Diageo (DEO) FY19 Earnings Gain, Soft Sales View Hurts Stock

Diageo (LON:DGE) plc (NYSE:DEO) reported preliminary fiscal 2019 results, ending Jun 30, 2019, wherein pre-exceptional earnings per share improved 10.3% year over year (in local currency). This was mainly driven by strong organic operating profit growth, lower finance charges, positive impact of share buybacks and favorable currency, offset by increased tax expenses and higher non-controlling interests.

However, Diageo’s stock declined nearly 2.4% yesterday probably due to management’s commentary about a slowdown in expected net sales for fiscal 2020.

Though shares of this Zacks Rank #3 (Hold) company have moved down 1.7% in the past three months, it fared better than the industry’s decline of 4.5%. This alcohol giant is gaining from the focus on innovations, achieving growth through buyouts and penetration in emerging markets.

Fiscal 2019 Highlights

On a reported basis, net sales and operating profit rose 5.8% and 9.5%, respectively, owing to organic growth. Top-line growth was, however, partly negated by acquisitions and divestitures. Its top line and operating profit also included modest favorable impacts of foreign exchange due to the strengthening of the U.S. dollar, offset by the weakening of several currencies like the Turkish Lira, Indian Rupee and the Australian Dollar.

Organic sales increased 6.1%, benefiting from broad-based sales growth across all regions and categories. Additionally, sales growth was backed by a 2.3% increase in organic volume and positive price mix of 3.8%. Price/mix benefited from continued premiumization, improved capabilities through the ongoing revenue management initiatives and a premium innovation performance of recently launched brands.

Improved price/mix and efficiencies from the productivity program aided organic operating profit, which grew 9%, higher than top-line growth. Notably, impacts of cost inflation and higher marketing expenses were fully offset by the aforementioned positives. Further, organic operating margin expanded 83 bps in fiscal 2019, marking a 198-bps organic operating margin expansion over the last three years. This expansion was above the company’s long-term organic operating margin guidance of 175-bps improvement from fiscal 2017 through 2019.

Financials

Diageo continues to generate solid cash flows in fiscal 2019, with net cash from operating activities of £3.2 billion. Furthermore, the company reported strong free cash flow of about £2.6 billion in fiscal 2019, up from the last year.

Diageo remains committed to its disciplined approach to capital allocation, primarily to enhance shareholder value. In sync with that, the company returned £4.4 billion in cash to shareholders in fiscal 2019 through share repurchases and dividends. This included £2.8 billion worth of share repurchases during fiscal 2019.

Backed by strong free cash flow, the company announced that it will further return capital to shareholders of up to £4.5 billion over the next three years. It also increased the full-year dividend by 5%.

Outlook

Backed by the robust organic profit growth over the last three years, Diageo reiterated its medium term for the period between fiscal 2020 and 2022, which was announced in May 2019. The company continues to expect organic net sales growth in a mid-single digit for this period. Further, it expects to sustainably grow organic operating profit by about 1% ahead of net sales, in the 5-7% range.

For fiscal 2020, the company anticipates net sales growth at the mid-point of 4-6%. This reflects a slowdown from fiscal 2019, lapping several successful innovation launches in the year. Based on current rates, the company expects foreign exchange to favorably impact net sales by £375 million and operating profit by £135 million.

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