Worth a drink

Last Updated: Thu, Aug 26, 2010 21:11 hrs

Diageo: Diageo will never set the pulse racing the way its products do. The world's largest distiller seems to make a virtue of being dull, as sales and profits creep up. But as the developing world becomes affluent enough to drink Johnnie Walker whisky instead of the local hooch, strong cash flow, relatively low debt and rising dividends add up to a low-risk equity investment.

Sales for the financial year to June just met guidance of low single-digit gains, with profits up by only the same amount. This seems to have induced ennui among the analysts, despite free cash flow of £2 billion ($3.11 billion), up from 1.2 billion in the previous year, a six per cent rise in the dividend and the promise of a similar rise next year.

The brokers’ analysts, though, crave excitement. "Lacklustre," says one. "Where’s the operational gearing effect from the small rise in sales of Diageo’s high-margin products?" wails another.

At least Diageo has sensibly not used the cash to start buying back its shares. A study by Collins Stewart last year showed that this mechanism, which rewards departing shareholders at the expense of those who remain, generally destroys value.

Diageo is too big to make meaningful acquisitions in many markets where further purchases would seem like domination. Instead, it's more likely to spend the money on marketing. Alcopops demand constant innovation to prevent sales falling. Apparently, Smirnoff Dark Roasted Espresso shows promise should Smirnoff Ice Mango fade.

Dull old Diageo has raised its dividend by 37 per cent in the last six years, and seems eminently capable of maintaining this slow, steady growth. At £10.50, down slightly following the results, the shares yield 3.6 per cent on the new dividend.

Diageo is a typical victim of the flight from "risky" equities to "safe" bonds which has driven down the yield on five-year investment-grade corporate bonds to around three per cent. Were Diageo to maintain dividend growth of six per cent a year, the 2015 yield at Thursday’s price would be 4.9 per cent. The shares look a better bet.

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