Apr 16 -
Summary analysis -- Diageo PLC ------------------------------------ 16-Apr-2012
CREDIT RATING: A-/Stable/A-2 Country: United Kingdom
Primary SIC: Food
Credit Rating History:
Local currency Foreign currency
01-Sep-2005 A-/A-2 A-/A-2
24-Oct-2003 A/A-1 A/A-1
The ratings on U.K.-based drinks manufacturer Diageo PLC reflect Standard & Poor’s Ratings Services’ view of the group’s “excellent” business risk profile and “intermediate” financial risk profile.
In our opinion, Diageo’s key business strengths stem from its leading position in the global premium spirits industry and the strength and resilience of its brands, with many holding the No.1 or No.2 position within their respective product categories. About 41% of the group’s reported operating profit in the six months ended December 2011 was derived from North America, 29% from Europe, 11% from Africa, 14% from Latin America and the Caribbean, and 11% from the Asia-Pacific region. The rest is attributable to corporate costs.
Our view of Diageo’s “intermediate” financial risk profile reflects the stable and strong cash-generative nature of the business; the group generated about GBP600 million of discretionary cash flow in the 12 months ended December 2011. At the end of December 2011, Diageo displayed Standard and Poor‘s-adjusted debt of GBP9.7 billion, with an adjusted debt-to-EBITDA ratio of 3.0x and an adjusted funds from operations (FFO)-to-debt ratio of 25.7%.
S&P base-case operating scenario
We project that volumes and revenues will grow in the low- to mid-single digits over the medium term. We believe that this will be fueled by strong demand and a preference for premium branded products in developing regions such as Africa, Asia, and Latin America where there is a growing middle income population with increasing disposable incomes. We anticipate that demand from these regions will help to cushion subdued demand in some European countries such as Spain, Greece, and Ireland where consumer confidence is weak amid the current uncertain economic environment.
In North America, we have seen some signs of recovery in the spirits and brewing industry. Based on this we anticipate that we will continue to see potential for modest revenue growth boosted by some upward pricing, albeit in a lower volume growth environment.
We believe that an increased focus on emerging markets that offer upward pricing potential, as well as a general focus on premium brands and cost-cutting measures will help the group improve its margins by about 150 basis points to 200 basis points over the next few years. At the end of December 2011, the group’s adjusted EBITDA margin was 31.5%.
S&P base-case cash flow and capital-structure scenario
Given our margin expansion and modest revenue growth projections, we calculate that Diageo will generate about GBP2.6 billion of FFO annually over the next few years. We project that the group will generate about GBP700 million of discretionary cash after annual capital expenditure (capex) of between 15%-20% of EBITDA and dividends of about GBP1 billion annually over the medium term.
We believe that the group will remain acquisitive over the next few years; in January 2012 Diageo purchased Ethiopian brewer Meta Abo for a cash consideration of $225 million. Indeed, we anticipate that infill acquisitions are likely to absorb the vast majority of the group’s discretionary cash flows over the medium term. The amount of discretionary cash that Diageo generates would in our view, be sufficient to fund small to midsize acquisitions as well as enable the group to maintain debt-to-EBITDA of less than 3x and FFO to debt of between 25%-30% over the medium term. These are the metrics that we consider to be commensurate with the current rating.
The short term rating on Diageo is ‘A-2’, reflecting our assessment of the group’s liquidity position as “adequate” under our criteria.
We consider liquidity sources over the next 12 months to include:
-- Cash and cash equivalents of GBP1.1 billion at the end of December 2011;
-- A combined $3.5 billion in committed bank lines maturing in May 2012 ($1.25 billion), May 2013 ($1.17 billion), and May 2016 ($1.08 billion); and
-- FFO of about GBP2.6 billion.
Liquidity uses over the same period include:
-- Short term debt of GBP2.7 billion at the end of December 2011;
-- Capex of about GBP560 million; and
-- Dividend payments of about GBP1 billion.
In addition, we consider the following factors to be supportive of the group’s liquidity profile:
-- The committed bank facility’s single financial covenant; a minimum interest coverage ratio of 2x. On Dec. 30, 2011, the ratio was 5.6x based on our calculations. We project that the ratio will stay comfortably within the covenant limit over the medium term.
-- The absence of downward rating triggers that would accelerate the maturity of a material amount of debt.
The stable outlook reflects our opinion that Diageo is sufficiently cash-flow generative to enable the group to maintain an adjusted FFO-to-debt ratio of 25%-30% and an adjusted debt-to-EBITDA ratio of less than 3x, the levels we consider commensurate with the current ‘A-’ rating, over the medium term.
Taking into account the group’s operational strength, we believe that any downside risks to the rating are likely to derive from a change in financial policy. Specifically, the rating could come under pressure if Diageo were to increase acquisitions such that discretionary expenditure was to exceed discretionary cash generation on a sustained basis.
In our view, an upgrade is unlikely in the near term, as it would require adjusted FFO to debt to increase to 35% and be sustained at this level. Our base-case operating assumptions do not facilitate such a material increase, and thus it would depend more so on a financial policy decision by management.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Key Credit Factors: Criteria for Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Standard & Poor’s Encyclopedia Of Analytical Adjustments For Corporate Entities, July 9, 2007