Diageo Is Worth Toasting

By Sham Gad | January 14, 2010 AAA

U.K.-based Diageo (NYSE:DEO), the world's leading premium drinks company, may be one of most appealing businesses in the U.K. today. This $43 billion enterprise currently trades for $69 a share, commands a forward P/E ratio of less than 14 and pours out a 4.2% dividend yield at that. Yet despite these signs often associated with slow-growth, boring blue-chip type names, Diageo is anything but.

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Cheers!
Diageo's diverse portfolio of offerings is a perfect blend of global diversity and concentration. While spirits is the anchor for Diageo, the company generates 22% of its sales from beer, an amount significant enough to make Diageo a global player in the beer market. The company's beer business highlight is its global brand Guinness. Diageo's two biggest beer markets are Europe and Africa, but the company also has a meaningful presence in North America and Asia. (For more, see Beeronomics: Factors Affecting Your Pint.)

A Premium Choice
In terms of premium drinks, Diageo tops the list, easily eclipsing Brown-Forman (NYSE:BF-B), Bacardi, and Pernod. Diageo boasts the world's leading scotch, tequila and liqueur. Some of the most popular names in the spirits business - Smirnoff, Captain Morgan, Crown Royal, and Jose Cuervo - all fall under the Diageo umbrella. (For more, see Parched For Profits? Try Beverage Stocks.)

A Toast to Success
For a company of its size and depth, Diageo's valuation is attractive. It's been commonly accepted that products like spirits will do well in all economic climates. While the global economic downturn has affected all companies, Diageo was able to deliver 4% organic growth along with a 10% lift in earnings per share in 2009. The beverage business can be a very high cash-generative business if managed properly. One need look no further than Coca-Cola (NYSE:KO) over the past decades for proof.

Diageo has been no different. Since the company's birth in its present form in 1997, Diageo has returned over $25 billion, adjusting for exchange rates, in the form of share buybacks and dividend payouts, an amount that equates to over half of today's current market cap. The company boasts an operating margin of over 20% and generates nearly $2 billion in free cash flow each year. For fiscal 2009, return on invested capital, the ultimate measure of value creation, was nearly 15%, well above the company's current cost of capital.

An Attractive Valuation
Despite a stronger balance and higher margins, Diageo's valuation is a discount to bigger rival Anheuser-Busch InBev (NYSE:BUD), which currently trades for nearly 23 times earnings against 17 for Diageo. Factor in the 4% yield versus nothing for BUD, and U.K.'s Diageo may be the most attractive spirits business in the space today. Time will tell, but given the company's superior financial stability and record of strong operating results, investors may be toasting to Diageo's shares in the not too distant future. (For more, see Guard Your Portfolio With Defensive Stocks.)

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