Diageo’s troubles in Latin America blindsided investors. They may have been hoping for fresh ideas from the new boss to steer the drinks giant through a stormy macroeconomic picture.
Debra Crew, chief executive since June, left sales targets untouched in her first capital markets day — the strategy for expanding products by country and flavour, as well as pushing more premium spirits, remains the same.
A lowering of adjusted profit growth guidance to be in line with sales, rather than between 6 and 9 per cent, was to reflect “a realistic and transparent view” of choppy trading conditions, Crew told investors.
The shares dropped another 3 per cent in the aftermath of the update, compounding last week’s sell-off. It left them down by almost a quarter since the start of the year, which translates to a forward earnings ratio of 17. That is about the cheapest valuation in almost a decade.
Loose guidance does not help confidence. Organic sales growth of between 5 and 7 per cent is being targeted over the medium term. That is a goal that was raised in January, from 4 to 6 per cent, by Ivan Menezes, the former chief executive, who died suddenly in June.
It is hoping to match that pace in operating profit growth over a similar period before profits kick higher than sales as inflation eases and the benefits of better supply arrangements have more of an impact.
However, there is no exact guidance for this year.
Problems in Latin America mean that sales during the first six months will no longer grow faster than the same period last year and operating profits will decline. The group then expects both metrics to improve in the second half of the year.
This year performance is likely to fall short of the its medium-term targets.
Latin America and the Caribbean, which accounts for 11 per cent of total group sales, will be a major drag. Inventory levels in September and last month came in far higher than expected. Sales in the region are set to be down by a whopping
20 per cent during the first half of this year.
Analysts think organic sales growth will trough during the first half of the financial year, at 1.5 per cent, before improving to 4.3 per cent in the latter half for an overall turnout of 1.8 per cent.
The question, as analysts at Jefferies, the bank, put it, is whether Latin America is the canary in the coalmine. Could other markets give up more of their pandemic gains?
North America is an issue. Diageo is no longer taking share in what is its largest market. In the past financial year, volumes were 5 per cent lower and prices held, which meant underlying sales in the region were flat on the previous year.
There has been a “sequential” improvement in North America, it said, and net sales should be higher in the first half of the year, compared with the latter six months of last year. Structural growth of 3 to 4 per cent in the spirits market in the United States is a cushion.
Judging by its longer-term record, medium-term sales targets of 5 to 7 per cent may be a push. Covid caused sales to boom as consumers were flush with cash and locked down — but in the five years before, it produced organic sales growth of at best 6 per cent, in 2019, but below 5 per cent in the four years before.
The question is whether Crew needs to push marketing and development spend in the hope of achieving punchier sales targets. It has been investing in advertising ahead of the rate of sales growth.
Diageo has rock-solid brands with history, which is a good base for pushing into new markets. It might just cost more to achieve ambitious sales growth targets right now.
Advice Hold
Why A cheap valuation compensates for the near-term risk
Close Brothers
In times of economic stress, Close Brothers has in the past maintained a chunky premium. Not any longer. The challenger bank is known for continuing to lend when heightened risk causes others to pull back. A stronger stomach is one reason why the specialist lender’s loan book has continued growing and it has earned itself a fat net interest margin, which stood at 7.6 per cent in the first quarter.
A reputation for sturdiness has been superseded by more recent unfortunate events. A decision to wind down its litigation finance business, Novitas, in 2021 has damaged credibility. Thus far, provisions taken against the business amount to £184 million. That is equivalent to a sizeable 75 per cent of the outstanding loan book.
The move was made after loans from claimants took longer than expected to recoup, were lower in value and insurers failed to pay out. Close Brothers has settled with one insurer, is in a legal dispute with another and in negotiations with the remaining party. If the latter is successful, there is the chance that some of the provisions could be written back.
Cost growth, which was guided higher at between 8 and 10 per cent for this year, is unhelpful. But analysts think the cost-to-income will reduce slightly this year to 65.7 per cent, from 65.9 per cent last year.
The shares are valued at a 24 per cent discount to the tangible book value forecast for the bank in 12 months’ time, the lowest in at least 13 years.
Speculation remains over whether a sale of the ailing asset management business is likely. Rocky markets offset net inflows in the first quarter, sending assets under management lower again, from £17.3 billion to £17 billion. The business could fetch about £330 million, RBC Capital thinks. A disposal would be an easy way to win back investors’ favour. Until then, there is a generous dividend to compensate them.
Analysts have forecast a payment of 68.58p, which leaves the shares offering a potential yield of 9 per cent at the current price. That is backed by a plentiful common equity tier one ratio of 12.7 per cent. Coming good on dividend forecasts would restore confidence.
Advice Buy
Why The shares look too cheap in light of the dividend
