Diageo performs admirably amid the gloom

It’s curious that some market pundits view investing in sin stocks as opportunistic. Analysis of Diageo’s (DGE) full-year figures make it plain that there are solid underlying reasons why these stocks tend to fare well in times of economic uncertainty. As history has shown, consumers are quite willing to keep spending on items that provide distraction or solace when the economy goes to the dogs.

Diageo reported double-digit sales growth across it regions for FY2022 despite deteriorating conditions in the global economy. Overall sales were up by a fifth, partly a reflection of the recovery in the on-licence trade, although the drinks giant also highlighted strengthening organic growth and market share gains.

The top line also benefited from price inflation across all its locales, combined with a 10 per cent hike in volumes. Somewhat counterintuitively, it appears as if drinkers are prepared to outlay more cash to buy the group’s upscale offering. Management confirmed that “premiumisation” – a regrettable term – continues to drive consumer choices despite increased pressure on discretionary budgets.

Premium-plus brands contributed 57 per cent of reported net sales and drove 71 per cent of organic net sales growth – seemingly we can’t get enough of life’s little luxuries. It is perhaps significant that the group’s marketing spend increased by a quarter. This was not only ahead of the net organic sales growth rate, but also part of the reason why it has been successfully hawking its upmarket brands.

Input cost inflation has been a feature of the global economy even as growth rates falter. Yet Diageo reports that “price increases and supply productivity savings more than offset the absolute impact of cost inflation”. Presumably, the group, thus far, has been able to successfully pass costs through to consumers, evidenced by a two percentage point increase in the gross margin to 42 per cent. Profits at the operating level increased by 18 per cent to £4.41bn, while associated net cash flow increased by £0.3bn to £3.9bn. Free cash flow decreased slightly through the period, although comparisons are skewed due to “an exceptionally strong working capital benefit in fiscal 21”. And the group closed out the period with net borrowing equivalent to 2.5 times cash profits, which is at the low end of the target range.

Energy prices could dissipate through the remainder of this year, but that’s set against the likelihood of further grain price increases through FY23. The shares change hands at 23 times consensus earnings and the stock has obvious defensive characteristics, but there must be a limit to the group’s ability to pass through cost increases, even if alcohol products tend to be somewhat price inelastic. We can’t be sure whether the stock will breach the technical barrier of 4,000p a share, so back to hold.

Last IC View: Buy, 3,655p, 27 Jan 2022