Diageo profits halve as pandemic hits bars

Johnnie Walker and Guinness owner was dealt a blow by coronavirus, but expects a better second half as restrictions ease.

Investors in need of a pick-me-up after the BP (LSE:BP.) dividend cut were disappointed by Diageo (LSE:DGE) today after the Johnnie Walker whisky maker's annual results led to a round of earnings downgrades.

Like BP, which cut its dividend by half earlier today, FTSE 100-listed Diageo is a popular choice for investment portfolios due to the quality of its earnings, strong brands and reliable cash flows.

Despite its full-year dividend being kept at 42.47p a share, the stock tumbled 6% to 2,710p as weaker-than-expected results and the ongoing uncertainty caused by Covid-19 sales disruption prompted City analysts to revisit their estimates for the new financial year.

Jefferies described the outlook as “murky”, with Diageo's premium rating under threat if sales in the first half of the year continue to disappoint. Shares have been trading on about 24 times 2021 earnings, which is some 11% above other stocks in European beverages.

This premium rating reflects Diageo's record of 15 years of dividend growth, which continued today thanks to the rise in the interim dividend earlier this year. But this is only part of the story in terms of shareholder returns, with a three-year £4.5 billion share buy-back programme on hold due to the need to conserve cash during the Covid-19 pandemic.

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Unsurprisingly, the recent closure of bars and restaurants in cities around the globe has dealt a significant blow to the maker of Baileys and Smirnoff. The on-trade (pubs/bars/clubs) accounts for an estimated 20% of sales in the United States and about half of European business.

Having started the financial year on the front foot, Diageo's net sales across the period to June 30 ended up being almost 9% lower at £11.8 billion. This included declines of 22% and 16% respectively for two of the ‘global giants’ in its portfolio — Johnnie Walker and Guinness.

Operating profits slumped 47% to £2.1 billion, with the results including a non-cash impairment of £1.3 billion to reflect the impact of Covid-19 in India, Nigeria and elsewhere.

Analysts at Morgan Stanley noted that all Diageo's key regions bar North America missed expectations in the results. They expect an improvement in sales as lockdown restrictions are eased, but with some margin dilution still likely in the second half of 2020. The first half of the financial year typically accounts for 60% of Diageo’s annual profits.

Diageo chief executive Ivan Menezes sounded a cautious note in the results, warning that volatility will continue in the 2021 financial year. However, he said actions to strengthen Diageo over the past six years meant the company was better placed to manage the impact of the pandemic. He says:

“We are now a more agile, efficient and effective business.”

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Menezes pointed to the example of using data analytics and technology to better respond to local consumer and customer shifts triggered by the pandemic. A strong liquidity position also means Diageo has the flexibility to continue to invest in the business for the long term.

The consensus for 2021 earnings has already come down sharply, but analysts at Jefferies think the City's current 2021 revenues estimate of £12.3 billion may still prove to be too high.

They added:

“Whilst there is a lot to like about the business given its brands, route to market and strong management, shares are at peak multiples and the growth outlook is murky. We see a risk to the premium rating if a slower growth picture is accompanied by negative earnings revisions for F21.”

Jefferies had a price target of 2,200p prior to today's update, whereas Morgan Stanley was at 2,470p. The stock had been trading at 3,200p in February.