DEO Stock Study (4-17-24)

Posted by Mark on April 8, 2024 at 15:01 | Last modified: April 17, 2024 17:23

I recently did a stock study on Diageo PLC ADR. (DEO) with a closing price of $136.03. My previous study is here.

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 2.5% and 3.3%, respectively (2.2% and 1.8% including ’20). Lines are somewhat up, straight, and parallel with sales declining in ’15 and ’16 along with EPS declines in ’15, ’16, and ’21. A debate may ensue about whether this is high-quality growth. I listed several YOY declines. 2014 sales (EPS) is not eclipsed until ’21 (’18). In addition, some would 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 26.4% in ’14 (excluding 17.4% in ’20) to 32.9% in ’19 with a last-5-year mean of 29.5%. ROE trails industry averages despite trending higher from 34.2% (’14) to 47.2% (’23) with a last-5-year mean of 39.3% (34.9% including ’20). Debt-to-Capital is lower than industry averages despite increasing from 58.2% (’14) to 68.4% (’23) with a last-5-year mean of 67.4%.

Interest Coverage is 5.8 and Quick Ratio is 0.6. Value Line rates the company “A” for Financial Strength and M* gives a “Standard” rating for Capital Allocation. M* also assigns Diageo a “Wide” economic moat.

With regard to sales growth:

• Zacks projects YOY 5.6% and 3.5% growth for ’24 and ’25, respectively (based on 5 analysts).
• Value Line projects 6.7% annualized growth from ’23-’27.
• CFRA projects contraction of 24.6% YOY and 9.9% per year for ’24 and ’23-’25, respectively (N.B.: “year” column does not add up for ’21-’24, inclusive).
• M* offers a 2-year ACE of 3.5%/year.

I am forecasting below the range at 3.0% per year.

With regard to EPS growth:

• MarketWatch projects 5.5% and 2.6% per year for ’23-’25 and ’23-’26, respectively (based on 23 analysts).
• Nasdaq.com projects 6.2% YOY and 8.9% per year for ’24-’26 and ’24-’27 [8, 5, and 1 analyst(s) for ’24, ’26, and ’27].
• Seeking Alpha projects 4-year annualized growth of 4.4%.
• YF projects 5-year annualized growth of 4.4% (rest of web page is either blank or “N/A”).
• Zacks projects YOY 8.7% contraction and 5.2% growth for ’24 and ’25, respectively (7), along with 5-year annualized growth of 5.7%.
• Value Line projects 3.8% annualized growth from ’23-’28.
• CFRA projects 9.6% and 9.2% per year for ’22-’24 and ’22-’25 (again, “year” column does not add up for ’21-’24).
• M* projects long-term growth of 9.1% per year.

My 3.0% forecast is below the range of five long-term estimates (mean 5.5%). The initial value is ’23 EPS of $8.29/share [much of the data from the website (automatically populated from M*) differs slightly from my previous First Cut (FC) on 10/13/23; for example, this read $7.91/share. I will point out other differences below].

My Forecast High P/E is 21.0. Over the past decade, high P/E ranges from 21.3 in ’14 [previous FC had 22.0 in ’15] to 32.9 in ’22 [previous FC had 32.4 in ’21] (2020’s 59.8—58.4 in previous FC—excluded) with a last-5-year mean of 28.5 and last-5-year-mean average P/E of 24.7. I am forecasting below the range.

My Forecast Low P/E is 13.0. Over the past decade, low P/E ranges from 17.7 in ’17 [previous FC had 18.0 in ’15] to 24.5 in ’22 [previous FC had 22.4 in ’22] (2020’s 34.1—33.3 in previous FC—excluded) for a last-5-year mean of 21.0. I am forecasting well below the range.

My Low Stock Price Forecast (LSPF) of $107.80 is default based on $8.29/share EPS. This is 20.8% less than the previous closing price and 20.5% less than the 52-week low.

Over the past decade, Payout Ratio ranges from 43.9% in ’23 [previous FC had 46.8%] to 71.6% [64.6%] in ’16 (2020’s 115.9% [117.0%] excluded) with a last-5-year mean of 53.6% [52.5%]. My 43.0% [46.0%} forecast is below the range.

These inputs land DEO in the HOLD zone with a U/D ratio of 2.2. Total Annualized Return (TAR) is 10.1%.

PAR (using Forecast Average—not High—P/E) of 6.1% 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 22 studies (eight outliers including my own 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 4.8%, 6.0%, 25.3, 19.0, and 63.6%. I am lower across the board. Value Line’s projected average annual P/E of 19.8 is lower than MS (22.2) and higher than mine (17.0).

MS high / low EPS are $10.76 / $5.94 versus my $9.62 / $8.29 (per share). MS low EPS seems unreasonably extreme. $5.72/share would be the lowest since $5.61 [was $5.46 in previous FC] in 2017. Looking closer at MS, six studies (27.3% of the sample) use $0.00 as low EPS (definitely unreasonable). Excluding these raises the mean to $8.16, which is close to mine. My high EPS is lower due to a lower growth rate. Value Line’s high EPS is $10.00/share. I am lowest of the three.

MS LSPF of $131.70 implies a Forecast Low P/E of 22.2: greater than the above-stated 19.0. MS LSPF is 16.7% greater than the default $5.94/share * 19.0 = $112.86 resulting in more aggressive zoning [the large discrepancy is another suggestion that MS low EPS may be extreme]. MS LSPF is also 22.2% greater than mine.

My TAR (over 15.0% preferred) is less than the 15.8% from MS. 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, I believe MOS to be at least decent in the current study.

Regarding valuation metrics, Relative Value [(current P/E) / 5-year-mean average P/E] per M* is low at 0.67. PEG exceeds 3.2 (overvalued) per Zacks and my projected P/E. PEG is high enough to make me question whether it even applies here (gut feeling that I can’t logically explain).

Generally speaking, I have doubts about DEO partially due to data inconsistency. I don’t see anything historical or projected close to the 11.8% sales growth listed at Manifest Investing (“Bull Sessions” on Apr 2, 2024). Numbers don’t add up from CFRA. YF has mostly missing data. MS is wonky and while this is largely due to the low sample size resulting in a failure to exclude studies that would usually be outliers, having any studies with $0.00 EPS estimates is something I rarely notice.

Some would try to set me straight, but for me DEO’s frail EPS projections also don’t jive with a wide economic moat.

Maybe currency conversion from sterling to USD is injecting some fuzzy math into the mix. This should not be the case as indicated here: “[As of Jul 1, 2023, Diageo] decided to change its presentation currency to US dollars… applied retrospectively, as it believes that this change will provide better alignment of the reporting of performance with its business exposures.” This would be post hoc rationale in a post hoc press release that is mysteriously dated > 6 months (Jan 30, 2024) after the change. As an ADR trading on the NYSE, I don’t have 10-K’s for clarification.

I lowballed Forecast Low P/E to get LSPF more than 20% below the current price (a minimum I try to uphold). The highest dividend yield over the last 10 years is 3.4% in ’16. With the current annual dividend of $4.01/share, any stock price below $116.90 would push the dividend yield > 3.4%. This is an argument to use a higher LSPF thereby raising U/D to 3.1.

As I have it, though, DEO is a BUY under $131. With a forecast high price around $202, TAR should meet my 15% criterion around $101/share.