Chit Chat Stocks - Diageo (Ticker: DEO) Not So Deep Dive

Episode Date: November 28, 2023

Diageo (DEO) is a multinational alcoholic beverage company, known for its extensive portfolio of well-known brands, but facing challenges from shifts in consumer preferences and the impact of regulatory changes on the alcohol industry. Listen closely as Brett and Ryan go through the history, financials, and future prospects of the company. Enjoy the show! ****************************** Chit Chat Money is presented by Interactive Brokers. Switch to the best brokerage in investing today: ⁠⁠⁠⁠⁠ibkr.com/info⁠⁠⁠⁠⁠ ***************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: ⁠⁠⁠⁠⁠https://chitchatmoney.substack.com/⁠⁠⁠⁠⁠ Want updates on future shows and projects? Follow us on Twitter: ⁠⁠⁠⁠⁠https://twitter.com/chitchatmoney⁠⁠⁠⁠⁠ Contact us: ⁠⁠⁠⁠⁠[e-mail]⁠⁠⁠⁠⁠ Timestamps Company Background | (3:09) Industry | (13:46) Management & Ownership | (23:20) Earnings | (26:44) Balance Sheet | (31:59) Valuation | (35:25) Our Analysis | (37:55) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siyaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Anything discussed on Chit Chat Money by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. welcome in this is chit chat money my name is brett schaefer and i'm joined as always by ryan henderson we are ending the month of november so that means the end of our sin

stock month this is perhaps the least sinny stock but i guess that's up to debate it's uh the largest alcohol company or actually excuse me the largest spirits company in the world alcohol. There's a couple other ones that are larger, I believe it is. And I'm pronouncing this, I hope correctly. D-I-G-O. Ryan, is that correct? Trio. G-O. G-O. D-I-G-O. I looked at the pronunciation before this because we're not going to go the whole episode mispronouncing this thing. I think it's-

D-I-G-O. D-I-G-O. D-I-G-O. Maybe like a sh, sh. Okay. All right. All right. I still don't know. This is definitely one of those companies. we'll get into what they do but they're one of those similar to altria similar to some of these other ones out there that they find some made-up name that the consultants probably spent a million dollars on but it sounds kind of nice uh but yeah okay before we get started uh we're going to be covering this company next week we're covering altria group i'm going to do a little we're going to figure out the exact format we're going to do i'm going to do a little pitch ryan's probably

going to give some feedback try to criticize it a bit uh but if you want to call it bulvers bear maybe yeah the most clickbaity title is possible right that's what we try to go for without crossing the line uh but before this we did smith and wesson firearms company we did british american tobacco and mgm resorts mgm resorts i think was quite a fascinating one especially for people that follow iac uh ryan some of that and an interview with rci hospitality uh which is a nightclub strip club operator ceo so that one's kind of a sin stock as well that you could also throw into this mix i think we did that either last month or during the sin stock theme yep yep we did that one full video you can find it on youtube or spotify or listen

wherever you get your podcast last thing before we get going here if you want the show notes if you want all that good stuff subscribe to our newsletter uh you get a couple of emails per week including on tuesdays the show notes for these not so deep dive episodes so ryan we are talking diageo i can't say it right diageo i don't i don't it's i'm just saying it with the spanish accent but i think it's i think it's diageo diageo let's get into it all right so But Diageo is, as you kind of alluded to, one of the largest alcoholic beverage companies by sales in the world. They aren't the largest in terms of total alcoholic industry, but they're the number

one producer of spirits or hard alcohol globally. They operate more than 200 plus brands. Actually, I didn't have to add the plus in there. More than 200 brands in total. And they sell through local distributors to both restaurants and retail stores. So during COVID, if you're looking at the numbers, you might see that revenue declined. A lot of that is from, I believe they call it the on trade, I think is the term they use, which is the restaurants, restaurant, nightlife, those kinds of customers, as opposed

to ultimately when it goes to a retailer like a Walmart, it ends up in the hands of actual customers as opposed to businesses. Anyway, so those are the two types of businesses they're selling to, retailers and restaurants. or on trade as they call it. And like I said, it's usually, it's like third-party distributors. So they have supply chains and partnerships around the world. And when I say this is a global business, it's really a global business. I've got a heat map here in terms of where their sales come from. And it's 40% North America, 11% Latin America, 21% Europe, 10% Africa, 19% Asian pacific so they've got sizable exposure to pretty much everywhere around the globe except uh they

don't really operate in russia anymore anyways um like i said a lot of local uh partners for for distribution which has certainly serves as an advantage to them which we'll talk about in a little bit but i think there's a number of ways you can kind of look at diageo the management team looks at them by geography you can look at them by price point. So they sometimes look at them as like premium brands versus value brands. But I think the easiest way to look at them is really just by product type in order to gain an understanding of what Diageo really is. So 79%, roughly four-fifths of their sales come from spirits. So the biggest drivers here are scotch, tequila, and vodka.

but they also have rum, liqueurs, gin, Canadian whiskey, something called Chinese white spirits. But really the big three drivers are scotch, tequila, and vodka. And so there's a whole bunch of brands that I'm going to rattle off here that are pretty recognizable. So there's Johnny Walker, Buchanan, Smirnoff, Ciroc, Kettle One, Casamigos, Don Julio, tank ray bulliet crown royale captain morgan the list goes on and on most important by far is johnny walker though should be clear to the listeners that's the most important brand yes but it's not like account it accounts for like half of their sales or something like that right so it's it's uh it's technically the largest brand in their portfolio but really scotch in

of itself is a quarter of the overall business. And Johnny Walker is the biggest part of that, but still it's less than a quarter of the overall business. So there are other important brands. I got to say, I was honestly surprised. I did not know all those brands were under one umbrella. And they seem like they pretty much dominate their categories for the most part. They are the market share leaders in spirits overall, especially in Scotch. But tequila is also growing fast for them. And we'll talk about that kind of later on. The second part of the business here is beer, which really, I think, only consists of Guinness.

It was the only one they advertised on their website. There may have been some other notable brands. This accounts for, I may have already said this, 15% of their revenue. So still small relative to the spirits, but Guinness as a whole, very important brand to them. i believe it's the largest beer brand in europe they've got a lot of variations on guinness so even though it's like the og guinness brand there's a lot of different like style guinness beers that they sell and then the last category here that i'll talk about is ready to drink this is small but people have talked about it kind of having potential uh this is like the

cocktails that are ready to go in cans they actually bought a company called i think it's called Loyal Nine Cocktails recently, two years ago. And there's other things in here like Smearing Off Ice, Ketel One Cosmopolitans. It's basically, these are ready to drink cocktails, but still relatively small part of the business. Let's talk history though. I think that paints a general picture of what Diageo is. The business itself is not that complicated. They have production facilities all around the globe. Like I said, they use third-party distributors. They've got negotiating leverage with a lot of those distributors because they're huge customers for them. They operate all around the globe. But the history here, I think,

is actually pretty fascinating. And it's a testament to the longevity of a lot of these brands. So Diageo was formed in 1997 through the merger of two companies, Guinness and Grand Metropolitan. Both companies were roughly a 10 billion pound market cap. It's British pounds. And there were houses to several different brands. So in Grand Metropolitan's case, they owned – I'm trying to remember. I think they owned Smirnoff, but they also owned Burger King. They owned Pillsbury. They divested those shortly after the merger, but they had a number of hard alcohol brands.

And then the Guinness side of things also owned a couple other brands outside of Guinness, so they also had some hard alcohol in there. So it was kind of a merger of equals and it created really, it wasn't the largest alcohol brand at the time, but basically turned them into one of the largest spirits producers globally. But when we go back to the history of the brand specifically, these extend back way further. So, Hague Club, which is a Scotch whiskey brand that Diageo started in partnership with David Beckham, I think not that long ago, that has roots that date all the way back to 1627. Guinness was founded in 1759 by Arthur Guinness. Arthur Guinness signed a 9,000-year lease on that brewery, and that's still their main production center. It's kind of like a museum today, I think. Have you been to the Guinness facility?

Yeah, I have. i guess uh i've been supporting the company the uh yeah i went a few years back and it's very fun so it's one of the biggest buildings there it's a whole idea that you got the production facility plus some historical museum plus some you know gift shops plus a bar like multiple bars where they sell a lot of guinness so yeah the it's fun it's fun time if you're ever in that city It's called the St. James Gate Brewery, I believe. You can also just look up Guinness Brewery. But yeah, 9,000 year lease that they're still running on today. Johnny Walker, well, the man's name was John Walker, began brewing whiskey in Scotland at 1820. The list really goes on and on. A lot of these brands have been around for more than a hundred years. And I think the point here for me is that it's very hard to replicate the heritage

and the mindshare that some of these brands have built over centuries of marketing, centuries of seeing your parents drink a certain brand and having it just kind of pass down through generations because it's what people in the past have drank. Anyway, just really difficult to replicate heritage. As of late, though, Diageo has been making a push into tequila, which has been the fastest growing hard alcohol category over the last decade. So in 2015, they acquired Don Julio, and in 2017, they acquired Casamigos. They've been serial acquirers over the year, and they've also disposed of brands, but they buy – I guess I can just talk about this now. they'll buy brands where they can they can pay kind of a premium so for cost amigos which was

george clooney's brand i think it was a billion dollar a billion pounds maybe that they paid for the brand 20 times sales yeah sorry but they've got instant scale and they can still earn good returns even by paying more than they should potentially or more than others would because they've got that scale advantage and they can instantly juice the returns from those brands. So that's kind of how they do it depending on consumer preferences. They have brands really that span the entire spirits category. So whether it's whiskey that becomes more popular, whether it's tequila, which is what's happened as of late that becomes more popular, they've really have a diverse portfolio that kind of touches all corners of it, but that kind of leads to

the industry overall. And I think you kind of had to do your homework here, Brett, because this was an important one, seeing as they are kind of the leading provider in the spirits category. So tell us about it. Is it growing? Where is it going to add? Pit Shop Money is brought to you by Interactive Brokers. Designed for active traders and sophisticated investors, Interactive Brokers offers trading assets in 150 markets with 27 in different currencies. Interactive Brokers also charges USD margin loan rates from 5.83% to 6.83%. They've also got the ability to trade stocks, bonds, futures, options, commodities, and more, all from a single unified platform. Brett and I use Interactive Brokers ourselves,

and I honestly have to say that if you spend a considerable amount of time managing your investments, if you're spanning the globe looking for new stocks, I highly recommend using Interactive Brokers as your platform of choice. Restrictions apply, but for more information, visit IBKR.com, member SIPC. Open an account with IBKR today. Yeah, I will say a good resource was an article written by our friend at Best Anchor Stocks, Leandro, who's actually going to be on the show shortly

with sleep well capital discussing the luxury sector we have that plan for recording coming up in the next uh well recording this week but then released within the next week or two so look out for that uh but we will link in the newsletter to his piece on that it was quite informative that's where i'm getting some of these facts here but yeah it's a complicated market we'll get into for anyone that knows this business at all the premiumization as they talk about the expensive versus cheaper brands and where Diageo is trying to go with that. I will note though, on the tequila topic, that if you're in the United States or in Mexico, I know we have over half in the United States, maybe a tiny bit of our listeners are in Mexico. You might think, well, tequila is already

super popular, but it's not necessarily about these markets. It's about bringing tequila, which was a really not a big spirit brand in Europe, other places around the world, even some places in Latin America, bring in that globally. And that's where a lot of the growth has been, especially in Europe. So to the industry, the total beverage alcohol, or as the abbreviation may go in their investor stuff, TBA, it is around $1 trillion in global annual spending. I'll have some graphics in the newsletter that kind of highlight this. They like to brag that they are only 4.7% of the TBA market, and they plan to get to 6% market share by 2030. However, this is a bit misleading because they mainly play in what is called international spirits,

which is only 22% of the TBA market. Using that number, their 4.7% market share turns into over 20%. So there's still room to grow if they can keep gaining market share in this industry, but they're a much larger player in their niche than they might try to lead on. They always talk about this. And yeah, some good progress. They've gone from a smaller percent of the TVA market. But what's helped them is that Spirits have been taking

volume share and value share from beer and wine. So they've been able to ride this wave without... Maybe some of it is due to their marketing, but they've had a nice little bonus here from the category just shifting into their favor. yeah the other thing is they could technically start acquiring up breweries beer brands wineries wine brands seltzers i don't know if that's a very big segment of the market but that uh so when you think about the total alcohol beverage industry i'm not sure i'd like to see

that but theoretically there is more market share to be had if they if they started doing that yeah they're in a better spot than say maybe constellation brands is that what the big one of the big beer ones or anheuser-busch or olsen coors stuff like that which could be a fun theme to do i would love to hit maybe everyone talks about anheuser-busch that's followed so closely but maybe one of the small ones uh speaking of though this is my discussion question i would reiterate though that spirits as a whole are taking market share from beer and wine but especially on price. My discussion question is,

do we think achieving 6% TBA market share, and I should have wrote here, by 2030, is achievable? Why not, man? Yes, I do. I think it's possible. Achievable, I guess, kind of remains to be seen. I don't think anyone knows accurately

whether or not it's going to happen, but it certainly is possible. Obviously, people drinking more spirits than beer or consumption habits changing benefits them, but I also think they have a lot of advantages because of their scale that I really wasn't aware of before studying this business that allow them to dominate the spirits shelf and the spirits aisle, which I would think is a positive feedback loop where they just continue to eat market share in the spirit space. Yeah. So with all the restrictions on alcohol and a lot of places you can't go, I think maybe everywhere, but I know for sure in the United States, you can't go direct to consumer. Online shopping is very strange and there's a lot of hurdles. I know there's some of those delivery companies, but it's really about getting that top shelf at the restaurant or bar and getting that distribution space in the grocery store, which is where people go or the liquor store or wherever it is sold in a physical place. So, yeah, I mean, they have that distribution advantage. think six percent is achievable um i'm not sure it could be 5.8 who knows but i don't see any reason why this trend will reverse anytime soon no and the other thing is beyond them having like advantages over competitors they also have a couple of benefits that are a couple of like

structural benefits industry-wide that are helping them. So more people drinking spirits as opposed to beer and wine, but also a shift towards tequila where they're really well-positioned. More people are drinking tequila. They've got Don Julio and Casamigos. They have a couple of really premium brands. So people within the spirit space are starting to drink more premium liquor. I guess that's, I don't know why that trend's kind of occurring, but people are starting to trade up. they're well positioned for that so it seems like they've got a kind of kind of a lot of micro tailwinds that are helping them propel that market share where it's not really anything they have to do yeah so that kind of leads into i will answer your question about the premiumization is that a

lot of people from their data that they've showed are drinking less but when they drink less they're still socializing so they're not opposed to instead of buying a 24 case of light beer or a couple of cheap bottles of wine they'll buy a couple of drinks worth of whatever spirits of choices and it'll be a similar price but uh per you know drink basis it's going to be a lot more and that does lead into another note here i think it's important is non-alcohol spirit sales are up 13 times through 2017 and the company is investing heavily here, which is nice to see. I don't really get this market because you don't really like the taste of it. Maybe some people like the taste of this stuff, but if you're going to fake it, why not just

have a soda thing or a tonic water? But hey, if it's Garland, they're going to take advantage of it and they basically use their brands like Tanqueray and Guinness and stuff like that to make what they call these 0.0 things let's see maybe that actually could be that could be interesting yeah uh just like those ads they sell on social media so that cure hangovers they'll definitely do that uh okay premiumization so it's showing up in their data for for sales in their developed markets which i'm assuming are north american europe maybe a little bit asian pacific as well their premium and super premium tier is 71% of sales last year, up from 53% in 2017. They've sold off some of

their lower value brands, and they bought up more of these premium or super premium brands. Casamigos, the biggest example. Can this trend continue, Ryan? I think probably yes. And the only thing that worries me a bit is now this is 71% of sales. So they can't take advantage of, okay getting rid of these bad assets and juicing organic sales growth by like it's the right move but now they're they're eliminating some poor assets and buying these good ones and once it's all good assets yeah it's fine but you're not kind of you know you kind of get what i mean here or below hanging fruits kind of gone the yeah yeah exactly yeah there's a lot of ways to kind of massage these numbers like the premium and super premium tier like maybe you could just say like

one of one of my brands yes near enough we're gonna we're gonna love that up to premium now right maybe they include that i don't know or yeah you could sell the non-premium it makes sense though the trend of like people are drinking less and it's become kind of a phenomenon among millennials and gen z that maybe it's because there's other substances that are being legalized or something but alcoholic consumption is moving towards more moderate drinking which if you're doing that you kind of can afford nicer beverages so that makes sense on the premium station side but i also worry that it's just a low interest rate phenomenon and that maybe like yeah the bear market people might start trading back down i don't know the cheaper stuff yeah yes yeah i i

thought about it yeah because this this trend really began it seems like uh right around the great financial crisis so you had a low base and then it seems like if the economy kind of takes the term for worse or something like that. We could see a difference here. And that could be what's happening in some of the concerns that happened this year after a high inflationary environment, seeing the consumer spending go down on some categories. But let me go to management and ownership. They've gone through some major changes this year. And I don't know how to pronounce his name, but Ivan Menezes, M-E-N-E-Z-E-S. He's a British, was a British guy born in India, I believe. He was the CEO since 2013, died earlier this year at the age of 63

from health issues. He did a great job, apparently, in revitalizing the business and going on some of those trends that have taken advantage of his post or the springboard for that, the catalyst. The CEO job was given to Deborah Crew. She was the CEO before this and before that, the president of north america for diageo before that she worked at a lot of cpg and food companies including pepsi mondelēz and nestle but what was interesting is i think she worked at reynolds american too as well as smith and wesson and she was something in the u.s military too uh i think she was like she either worked for them or was an officer i can't remember exactly but working for all these in-stock companies uh she definitely has experience working in these industries that

may be a bit more uh harder to work with you know i mean there's a lot of regulations stuff like that shockingly compensation for the executives is base salary executive cash bonuses and long term equity awards the classic compensation consultant here the bonuses are based on net sales growth operating profit growth and cash flow conversion which is all thumbs up for me Those are pretty solid. Didn't see much of an adjustment there, but it was an extremely long annual report. I was not going to read the 400 pages there. A lot of it was ESG stuff. Sorry, just not going to do it. The hurdles are all decent for these. You have a target sales growth of 6.5%, 7.5% for operating growth, and 100% for cash conversion last fiscal year.

And these are around the targets that they discuss with investors. So I think it's an example of when you see a company at like their capital markets day or the investor day, have their targets of what they're looking at. You want to make sure those are the same numbers that they're getting paid on. And then the long term equity equity awards had some complicated stuff. The only low light would be that one of or part of it was based on total shareholder return on a relative basis to their peer group. because it's just a slight concern to me because i mean relative returns i'm sorry i don't care as a shareholder and then uh as a large cap multinational company don't really think ownership of the stock is worth much here there were some of the index funds i think i saw some

larger uh active fund in there but maybe this is the size of a company where an activist can come but there's really very few that have the size and the firepower given the market cap so that's really it new management team they had to take over for this guy who died suddenly and we'll see how it goes and we'll talk i guess with earnings ryan things have gone a little disappointingly now a little bit uh and there have been concerns that analysts are worried about bulls kind of talk through them and see if it's a long-term break in the thesis here yeah and the other thing is with this company being a i think they're domiciled in britain that right they only report they only report every uh six months instead of every quarter

so you're getting maybe they have like the interim results or whatever but you're not getting like the consistent quarterly updates um but over the last 12 months they've generated 17 billion pounds in revenue that is up 11 percent year over year they've actually shown really strong growth coming out of COVID. I think a lot of people, maybe it was they got their stimmies and decided that we're going to buy some premium alcohol. I don't know, but they saw really good comps and organic sales growth across a lot of their categories. They also had some inorganic growth because of the recent acquisitions. But in general, 60% gross margins, I think it's really a testament to the brands here and their ability to produce alcohol well at scale. $3.7 billion in last 12-month

profits after taxes, so net income, but only $1.8 billion in free cashflow. A lot of that is a big inventory buildup that's really hurting them. Over the last two years, inventories have been rising from 6 billion pounds to 7.7 billion pounds. Now, inventories is difficult for Diageo? So there's a couple of things here. First of all, retailers might not be replenishing stock quite as fast. So that leaves you with more inventory on hand. But on top of it, if you're raising prices and your volume of inventory goes up, the nominal value of your inventory also goes up. And sometimes Diageo actually called this out where there's a segment of their inventory called maturing inventory.

So I think tequila, for example, it requires like three years of sitting in, I don't know if it's casts or barrels or whatever, but it has to sit there for a while. And you're accumulating, basically smaller companies can't really do this. So it's kind of an advantage for them. But in the meantime,

that's getting recorded as inventory. So you're going to have a consistent free cashflow lag relative to your gap numbers. On average, 85% of net income is converted to free cashflow for Diageo. But since there's been this kind of inventory buildup, we've seen a significant free cashflow lag over the last 12 months.

The concern here is that there's basically the problems and we're seeing it really specifically in Latin America where consumption has come down a lot. Retailers aren't going to replenish as fast for a while. And maybe there's going to be sort of excess inventory for some time. They're worried about overstocking. that's kind of what the analysts are all pointing to overstocking previously and now okay they don't

need as much anymore and that trend didn't show up and like diageo's selling them that you know the same amount of stuff and oh it's growing it's growing it's growing but the actual sell through to the customer is lower and the analysts are concerned basically as they always are that it's higher uh than we think and that's where the uncertainty is yeah and maybe i probably should look at this a little more closely but my thought here and correct me if i'm wrong it's okay if some of these mature for a while it's okay if you have the hard alcohol sitting on shelves for a while they will sell through eventually but i don't know what the markdowns would look like yeah i think it would just i don't well

it's not it's not going to impact diageo because they've already sold it so the more the impact is oh we thought there was more growth rate of the consumption of the volume that was going through to these end uh to these distributors but in fact they need maybe a little bit less we're going to reset that run rate and we saw it hard in latin america because like they they mentioned this too since stuff doesn't need to get written down it's not like the things you know they can sit on inventory for a while that's not a big deal but the concern is okay well we don't have the perfect read into whether we're overstuffing this channel by accident right yeah that makes sense um i guess the only other thing i'd call out here in terms of earnings brett just laid

it out there well worried about overstocking the channels or overstocked channels and then latin america they seemed at the capital markets day they called this out as like a market that's really isolated in terms of poor performance that's always getting concerned when they say something's isolated that is the hope isolated isolated incident you know uh but that's what they did i will say they're seeing good growth organic growth too out of north america out of europe a lot of that is coming from more price increases than volume and then not even just Not even pure price increases, but also just a mix shift to higher-priced items. So that premiumization, you're going to see higher pricing, but really it's consumers shifting their habits from the lower-value to the higher-value brands.

If we look at the balance sheet, though, liabilities, they've got £17 billion of gross borrowings. once again i'm going to take a second to call out uh european investor relations pages and annual reports it seems like they make these things really tough to find and kind of annoying so if you ever feel like getting that together europe it would be much appreciated they do have a 20f but it is only one time you know yeah they have a filing in the u.s but yeah the annual reports notice i say that jokingly but the 20f is 400 pages and a lot of it's quite redundant and there was four letters one from the chairman one from the ceo one from the probably the head of esg i don't remember but they started it with four so i was like we just

don't need this uh we're so excited for our growth and we are just can't be more excited for the team and what they've done this year okay yeah anyway so use the keyword when you're looking at the 20f because you might want to skip certain parts but um going through the balance sheet, 17 billion pounds of gross borrowings. They only have 1.4 billion cash and cash equivalents. So you're looking at a little over 14 billion in net borrowings. Most of that is fixed rate debt. So 77% is fixed rate. It's termed out pretty well. So most of us do that for three years. They tend to roll their debt. They actually try, and this is stated in their 20F, that they try to maintain a leverage ratio between two and a half times and three

times net debt to EBITDA. Currently they sit around 2.6 times. So they're well within kind of that band. When we look at the asset side though, I mean, so I said $15 billion in net debt. I mean, they generate north of $5 billion in EBITDA, which as a shareholder, we probably don't really care that much about EBITDA, but if you're a debt holder, it's a useful metric. Anyway, so I mentioned the cash and cash equivalents. The other part, the inventories, it's kind of hard to think about inventories sometimes because investors, it feels like no one is happy. No one's ever talking positively about inventories. You're only really talking about it when it's a negative, but 7 billion or 8 billion pounds of inventories, they will sell

through that over time. The other thing is real estate. It's not really noted as an asset to them, But I mean, there is real estate assets, but it's not huge. Although when you look at like a 9,000-year lease at a hilarious price per square foot that they've got in the Guinness Brewery, that's an asset. Yeah. What's the sum of the parts of that? Let's run something there. Let's discount that back to do it. The balance sheet is fine.

I actually like that they run levered. It's a pretty predictable business. they are very advantaged and we'll talk about some of the competitive advantages here in a second so i like the borrowings the only problem is if they start to roll this debt and they continue to be within the two and a half to three times range the interest rate's going to go up over time so you're going to get kind of lower returns lower returns on equity um as that cost kind of goes up yeah yeah that is an interesting point there and i will say consistent dividend grower on a per share basis and a consistent share repurchaser, which are the positives there.

Let's hit valuation quickly. On a US dollar basis, we're at about an enterprise value of $95 billion. And if we look at, I'm kind of looking at an EV to profit before taxes. You can do after tax, but it doesn't make a big difference to me. We're at about 17.1 on an enterprise value to profit before tax which is lower than they've been they've typically been on a premium here but it's not that much different than honestly might be more expensive than some of the market some of the european markets but it's probably not too much off from the s&p 500 right around there and they've gone through a big drop so historically yes uh ryan shared a good chart on twitter about that too they are at a lower multiple than they have been historically but

now they're kind of right around the market average they had been a lot of these spirits brands uh companies have been valued you know it's quality high quality business secular growers with pricing power and they've all gotten typically a premium valuation over the last decade yeah sorry let me share my screen real quick and i will show you let me allow you um for anyone watching the video here i'm going to share my screen show everyone that basically the valuation over the last 10 years. So sharing it now. The EV to EBITDA trades at a 10-year low,

and it looks like the EV to EBIT trades at a 10-year low as well. So it is, even though it's still relatively expensive when we think about European stocks generally, it's been regarded as a really high quality business for a long time. We're going to talk about some of those advantages here in a second, like I keep saying.

this rewriting is new. Historically, it's traded at 20 times EV to EBITDA. So I don't know if I'd underwrite that as a part of your thesis that I wouldn't expect multiple expansion, but at least you're not as worried about multiple compression from here on out. Yeah. And I think a lot of analysts or investors in general are worried that

the forward earnings are going to be lower than the trailing earnings. And that's what they're kind of pricing in here. I guess we'll try to evaluate what we think on that, but there is a little bit of uncertainty there. But if the business still continues to chug along and grow, you saw sales growth and margin expansion. Well, they're going to have a lot of firepower to repurchase shares at these prices. All right. Anecdotal evidence. Ryan, what do you think here?

This is, I guess, a fun one for a lot of people. Yes, I do have some experience with their brands. uh i will say i don't really have any loyalty to any of them and i don't know if this is like a new thing and maybe there's less loyalty to alcohol brands today but i'm not married to anyone like yeah maybe if i were like a scotch drinker i'd be married to a certain brand but i don't sit there and buy the same exact alcohol brand every time i go to the store to get something um you know it varies so i don't think that's new and they are diversified enough that they're gonna land some customers anyways but just thought it was worth bringing up i also think tequila

i don't have that great perspective perspective because it's been big in america for a while but it feels like it grows in relevance more and more like i constantly see more kind of tequila-based drinks uh at least when i go out to restaurants they push the yeah everyone's pushing that and yeah i agree with you there's no loyalty but what's interesting is well okay if you're looking you're like you're talking with someone a significant other and they're like oh pick up a bottle of vodka for the party at the grocery store and then you go to the grocery store you see a bottle of smirnoff it's right at the eye level and you go okay this is a reasonable price yeah let's get that you know everyone knows this one so i think these are good brands probably not

great brands but i think they're good and coupled with the distribution advantage it can be that's why they've maintained relevance for a long time it brings up a good point too which is you're when you're buying for multiple people you're gonna go and maybe when you're buying for yourself this is something where if you buy the wrong brand i mean i don't think any of them taste good but you can get a lot of flack um so you kind of go with a trusted brand which all majority of Diageo's brands have been around for quite a long time. They're very well-trusted, recognizable. You're not going to go wrong buying the Smirnoff.

Whereas if you buy the upstart vodka brand, you might get some flack from your social group. Yeah, yeah, exactly. And I think I'll try to maybe compare this next group when we talk Altria group, but I don't think the brands are as strong. Now, there's other disadvantages to the tobacco that the volume declines are sharp, and that's the opposite here. but the brand isn't as strong as a lot of these tobacco ones so my act 11s yeah i mean uh look they're going to be where the consumer is and that's the most important thing here and then to have a recognizable brand because think about when you're at a bar and they go what do you want you just look for something that you know that's recognizable that you've had before and you go

what i'm having a gin and tonic and they go tango ray good yeah yeah sure but that's what most people do i think at least that's what i do and then i do think they definitely have pricing power here given how cheap it is versus unit of consumption at about 17 servings on a 20 bottle of spirits that's not the end of the world if that thing bumps up to 50 right over a couple decades so yeah all right future growth opportunities ryan you mentioned tequila but anything further here no i it's hard for me to say like what they can do proactively to grow with tequila i think at this point they just kind of ride the wave they have two really good brands and don julio and casamigos and a couple of other tequila brands as well i think in general my takeaway from

the the growth in tequila is that i like their m&a strategy and i like that they're advantaged in M&A where if you have an upstart, let's call it, okay, Dwayne The Rock Johnson launched his own tequila brand recently, like Terramana Tequila, I think is what it's called. If that starts to catch fire and it starts to become really popular, you can easily, if you're Diageo, you can make him an offer that most people can't make and you can still generate good returns because you have that global scale. Now you obviously don't want to just start throwing out money willy-nilly for every acquisition, but I like that they're advantaged if consumer habits change.

So I think that's more of a highlight, but I would just say I'm not upset when they get into M&A like I might be with some other companies. Yeah. And there's a reason that you know, that we both know what Casamigos is, but we don't know what a lot of these other celebrity endorsed brands are because they don't have the distribution and they don't have the marketing muscle. So, look, just think about it yourself. What's the one that everyone knows that's the newest tequila brand? It's that one. But mine's going to be something we haven't talked about, and that is India, but more broadly, other population tailwinds. At the Capital Markets Day, management talked up the Indian market a lot, the aging up of some of these countries.

By 2030, around 600 million more legally aged drinkers will be out there in the world, and a quarter of them will come from India. Luckily, Diageo has already invested heavily into that market with its premium drinks, or excuse me, spirits strategy. Also, luckily, India is a big whiskey drinking market. they have a local brand as well as i forget his name it starts with a g but you can find it just look up india whiskey brand you'll find one of them and then there's also uh johnny wong which you know does well everywhere so that's good that's all i do for them they have the population tailwind there they have the fact that that's already a whiskey drinking market and luckily or maybe not luckily, but money spent on spirits per capita seems to grow as long as per capita

GDP grows in a region, or is that pricing power potential outside of inflation? So when you have a legal age population growing plus nice wealth gains in India, which has happened over the last five to 10 years, there can really be durable growth in spirits consumption for many years. And if we get these, what would it be around 180 million here by 2030, that can provide a lot of growth, especially if they keep up this GDP growth in the region. And it's not just there. That's more of a specific example, but I'm sure other areas in and around Southeast Asia, Africa, places like that.

Anything else on that, Ryan? No, I think just having the right brands, being ready for any consumption habit changes, and putting a lot of money into marketing and to develop markets or emerging markets is kind of the playbook for them. Highlights and lowlights though, I'll kick things off here. I've got a lot of highlights. So there are scale advantages galore in this business. They can acquire smaller brands at steep prices and still earn an attractive ROI thanks to that global distribution that we talked about. They can invest more into marketing than smaller peers can. They can afford to let their inventory age for longer. So maybe you can sell that as a higher premium, age for longer.

It becomes almost an advantage to have that inventory. And they have better negotiating leverage with distributors and end customers. So positives all across that. The Diageo brands, some of the houses there are incredibly difficult to replicate. Johnny Walker's been around for 300 years. Some of them are aged 10 years. Yeah, your grandfather was drinking it. Your father was drinking it.

Maybe your great-grandfather was drinking it. And it's just really hard to replicate that mindshare that Diageo's brands have with a lot of their customers. Other ones, there's geographic advantages in certain of their product lines. So some brands like Cognac, which I don't think they're very big in, but Scotch, they're constrained and must be manufactured in specific geographies. Same with tequila. I think tequila, you have to harvest the blue agave for five to seven years, and then you have to let it sit for a certain amount of time. an upstart in a specific in a specific region of mexico too so it's not just it's only it's similar to scotch only scotland mexico uh tequila only a certain area of mexico

now i will say i would think that most companies can't really wait that long but there's you can like buy the agave from a third party or you're gonna buy it you can buy it from a farm or whatever. But you're probably not going to be able to get it at the same cost that you would if you were doing the farm yourself. Last one here, there's some tailwinds in their favor, premiumization and drinking in moderation is becoming increasingly popular and they are well positioned for that. And then last one is alcohol as an institution has been around for an incredibly long period of time and should stay around. So I would be very surprised if this changed. It's not enduring some of the difficulties that a brand like tobacco companies are right now um low lights

though i'm not sure brand loyalty is what it once was the new management team is unproven has little background in the alcoholic beverages space and the previous ceo seemed to do a really good job so anytime there's like a quick ceo change and someone just gets thrust into the ceo see i think it's kind of i worry a bit the last one though and i think this is probably my biggest one the barriers to entry have come down thanks to modern marketing and i worry that the competitive advantages aren't quite as big as people might think so for example ryan reynolds aviation gin which they bought but right but you don't necessarily want them having to buy a new gin brand every year because someone else popped up and

started one. There's, I'm trying to think of some other popular ones. Conor McGregor's proper 12, I think is like a Irish whiskey. I can't say I've ever heard of that one, but I don't know. Jameson's on their, on their, their deals. I haven't seen much. I can't say at the store, at the restaurant, at wherever I have not seen much of, of this. I have seen a lot of Jameson as I have for the last 10 years. And I don't know if that's happened yet, but maybe not with the proper 12.

It's a brand that I've recognized kind of just through social media marketing, which if you're a famous celebrity, it's a little easier to start a brand with social media. Right. Yeah. I mean, you can, you can put on a video that gets 10 million views, but does that lead to drinking? Yeah. Maybe it's a little bit of a democratization, but I don't, i think diageo would push back and say like it would take a lot of marketing to truly see market share from well within that category they don't even own it like how long would it take for

proper call to take on jameson i think it would take a lot of time right yeah i agree but i still think the if you see your favorite celebrity i don't know who your favorite celebrity is but let's say messy for me started a tequila brand i think i'd be drinking his tequila brand and yeah but what if you can't what if you there's no what if there's no distribution i mean that comes that's what i was going to say is there is that's where diageo's advantage is bigger for me is in the distribution it's not i think the marketing being able to spend more on marketing than other brands i don't think that's quite as much of an advantage as it used to be yeah but it still has the sort of coca-cola type advantage because if you watch sports you see the

smirnoff commercials where it's just some really happy people making drinks and laughing and you're like all right smirnoff great and it that works um but yeah let me hit my highlights look you clearly if you have long-standing brands that have lasted over a century you have an advantage versus the competition i think that's clear like i mentioned before how many years and how many billions of dollars in marketing would it take to dethrone johnny walker or guinness i think quite a lot definitely not impossible but probably insurmountable for someone that doesn't want to play that long game which i think few people are uh i think you mentioned the time literally being on their side and then one thing we haven't talked about only or only talked

about briefly is consistent capital returns for the culture so both growing the dividend per share payout consistently as well as consistently repurchasing stock given the cat you know They generate consistent cash flow here with a little bit of an inventory hiccup sometimes, as Ryan talked about. I don't. This should be able to continue. And I like that that's part of the culture here. Lowlights. We talked about India. We talked about the emerging markets and they make a great pitch. They had a couple of slide decks and I was like, OK, makes sense. You know, per capita GDP is growing. We've got a ton of people aging into the 20 to 30 year old range in these markets that are going to start drinking these premium spirits. But I kind of think, are we really going to bet on these historically unstable regions from both economically and politically, political standpoint?

Is that the bet you want to make for this company? I think with someone with minimal boots on the ground in these places, I don't know if I would get that comfortable betting on that being my thesis. And then second one, I'm not sold on this new management team. the capital market state was a bit uninspiring, a bit robotic, kind of got bored and just turned it off because they were just talking really, really boring stuff. I don't know if that disregards them completely. I would

like to see their performance, but when a good CEO leaves abruptly, there's uncertainty here. I don't think you can disregard that. All right, Ryan, anything else? If not, why don't you go into your bull case and bear case as we close out here? I think the bull case

for me is you get 2% to 3% volume growth globally, 2% to 3% pricing growth, whether that's an increase in prices or shifting consumer preferences to more premium brands, you get that low single-digit pricing growth. Steady margins, which I think is achievable, and maybe even multiple expansion. Wouldn't bet on it, but it is the bull case we're talking about here, and it's trading at the lowest EBITDA and EBIT multiple in a decade. So, you know, there is certainly the possibility. If those things happen, I think you get near a 10% return, maybe even higher.

And I think there's some real safety in the business quality. So it feels like a pretty low risk, potential 10% return here. I think it's pretty favorable, honestly. Yeah. Yeah. I mean, it seems on a long timeline, it'd be hard to lose money, even if they're over earning a bit right now because of the inventory stuff. If those aren't really materialized as much as analysts kind of think, you probably still make money. But I would say for listeners

today, you are trading at 17 times pre-tax profit. So it's not dirt cheap. And if they can keep growing at about 5% revenue and then steadily expand their margins with the scale as they have been, and as Ryan talked about, they have 60% gross margins. So there's plenty of room to expand that the stock is likely going to do fine you know but at this earnings multiple if the multiple doesn't expand which is something i really don't like betting on um it's hard 10 returns might be the max going forward it's just hard to see how a business like this can really grow its earnings this quickly but i guess it'll lead into my more or less interested or maybe the better cases kind of these bet on the emerging markets

aren't going well and then also the premiumization as I mentioned was more of a Zerp phenomenon or maybe follows kind of a bull and bear market thing as I think the listeners can understand there and then also the channel stuffing stuff or the inadvertent overstocking

from their end distributors or the end retailers yeah I think that's a fair bear case I mean the risk I think is that they have negative volumes for a couple of years globally it's yeah maybe not negative revenue or not revenue declines but negative volumes because it's gonna the it's gonna have give revenue growth a hard time yeah i mean i have no concerns i have

no concerns that they that i they can grow prices by three to four percent in perpetuity it's a that's a huge advantage i'm no concerns about that but there are there are real concerns here for sure. Yeah. I don't think this is the end of the world if they have negative volumes for a couple of years because still, they could have volume declines, but still have market share growth. And I think they'd be positioned well for the long run. But the next couple of years could really suck. Earnings could be rough and multiple expansion certainly isn't guaranteed. So in that scenario where volume declines are rough, emerging markets don't materialize the way people are hoping, I think you're better off with treasuries. But I don't know.

Yeah. It feels like a fairly good risk-reward here. I think you can get above treasury returns here with not quite as much risk as a lot of other businesses. But I do feel like the ceiling's a little capped out. If you're only growing revenues 3% to 4% a year, which seems like their organic revenue growth rate on average probably over the last 10 years, maybe a little higher, it's hard for me to see how you get to 10% plus earnings per share growth. Even if margins expand a little bit, I mean, they're already earning a lot margin-wise. So I don't know, 10%, like you said, it feels kind of like the ceiling. Yeah. And I think you kind of answered, you're more or less interested. I'm in a similar boat, more interested, but at the right price. I know we'd say this a lot, but that's true. 90% of the time we're going to be like, or maybe not 90%, maybe 40% of the time, something like that. We go, hey, well, we'd buy this thing, but it has to be at the right price.

And for me, I think close to 10 times pre-tax earnings, which is a big drop from here, I would be all over this thing. I would say if it got to 10 times pre-tax earnings, something has gone really wrong. So you'd have to kind of plug your nose in that situation. But I think the brands are still going to be durable, regardless of what the inventory stuff or whatever risk materializes. But at these prices, I don't see why I would own this thing over American Express at 15 times earnings. That's kind of my hurdle for these non-major cap, magnificent seven stocks that are maybe not tech focused, but, you know, are kind of a larger company where the growth is not going to be super explosive. Why would I buy this over American Express for the next 10 years, next five years at when American Express is trading at 14 times earnings and Diageo is trading at after tax? what like 20 something times i just don't you know that's kind of like okay that's my hurdle

at the moment for these type of stocks i have i had a take before we recorded the show i don't know if i still have it but would you be surprised if this was buffett's secret position yeah i actually thought like well they had bought guinness in the past or whatever one of these were for us maybe it was this company but i think it was maybe it was the 90s it could have been guinness itself like yeah it could have been that he definitely likes these i these are businesses he likes so i wouldn't be surprised yeah i kind of kind of have a feeling that's your day i give it a good uh good chance there uh what do the economists say 40 chance so you can't be right going well i do think that if we like if i'm looking back 10 years from now i would not have

been upset with myself for buying diageo here yeah yeah it feels like i think it's pretty high yeah unless management really screws up i think yeah it's hard it's going to be hard to lose money i think there's look we're not i think this is great for someone over the age of like 50 60 individual investor that's trying to retain wealth if you know what I mean buy a little dividend grower but for us it might not be perfect for for our uh for what we're targeting which might be a mistake but yeah a little more we're going for something though you know the a little more loss tolerant which should maybe be the rephrasing yeah and that does lead into we are doing next week uh I'm going to be doing a little pitch on Altria group I'm going to try to pitch

Ryan, why the dividend per share can keep growing over the next five to 10 years, despite more volume declines, but that's going to do it. As a disclosure, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I may own either one, both, or none of us positions discussed in this podcast. Thank you everyone for tuning in and we'll see you next week. don't you wish you could just hit skip on the worst parts of your life you know the same way you can skip an ad i get it i'm siaya and i live in ice cove i've made some questionable decisions that didn't end up the way i planned and today i'm still figuring it out somehow things usually

get worse before they get better. Apparently that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem.