DEO Stock Study (10-13-23)

Posted by Mark on January 11, 2024 at 06:41 | Last modified: October 13, 2023 10:52

I recently did a stock study on Diageo PLC ADR (DEO) with a closing price of $151.30.

M* writes:

     > The product of a merger between Grand Metropolitan and Guinness
     > in 1997, Diageo is one of the world’s leading producers of branded
     > premium spirits, approximately level with Kweichow Moutai in
     > revenue terms. It also produces and markets beer and wine. Brands
     > include Johnnie Walker blended scotch, Smirnoff vodka, Crown Royal
     > Canadian whiskey, Captain Morgan rum, Casamigos tequila, Tanqueray
     > gin, Baileys Irish Cream, and Guinness stout. Diageo also owns 34%
     > of premium champagne and cognac maker Moet Hennessy, a
     > subsidiary of French luxury-goods maker LVMH Moet Hennessy-Louis
     > Vuitton, and a near-56% stake in India’s United Spirits.

Over the past decade excluding 2020 (COVID-19), this large-size company has grown sales and EPS at annualized rates of 2.6% and 3.3%, respectively (2.2% and 1.8% including ’20). Lines are somewhat up, straight, and parallel with sales declines in ’16 and ’17 along with EPS declines in ’15, ’16, and ’21. A question can be asked about whether this is high-quality growth. I listed several YOY declines. Some would also say a large company with a sub-5.0% historical/projected growth rate is suspect.

Over the past decade, PTPM trails industry averages (peer data not available) while ranging from 17.4% in ’20 to 32.9% in ’19 with a last-5-year mean of 27.1%. ROE trails industry averages despite trending higher from 31.6% (’14) to 43.2% (’23) with a last-5-year mean of 35.9%. Debt-to-Capital is lower than industry averages despite increasing from 58.2% (’14) to 68.4% (’23) for a last-5-year mean of 67.4%.

Interest Coverage is 7.0 and Quick Ratio is 0.5. Value Line rates the company A for Financial Strength and M* gives a “Standard” rating for Capital Allocation.

With regard to sales growth:

• CNN Business projects 1.4% YOY and 3.4% per year for ’24 (FY ends Jun 30) and ’23-’25 (based on 22 analysts).
• Zacks projects YOY 9.9% and 5.3% growth for ’24 and ’25, respectively (4 analysts).
• Value Line projects 3.8% annualized growth from ’23-’27.
• CFRA projects 8.5% YOY and 4.8% per year for ’24 and ’23-’25, respectively.
• M* offers a 2-year ACE of 3.8%/year and projects 5-year annualized growth of 4.5% in its analyst note.

I am forecasting toward the lower end of the range at 2.0% per year.

With regard to EPS growth:

• CNN Business projects 4.8% YOY and 6.8% per year for ’24 and ’23-’25, respectively (based on 22 analysts), along with 5-year annualized growth of 7.7%.
• MarketWatch projects 4.2% and 5.7% per year for ’23-’25 and ’23-’26, respectively (25 analysts).
• Nasdaq.com projects 7.7% YOY and 7.2% per year for ’24 and ’23-’25 (7, 5, and 2 analysts for ’24, ’25, and ’26).
• Seeking Alpha projects 4-year annualized growth of 7.7%.
• YF projects 5-year annualized growth of 7.7% (rest of web page is either blank or “N/A”).
• Zacks projects YOY 0.6% and 7.7% for ’24 and ’25, respectively (5), along with 5-year annualized growth of 7.3%.
• Value Line projects 7.3% annualized growth from ’23-’27.
• CFRA projects 9.6% and 9.2% per year for ’22-’24 and ’22-’25, respectively (2023 data seems corrupt).
• M* projects long-term growth of 9.7% per year.

My 6.0%/year forecast is below the 6-long-term-estimate range (mean 7.9%). Initial value is ’23 EPS of $7.91/share.

As a partial aside, I don’t usually believe a significant difference between sales and EPS growth rates is sustainable. Because the analysis depends more on EPS than sales growth, I attempt to make reasonable, independent predictions for both. Were it deemed necessary, I would be more likely to alter a sales growth forecast to narrow the difference since fewer long-term sales than EPS estimates are available.

My Forecast High P/E is 22.0. Over the past decade, high P/E ranges from 22.0 in ’15 to 32.4 in ’21 (2020’s 58.4 excluded) with a last-5-year mean of 28.1 and last-5-year-mean average P/E of 25.7. I am forecasting at the bottom of the range.

My Forecast Low P/E is 15.0. Over the past decade, low P/E ranges from 18.0 in ’15 to 22.4 in ’22 (2020’s 33.3 excluded) for a last-5-year mean of 20.7. I am forecasting below the entire range.

My Low Stock Price Forecast (LSPF) of $118.70 is default based on $7.91/share EPS. This is 21.5% less than the previous closing price, 19.0% less than the 52-week/2022 low stock price, and 6.6% less than the ’21 low stock price.

Over the past decade, Payout Ratio ranges from 46.8% in ’23 to 64.6% in ’16 (2020’s 115.9% excluded) with a last-5-year mean of 52.5%. I am forecasting just below the range at 46.0%.

These inputs land DEO in the HOLD zone with a U/D ratio of 2.2. Total Annualized Return (TAR) is 10.6%.

PAR (using Forecast Average—not High—P/E) of 7.3% is less than I seek for a large-size company. If a healthy margin of safety (MOS) anchors this study, then I can proceed based on TAR instead.

To assess MOS, I start by comparing my inputs with those of Member Sentiment (MS). Based on only 17 studies (my study and 3 outliers excluded) over the past 90 days, averages (lower of mean/median) for projected sales growth, projected EPS growth, Forecast High P/E, Forecast Low P/E, and Payout Ratio are 3.5%, 6.7%, 24.6, 18.8, and 60.6%. I am lower across the board. Value Line’s projected average annual P/E of 20.0 is just higher than MS (21.7) and higher than mine (18.5).

MS high / low EPS are $10.73 / $5.72 versus my $10.58 / $7.91 (per share). MS low EPS seems like an “unreasonable” candidate. $5.72/share would be the lowest annual EPS since $5.46 in 2017. Looking closer at MS, five studies (29.4% of the sample) use $5.28 or lower with three studies at zero (definitely unreasonable). A case could be made to recognize the $7.00 median as MS low EPS instead. With regard to high EPS, mine is lower due to a lower growth rate. Value Line’s high EPS is $11.00/share. I am lowest of the three.

MS LSPF of $124.60 implies a Forecast Low P/E of 21.8: greater than the above-stated 18.8. MS LSPF is 15.9% greater than the default $5.72/share * 18.8 = $107.54 [the large discrepancy is another suggestion that MS low EPS may be too extreme], which results in more aggressive zoning. MS LSPF is also 5.0% greater than mine.

My TAR (over 15.0% preferred) is less than the 12.7% from MS. The MS sample size is too small to allow for a valid comparison alone. Based on input selection below or near the bottom of analyst and historical P/E ranges including LSPF less than multi-year lows, MOS seems robust in the current study.

I track a few different [usually conflicting] valuation metrics. PEG is 2.6 and 3.1 per Zacks and my projected P/E, respectively: the latter significantly overvalued. Relative Value [(current P/E) / 5-year-mean average P/E] per M* is somewhat cheap at 0.8. Kim Butcher’s Quick and Dirty DCF prices the stock at 17.0 * [$12.90 – ($5.00 + $3.20)] = $79.90, which suggests the stock to be 47.2% undervalued. The “quick and dirty” sometimes produces such wild results. I don’t know if it’s a reflection of cash flow inefficiency, currency conversion, something else, or a true reflection of stock price.

DEO is a BUY under $147. With a forecast high price around $232, TAR should meet my 15% criterion around $116/share.