March, up from €73 million a year ago — yet it seems the market has doubts.
When this column reviewed the recycling specialist’s prospects in November, the shares briefly rose from 778p to 840p before sagging to 651p at one stage. An initial 13p gain after last week’s earnings upgrade shrank to 7p by close of trading, though the stock was steadier yesterday.
The company operates in six countries: the Netherlands, Belgium, Britain, France, Portugal and Hungary. It collects, sorts and processes waste, turning it into raw materials for the construction industry, a straightforward business with a fashionably green tint.
Renewi has been affected by the economic effects of the pandemic. Less activity, particularly in pubs and restaurants, means less waste, but while volumes fell, higher commodities prices meant higher prices for recyclate, as recycled materials are known. That alone is predicted to contribute €40 million to the current year’s underlying earnings.
The Dutch and Belgian governments are taxing carbon-belchers and are encouraging moves from burning waste to reusing it. In the longer term, the company is a well-managed bet on a more recycling-conscious commercial climate, but we are not yet out of the pandemic and labour costs are rising.
Martin Young, at Investec, the most bullish analyst covering the company, has argued that “an increasingly confident Renewi is heading in the right direction” and he has lifted his target share price from 840p to £10.40, as well as predicting a return to dividends at the full-year in March. But a forward price-earnings multiple of ten does not look particularly appealing, given the uncertain recovery in recycling volumes.
ADVICE Hold
WHY May be worth letting the bears exhaust themselves before buying
