Diageo Financial Analysis: Ratios, Strategy & Performance

Company Overview and Corporate Structure

Diageo (NYSE: DEO; LSE: DGE) was created in 1997 with the merger of brewer Guinness and spirits-maker Grand Metropolitan. The company's major brands include Guinness, Johnnie Walker, Lagavulin, Captain Morgan, Tanqueray, Bushmills, Crown Royal, Baileys, Smirnoff, and a number of other beer, wine, and spirits properties (Diageo.com, 2011). When Diageo was formed, it inherited a number of food interests from Grand Met, including Burger King and Pillsbury, but in the early 2000s it divested its food businesses to focus strictly on alcoholic beverages. The history of many of the companies and brands within the Diageo family dates to the 18th and 19th centuries. Diageo holds roughly a 29% share of the premium spirits market. It competes in beer as a differentiated provider, and its share of the heavily fragmented global beer market is considerably smaller as a result.

Diageo is structured on the basis of geographic units. The four main units are Asia Pacific, Europe, North America, and International (2010 Annual Report). Within each geographic area, individual nations and brands have their own companies. Within each nation/product company — for example, Guinness Anchor Berhad for beer in Malaysia — there are units for individual products and divisions that separate the production and marketing functions. Diageo markets in far more locations than it produces. For example, its scotch business has production at dozens of sites throughout Scotland, but marketing is conducted nationally around the world. Key production and marketing units are Diageo Ireland, Great Britain, Scotland, Diageo Brands NV in Europe, and Diageo North America. In addition, there are several sub-units dedicated to financing, located in Europe, Britain, and the United States (2010 Annual Report).

The board of Diageo is comprised of 11 individuals, seven of whom are non-executive (external) directors, with the remainder coming from within the company. Strategic leadership is taken by the Executive Committee, which is comprised of a mix of functional and regional managers — including executives for marketing, procurement, Asia Pacific, Africa, HR, and finance. This team is responsible for steering global strategy for Diageo, with sub-units taking direction from this overall strategy.

There is no "Letter to the Stockholders" in the 2010 Annual Report; instead, there is a "Chairman's Statement." In it, the chairman notes that the current operating environment is characterized by volatility. The company responded by making significant changes to its business, including organizational restructuring and steps to reduce its cost base. The chairman reports that the strategies outlined the previous year were implemented, resulting in "greater efficiencies and stronger performance." He concludes by noting that the company increased its dividend to stockholders.

The audit of the financial statements was conducted by KPMG and was "audited to the extent required by the regulations." The report was approved by the Board of Directors and complies with applicable UK governance regulations. The auditor's report is clean — there are no matters to report with respect to the Companies Act of 2006, the IASB, or the directors' report. The statements are deemed to "give a true and fair view of the state of the group's affairs as at 30 June 2010 and its profit for the year ended," that they have "been properly prepared in accordance with IFRS," and have been "prepared in accordance with the requirements of the Companies Act of 2006 and Article 4 of the IAS regulation" (p. 105).

Appendix A: Common-Size Income Statement

Diageo Common-Size Income Statement, 2009–2010
(Source: compiled by author using figures from the Diageo 2010 Annual Report)

Line Item — 2010 — 2009
Sales: £12,958M — £12,283M
Excise: 24.53% — 24.20%
Net Sales: 75.47% — 75.80%
Cost of Sales: 31.63% — 31.69%
Gross Profit: 43.84% — 44.11%
Marketing Expense: 10.95% — 10.80%
Operating Expense: 13.03% — 13.62%
Operating Profit: 19.86% — 19.69%
Profit Before Tax: 17.28% — 16.20%
Tax: 3.68% — 2.33%
Net Profit: 13.60% — 13.87%

Appendix B: Common-Size Balance Sheet

Diageo Common-Size Balance Sheet, 2009–2010
(Source: compiled by author using figures from the Diageo 2010 Annual Report)

Line Item — 2010 — 2009
Non-current assets: £12,502M (64.26%) — £11,951M (66.33%)
Non-tangible assets: 34.57% — 34.49%
Current assets: 35.74% — 33.67%
Inventories: 16.87% — 17.08%
Receivables: £2,008M (10.32%) — £1,977M (10.97%)
Cash: 7.47% — 5.07%
Total Assets: £19,454M — £18,018M
Current Liabilities: 20.27% — 22.12%
Payables: 13.44% — 12.05%
Non-Current Liabilities: £10,724M (55.12%) — £10,158M (56.38%)
Borrowings: 42.03% — 42.65%
Deferred Taxes: 3.82% — 3.36%
Retirement Liabilities: 6.45% — 7.90%
Total Liabilities: £14,668M (75.40%) — £14,144M (78.50%)
Shareholders' Equity: 24.60% — 21.50%