TheMarketTone.com

Diageo’s stock has struggled along with the overall market this year. The concerns surrounding the stock (strong GBP, weak consumer, and rising input costs) should have been eased after last week’s conference call. If anything, Diageo’s H2 earnings reaffirmed the long case for investors.

The long case:

o Cost Control
o Demand Growth Continues
o Very Attractive Valuation

Cost Control
By far, the two most sensitive costs DEO faces are its input costs and transportation costs. While DEO is largely levered to these costs, the profit growth in H2 was directly achieved through cost cutting and cost control. This is substantial because other distillers and brewers have suffered from rising corn, wheat, hops, aluminum, and plastic costs. Furthering this point, Organic net sales increased 6.6% while profits increased 9%.

Demand Growth Continues
While Europe and North America have recently slowed, the overall industry appears stable.

For example, Brown-Forman’s recent quarter reported:

o Jack Daniels volumes were up +4% globally, single-digits in the U.S., and +8% internationally
o Southern Comfort down in the U.S.;
o Finlandia continued strong growth outside the U.S. +16% globally.

These results were echoed by Constellation Brands, Fortune Brands and Diageo.

DEO’s H2 sales growth was largely driven by international performance. International sales grew by 16%, North America by 5%, and Europe by 3%. The strong performance was lead by positive growth in all brands with the exception of Johnny Walker. This should relieve the fears investors have over slowing demand growth.

Valuation
After the release analyst estimate remain unchanged, leaving the shares on at a 2009E PE of 15.1x and 2010E PE of 13.7x with an expected yield of 3.7%. This is slightly ahead of the market average, but given their earnings constancy and strong results it is probably deserved.

DEO’s recent earnings show that management is executing flawlessly in a potentially difficult environment and its customers continue to purchase it spirits. DEO stands out in the consumer products space not only in performance but valuation.