Booze Cruisin’ With Diageo

By Peter Pham - June 18, 2012 | Tickers: XLY, DEO, EWM, SPY | 0 Comments

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Diageo (NYSE: DEO), maker of favorite liquor brands like Johnnie Walker, Smirnoff, Guinness and Baileys has recently announced it is considering listing in Hong Kong to take advantage of growth markets in Asia.

Barreling Ahead

Diageo Chief Executive Paul Walsh cites big growth in emerging markets as the driver for the discussion, saying that over the next 15 to 20 years “there will be two billion new consumers coming into legal drinking age who have the economic wherewithal to access brands such as Johnnie Walker” in fast growing regions like sub-Saharan Africa, Asia and Latin America. In anticipation of the expected surge in demand, Diageo is set to invest $1.57 billion on boosting Scotch whisky production.

Faced with weak sales in Western Europe, the company has big plans for its Asia business. Diageo has already cut its marketing spending in Spain and Greece as those countries continue to languish; losing their thirst for top shelf brands.

Johnnie Walker is a favorite in brand-conscious Asia, where “bottle service” in bars and clubs is a popular way for imbibers to show off their premium status by keeping the bottle at the table for all to see.

Glass Half Full

Diageo says “In Asia Pacific, our premiumization strategy in Scotch in the emerging Asian markets continues to deliver double-digit growth." The company currently derives 40% of its revenue from emerging markets and forecasts that it will grow that number to 50% by 2015.  This is why listing in Hong Kong is key to their continued growth strategy; it publicly validates the company’s commitment to the region while giving more local investors a means to invest in a strong member of their community.

Diageo’s sales overall in the last two quarters of 2011 rose by 8%, while sales in emerging markets grew a hefty 18%. This is expected to grow even more as Diageo acquired a stake in China's Sichuan Shuijingfang and companies in other emerging markets like Brazil and Turkey. Their approach across all price points in Malaysia, for example, which include joint ventures with Heineken has netted them a near stranglehold on the beer market there, at 60%.  Since Malaysia combines both the 2^nd highest per capita income in ASEAN as well as as excellent demographics, the iShares Malaysia Index ETF (NYSEMKT: EWM) is weighted more heavily towards consumer discretionary stocks and other single country ETFs. 

Diageo has also been in talks with Jose Cuervo, the world’s largest producer of tequila, as it seeks to fill out its portfolio of top liquor brands, a deal here would be big for their distribution channels in the Americas.

Bottom’s Up

There are challengers. Jinro soju, a Korean brand of rice liquor, recently overtook Smirnoff vodka as the best selling liquor in the world, with sales more than double that of Diageo’s Smirnoff. Koreans down roughly one billion bottles of it every month. Indian upstart Bagpiper gave Johnnie Walker a scare a few years ago as it seemed to be positioned to overtake it as the world’s top Scotch, but has since dropped back in the rankings.

Paul Walsh says "there are huge opportunities in countries like Colombia, Vietnam and Indonesia which are large markets with emerging middle classes." Their demographic profiles also point to those burgeoning middle class members being in their prime alcohol consumption years.

The company’s stock is up sharply since plunging in 2009. The stock now trades at $99.18, down slightly from its all-time high of $104.01 last month. It has held up well during this recent correction outperforming year to date (up 12.2%) both the SPDR S&P 500 ETF (NYSEMKT: SPY), up 3.7%, and the SPDR Consumer Discretionary ETF (NYSEMKT: XLY), up 8.6%.  It is trading at a current multiple of 24 with a 2.6% yield. Projected earnings this year are to rise from $4.13 to $5.95 per share, which implies a forward multiple of 16.6 at current prices. Given the fragility of the markets right now Diageo’s strong position make it attractive having low downside risk and very high reward on a resumption of the 1^st quarter’s bull trend.

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