Tuesday, December 30, 2014

Eighth Pick in the WMD Portfolio - Diageo

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

The previous two portfolio picks, Spectra and Oxy, are both in the energy industry. There are still lots of bargains to be had in energy, that should pay off eventually. For my next pick I am going a little more simple than trying to predict what the Saudi do, how OPEC reacts, and when energy prices run back up; in the case of Diageo its a simple matter of brand and distribution excellence meets global consumer preferences for quality beverages. 

Despite an overall solid year for the stock market as a whole, Diageo shares have been left behind. The S&P 500 is up about 13% year to date as of now Diageo shares are down around 10%. That's a wide gap. But why? One reason is that Diageo relies on emerging markets for growth and that has slowed. Another is that China has been on a concerted effort to reduce corruption and high priced booze is an easy target. 

But Diageo has the brands and global scale to weather these events. Diageo owns number one and/or number brands in most categories for example:
  • Vodka - Smirnoff, Ketel One
  • Scotch - Johnnie Walker, Caol Ila, Talisker
  • Gin - Tanqueray, Gordon's
  • Rum - Captain Morgan
  • Canadian Whisky - Crown Royal
  • Tequila - Don Julio

This is just to give you a taste, they own a lot more besides the above. Plus Diageo owns Guinness which a National Geographic photographer friend who has been everywhere says is his first choice beverage because you can rely on it pretty much wherever you are in the world. Diageo does have a hole in its portfolio for bourbon and American whisky, but beyond that its a dominating player in the categories its in. When he invested in Harley-Davidson, Warren Buffett remarked that he liked buying into brands where the customers tattoo the name on their chest. Some Diageo brands have a similar following. I wonder how many people have Guinness tattoos?

Diageo's current yield is 2.98%. That's a yield 50% better than the market for a company that is not an average company. Diageo's five year average Return on Equity is 38.7%. 

The company does operate with some leverage, its Debt/Equity ratio is 1.1 which is higher than I normally like. However Diageo has excellent interest coverage ratio at 5.7. It can afford to pay off its debt. And its one of the few companies where acquisitions can make sense because they have the distribution network across the world to push brands through. The dividend is safe at a 54% payout ratio.

Diageo has grown its dividend at 7.5% annualized over the last five years. Still, the price is not cheap at a P/E of 20, but these kind of companies do not really go into the bargain basement.  The overall quality and yield make it a good combination to add to the WMD portfolio.

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