When is the post-lockdown hangover going to ease up? For Diageo, it is a headache made worse by inflation dulling consumer spending. The heady rise in sales, boosted by demand for premium spirits by cooped-up consumers flush with cash has come thudding down. Volumes fell by just under 1 per cent over the latest 12 months, after a 10 per cent jump the year before.
The party was never going to last. Like other large consumer goods companies, Diageo has been forced to balance hefty inflation with maintaining demand. Price inflation and a further shift towards premium spirits pushed the top line forward by 6.5 per cent on an organic basis, a touch better than the 6.4 per cent analysts had expected.
Diageo is pivoting towards the growing spirits market, led by tequila and Scotch. The volume of tequila sales, which includes Don Julio and Casamigos, was an impressive 10 per cent higher last year, while Johnnie Walker, its core Scotch brand, increased sales by 2 per cent.
It is also pushing upmarket drinks. Organic sales of “premium-plus” brands, retailing at more than $50 a bottle, have increased at a compound annual rate of 17 per cent over the past four years, while value names are up by 3 per cent. The strategy is sound, even if moderation in the rate of growth for the most expensive brands is inevitable. The pace of demand for “premium-plus” slowed to 7 per cent last year.
That is hardly surprising at a time when customers are trading down. The proportion of Diageo’s business maintaining or growing market share stood at 70 per cent over the whole of last year, a worthy position for a group of Diageo’s scale and maturity. But that was down from 75 per cent in the first six months.
Caution is reflected in the market value, with the shares trading at 19 times forward earnings, a discount to the long-running average and below a pandemic peak of almost 30. But it is also an undemanding rating for a company that has delivered more than three times the return of the FTSE All-Share over the past decade at more than 60 per cent.
The state of the North American market, Diageo’s largest accounting for almost 40 per cent of global sales, is the biggest source of trepidation. Here, sales volumes fell 4 per cent, skewed by distributors restocking post-Covid. However, stockpiles have stopped building, which could draw a line under sagging sales. The increase in products being depleted is running two percentage points ahead of shipments, a better indication of demand than inventory levels.
Guidance on how the balance between inflation and sales will play out this year is vague. The company expects organic sales growth to accelerate from the second half. Analysts at RBC Capital think sales volumes will edge back into growth at 0.6 per cent, which, with higher prices and the shift towards premium brands, will translate into 5.2 per cent organic sales growth overall.
Diageo’s mid-term ambitions have not been dimmed by shaky consumer spending. In January it lifted three-year targets for both organic sales and operating profits. It is punching for underlying sales growth of 5 per cent to 7 per cent, up from the 4 per cent to 6 per cent previously, and operating profit growth of 6 per cent to 9 per cent.
Debra Crew, the new chief executive, has inherited a business in much fitter form than when her predecessor, Sir Ivan Menezes, took over. He sold off peripheral assets in the wine category as well as lower-end brands. Funding purchases will not be a problem, with the business throwing off another £1.8 billion in free cash last year. The question is whether she increases marketing spending to push sales forward faster.
ADVICE Buy
WHY Could benefit further from pivoting towards the growing spirits market
HSBC
The fruits of rising interest rates keep coming, at least for the biggest lenders. HSBC has become the latest London-listed bank to beef up its guidance, now bracing investors for a return on tangible equity in the mid-teens this year and the next, more bullish than a previous expectation of at least 12 per cent.
Some of the spoils will be handed back to shareholders, with another $2 billion in share buybacks, taking the total for the year to $4 billion, larger than anticipated. Investors also can look forward to a meaty dividend, with analysts at Shore Capital forecasting a payment of 55 cents a share this year. Returns next year should also benefit from a 21 cents special dividend from the sale of its Canadian business.
Capital levels support beefy returns. Gains made on the acquisition of Silicon Valley Bank UK helped to push the common equity tier one ratio up to 14.7 per cent, above the top end of an internal target range.
HSBC is a more complex prospect than counterparts such as Lloyds, NatWest or even Barclays. It is a play on the fortunes of the Chinese economy, as well as the rapidly growing middle class in Asia. About $300 million of the $1.3 billion in impairments taken over the first six months of the year related to the Chinese commercial property market, but the overall impairment allowance was broadly in line with historical norms at 0.28 per cent of average loans. The gains to be reaped from the reopening of the Chinese economy have been focused on more keenly since the start of this year. That has driven the shares higher and narrowed the discount versus the tangible book value for the bank at the end of this year to only 5 per cent.
The lower use of structural hedges, essentially multibillion-pound portfolios of derivatives and bonds designed to smooth income, means that HSBC feels the impact of rising interest rates more quickly. With the focus turning to when interest rates will peak, banks might need an alternative narrative for investors to grasp on to. Sentiment towards HSBC will rest more on any pick-up in the Chinese economy.
ADVICE Hold
WHY Shares offer a generous dividend but the Chinese economy remains shaky
