Sunday, May 3, 2015

Diageo PLC (DEO) Dividend Stock Analysis

Hello, this is Div4Son. 

Diageo PLC (DEO) didn't show up on my April screener.

However, I am aware of DEO since I started dividend stock investing last year. Moreover, DEO seems to pay a 'non-standard' twice yearly dividend. In Yahoo, the dividend yield is 2.3% whereas Morningstar (which uses the TTM) sets it at 3.1%. 

After readjusting the dividend yield, DEO easily passes my screen set for April:
  • Yield over Avg Yield > 1.10
  • Yield > 2.5% (but less than 7%)
  • Payout Ratio < 0.8
  • Chowder > 10
I currently don't own any positions in DEO, and definitely would like to add to the portfolio if the fundamentals are in place. I have implemented (a quick) due-diligence process to follow when I buy (or sell) any stocks. This article summarizes my thought process about DEO.

In general my basic strategy is:

Good quality + high yield + high growth (+ time & patience)

This strategy follows the same framework as the SBI book. 

About Diageo PLC (DEO)

Diageo PLC (DEO) is based in UK and is the world's largest wines and spirits company

Its main operations include all aspects brewing & distilling including bottling, packaging, distributing, developing and marketing a wide range of alcoholic beverages. It operates globally (~180 markets). 

It was formed in 1997 via the merger of Grand Metropolitan and GuinnessDiageo is also very active with large acquisitions (including various Seagram assets) in 2001 as well sales (e.g. Pilsbury in 2001/02 and Burger King in 2002/03). 

Summary of Criteria 

DEO April 2015AreaCriteriaCheckListComment
Quality Company
Dividend Growth>5 yearsNo5 years
ROE/EPS/Op MarginStableYesSee Chart
Long term Avg GrowthStableYesSee Chart
Cyclical Nature
10 yr CAGR ~5-7%
FCF over DividendsYesYesSee Chart
M* MoatWide MoatYesM* Wide
M* & S&P
Credit Rating
> BBB+YesM* A-
Cash to Debt & Interest Coverage, Debt to EquityCash Debt >1 or Interest Coverage > 5NoCash to Debt 0.08, Interest Coverage 4.78
Debt to Equity 130%
M* & S&P Stars> 3 Stars for bothYesM* 4 Stars
S&P CapIQ 3 Stars
Payout Ratio<60%Yes53%
Dividend Growth
& Yield
Dividend Yield>3%Yes3.1% (TTM)
2.3% (Yahoo)
Dividend Growth>5%Yes5Y CAGR 9.2
Yield/Avg Yield>1.1Yes1.3
Dividend Yield Theory Mid PointBelow Mid PointYesMid Point 116;
Low Point 76
DRRM~10%YesAssuming 7% growth; projected return=10.13%
M* Estimate<M* estYesM* 126
S&P Estimate< S&P cap IQ estYesS&P Cap IQ 120
Data from M*, gurufocus, yahoo finance, S&P CapitalIQ, David Fish CCC list

Quality analysis

Years of Dividend raises

DEO has 5 years of dividend raises. While I normally look for companies with more than 5 years, DEO's continuous 17 dividends is a plus point. Moreover, UK companies usually have a slightly different opinion on dividend raises. They tend to keep providing dividends, not necessarily raises.

Stability of key metrics

These ratios provide an indication of how wide the moat is. I am looking for overall stability (or even better - growth). If the ratios decline year over year, then this is an indication of moat reduction. I also compare these ratios with other companies within the same sectors.  

As you can see, DEO is showing stability in these ratios. Also, compared with other Spirit and Wine companies DEO is the clear leader in terms of ROE which shows that they have a strong moat.

Average growth 

Here, I look for the stability of growth indicators over ten years.  Growth data is very cyclical. Therefore, I used the absolute Revenue and EPS numbers over 10 years.

The 10 year average trendline is around 5-7%.

Free cash flow over dividends 

I use the free cash flow per share and compare this with dividends per share. FCF should cover the dividends.  As you can see DEO's FCF easily covers the dividend YoY. 

M* Moat

I simply use the moat indicator from M*to validate my findings.  
DEO has a wide moat due to the its intangible assets (top 1 or 2 brands) and cost advantages being a leader in the industry.

Credit rating

Here, I look for companies with credit rating of BBB+. Just like banks wanting good credit from you when you apply for a loan, you want companies which are stable from a credit perspective. 

DEO's credit rating from M* is A-.


I look at the debt to equity ratio (<50) and cash to debt (<1) and interest coverage (>5).
Sometimes, a little good debt is good for a business. But too much debt can bring it down.

DEO's Cash to Debt is lowly 0.08. The Interest Coverage is  just under 5 (4.78).

So, this could be bad news. Its Debt to Equity ratio is at 130% which is much higher than my preferred 50% threshold. Looking at the 10 year debt to equity numbers, DEO typically has a high debt to equity ratio. 

In the years where debt/equity was high, the dividend was static -- they still continued paying a dividend, but no YoY increase. 

Therefore, I should expect DEO's dividend to remain static during some down years in the future, which is probably okay if the yield is high, and I continue to reinvest the dividends.

M* and S&P capital IQ rating

I am looking for 3 stars and above from either. A four star is a bonus.  

M* gives DEO 4 Stars and S&P CapIQ gives 3 Stars. 

I am seeing that if the combined M* & S&P Capital IQ stars is 7 or more, then this usually is a good indication to buy (if the company has good fundamentals).

Dividend Yield and growth 

Dividend yield is 3.10%. (Note Yahoo gives 2.3%.) 
5Y CAGR 9.2%

The average YoY dividend growth is around 7%. The previous two dividend jumps have been over 9%.

DEO's Chowder is 12.3% - which is over the threshold.

Payout Ratio

The payout ratio for DEO is around 53% - lower than the threshold of 60%. This shows the DEO has room to growth its dividend.

The trend is also very good - with most years <60%. This is a good indication for continued dividends.

Value analysis

Average yield

The current yield per average yield for 5 years ratio is 1.3. I use this as a quick indicator for fair valuation (if greater than 1.1). 

Note: I was using Yahoo's dividend yield previously, and this missed my screener.

Dividend yield theory mid point

Using the dividend yield theory spreadsheet (based on the Dividends Don't Lie book), I calculate the mid and high points for the yield, from which I derive the price. 

Note: You can get the spreadsheet at:

Based on the price/yield chart, I estimate the high/low yields to be 4.5%/2.2% respectively. Note: with irregular dividend patterns, I had to manually adjust the dividends so that the chart data would align.

Therefore, DEO high, mid and low prices are: 

High Price:156.54
Mid Price:116.53
Low Price:76.53

I am okay to buy great companies at reasonable prices and I think the price lower than 116 is reasonable for DEO. However, I am not buying it at the low price point (~mid 70s). It is quite possible for the price to drop lower. If that happens, I would be glad to average down - if the fundamentals are still in place.

Dividend Drill Return Model

Also, using the dividend play book DDRM model per the Dividend Playbook, I try to estimate the total return. Using the growth information above 5-7%, I use a growth rate of 7%.

Dividend Rate ($)2.56
Divided by: share price111.09
Current yield (%) 2.30
Core Growth Estimate (%)7.00
Divided by: ROE (%)27.82
Multiplied by: EPS ($)4.65
Cost of Growth (%)1.17
Earnings per Share ($)4.65
Minus: Dividend2.56
Minus: Cost of Growth1.17
Funding Gap ($)0.92
Divided by: Share Price ($)111.09
Share Change (%)0.83
Core Growth (%)7.00
Plus: Share Change (%)0.83
Total Dividend Growth (%)7.83
Plus: Dividend Yield (%) 2.30
Projected Total Return (%)10.13

I estimate the projected return to be just over 10%. I am happy with anything around 10%. 

Rearranging the numbers using calculated div growth%:

Dividend Rate ($)2.56
Required Return (%)10.00
Growth (%)7.83

So, the price range is around my mid price point.

M* and S&P valuations 

Morningstar gives a fair value of 126. S&P capIQ gives a fair value if 120. Therefore, with a current price around 111, DEO is reasonably priced. 

  • Spirits companies are subject to heavy regulation and taxation. (e.g. China's government cracking down on expensive wine/spirits to officials 
  • Distilled spirits is very cyclical than some other consumes staples industries (which is reflected in the irregular growth patterns in revenue and EPS).
  • The company's acquisition strategy is risky. 
  • DEO is higher debt to equity compared with its competitors. When this ratio is high, this affects the dividend growth 


I think with DEO, there is a real possibility that the dividend will be static will no growth in the down years. I will therefore adjust my sell strategy accordingly. If they continue to provide a good dividend decent yields, I will continue to hold and reinvest.

The debt is also very high (even though it is typically high) -- and I will monitor this going forward.

I bought 15 shares of DEO on April 30 at around 111. My forward dividends for DEO is around $40 using Yahoo's yield (and a bit more if I use the 3.10% TTM model). 

That's it for now. Please let me know what you think of DEO.


Disclosure - long DEO

1 comment:

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