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Steven Chen
Steven Chen
Articles (140)  | Author's Website |

Urbem's 'Wonderful Business' Series: Diageo

A moaty bet on premiumization

UK-based Diageo (NYSE:DEO) (LSE:DGE) produces and markets alcoholic drinks under a board collection of brands across categories and price points. The company was formed in 1997 following the merger of GrandMet and Guinness, with a name to encourage everyone to celebrate life every day (DIA is Latin for "day" and GEO is Greek for "world").

Diageo distributes more than 200 branded products to 180 countries and territories from over 150 production sites worldwide. As of FY2019, it generated 35% of its total sales from North America, 23% from Europe and Turkey, 21% from the Asia Pacific and the rest from Africa, Latin America and the Caribbean. The top three contributing categories were scotch (25%), beer (16%) and vodka (11%).

Diageo’s global reach to customers, strong market position and support force (especially in the US) is something that is hard for competitors to replicate. The company owns multiple famous brands, such as Johnnie Walker, the best-selling brand of blended Scotch whiskey in the world, which is going to celebrate its 200th birthday next year. Diageo, Jack Daniel’s (owned by Brown-Forman (NYSE:BF.A) (NYSE:BF.B)) and Hennessy (co-owned by LVMH (XPAR:MC)) are the most frequent nominees of premium alcohol brands on the list of InterBrand’s 100 best global brands.

Diageo employs a market-based approach to business, meaning that local teams select relevant brands and strategies to seize consumer opportunities with quick reactions to market trends based on their insights. Thanks to the comprehensive coverage across different categories and price points through both international and local brands, such a flexible model enables the management to optimize returns on investments, diversify away risks specific to regions and segments and widen the economic moat over time.

Per the chart below, Diageo consistently outperformed the majority of our selected peer group, including Pernod Ricard (XPAR:RI), Remy Cointreau (XPAR:RCO) and Davide Campari-Milano (MIL:CPR) in terms of ROIC for recent years. Only Brown-Forman performed better.

In addition to the brand moat, we like the non-cyclical nature of the alcoholic beverage industry. As demonstrated below, Diageo improved its annual sales and operating income during the 2008-2009 recession. (Note: The sharp decline in sales between 2002 and 2003 was due to the sale of Burger King).

We particularly like Diageo’s value proposition to support premiumization, as consumers want to drink better instead of more in both developed and emerging markets. It is noticeable that spirits continue to take share from wine and premium beer continues to outperform mainstream beer. The whole spirit segment (representing approximately 70% of the total revenue) is expected to grow at more than 3% annually between now and 2023, according to Statista. Diageo's management expects 730 million new premium alcohol consumers, with 85% of them coming from emerging markets, to become able to afford international style spirits over the next ten years.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation; investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market; we own shares of Diageo.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

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