Executive Summary
Diageo is a global enterprise with thousands of employees and a variety of product range. In this report, the analysis and evaluation of Diageo are done to measure its performance. The paper examines the analysis of the Diageo with Suntory by calculating the profitability, liquidity and efficiency ratio. The results show that the bank must invest in the Diageo as it has a good financial position and they are working for welfare too. The return on equity, return on capital, gross profit margin, operating profit margin and net profit margin of Diageo are higher than that of Suntory. However, the quality of earnings is approximately equal. It implies that Diageo has high profitability as compared to Suntory. The period for settlement for trade receivables both companies are nearly equal. It implies that the efficiency of Suntory is relatively greater than that of Diageo. The current ratio of Diageo is greater than that of Suntory. However, the quick ratio of Suntory is greater than that of Diageo. It implies that the Diageo has a relatively stable financial position than Suntory.
Introduction
With a wide variety of spirits and beers in the portfolio, Diageo marks itself as a global frontrunner in alcohol beverage industry. It is registered as incorporated as public limited company in Wales and England and is listed on ‘New York Stock Exchange (DEO)’ and ‘London Stock Exchange (DGE)’, both. (Our Business, 2018). Following are the few highlighting aspects of Diageo.
Moreover, Johnnie Walker and Smirnoff are two of the five largest premium brands worldwide which are owned by Diageo. Rest of the brands are follows. (Our Business, 2018)
The following is the global reach of Diageo.
The main aim of this report is to outline how the performance is measured and how well Diageo is operating. Its comparison is done with the biggest competitors in the market Suntory (5 Diageo Competitors Worth Looking Into, 2014) to help decide whether the bank should invest in the shares of Diageo at the current market price of £ 2,541.
The financial analysis techniques used in the report are ratio analysis of Diageo and cross sectional analysis (Peavler, How Do You Do Financial Statement Analysis?, 2018) with its competitor Suntory for the same ratios. Furthermore, the yearly comparison of Diageo is conducted by the aid of calculated ratios given in the published financial statements.
Critical Review
Financial statements can be better comprehended and contrast made between current and past data of the company as well as comparison with competitors can be done through ratio analysis. This can help in identification of trends over time while also supervising and gauging the overall financial position of any company. This information is also useful to other stakeholders. The analysis can then aid in making future financial decisions. (Lohrey, 2018). To get the most out of this type of analysis it is important to always select the most relevant ratios as not all ratios may be relevant everywhere. Secondly, the ratios need to be comparative; that is to say they must be compared to previous year data or with other competitors like this report contrasts between Diageo and Suntory. A stand-alone ratio gives a very generalised picture and does not aid much in understanding. Comparative ratios will help identify trends that will also aid in problem identification. Lastly, the ratios should be to whatever extend possible be matching like-for-like; this is to say when comparison is being made between two competitors try to compare for similar accounting periods and accounting periods and to also compare companies operating in the same industry conducting the same type of business (Brettandwater, 2010). Although Diageo and Suntory are operating in the same sector the latest financial data available for Diageo was for the fiscal year ended in June 2018 and latest data available for Suntory is of fiscal year ended in December 2017.
One of the biggest limitations of ratio analysis is like in the case of Diageo and Suntory like-for-like cannot be applied to its full potential and therefore making the data less useful than if both companies had the same accounting periods. Another limitation of this analysis is making judgements that may differ from person to person. For comparison purposes the yen has been converted to pound sterling in some instances in the report, another analyst may not feel like this is the best way to go about it. Other limitations include; companies using different accounting policies from each other, company balance sheet giving untrue picture due to inflation and companies using window dressing to manipulate financial statements. (Peavler, What Are The Limitations of Ratio Analysis?, 2018)
Moreover, Diageo operates with a large number of groups who have different range of taxes which usually change according to the tax authority by the local governments. In such cases, these charges which include indirect or direct taxes and transfer prices, show an uncertain amount. There the limitation arises as the decision by the management is considered by the company while satisfying the local governments. Thus, creating provision of taxes in this situation too.
In addition to this, water is very essential for the production process and with the climate issue it becomes a limitation as our cost increases while we recycle water for the production process of the products.
Analysis
DuPont Analysis
This ratio enables us to examine the change in figure over the time to see the variation in ROE due to the 3 main drivers: operating efficiency, asset use efficiency and financial leverage. These drivers are calculated by net margin, asset turnover ratio, and equity multiplier. Respectively. Following is the formula:
DuPont analysis of Diageo is conducted of 2017 and 2018 and with its competitor; Suntory in order to have a realistic view of how efficiency these assets are used along with its combined effort of profit margin and asset turnover.
Observing the Suntory ratio values in DuPont analysis it can be concluded that all three drivers in ROE are lower than Diageo, so it should not be considered. Moreover, when we see these 3 main ratios in ROE for Diageo it can be said that Diageo have performed better as values are greater in 2018 as compared of 2017. Equity Multiplier has increased as Diageo has purchased assets in 2018. Net profit margin was greater in 2018 as the excise duty, cost of sales and taxes had reduced in 2018 as compared to 2017. Asset turnover enable us to conclude that revenue as compared to assets are used efficiently due to the increase in sales, reduced taxes, excise duties and cost of sales. There were also sales of businesses in South Africa which generated more in flow.
Profitability Ratios
Following ratios are calculated and analysed. Return on capital employed is a measure of efficiency with which the company’s assets are employed. Diageo’s ROCE is 15.8% which is much higher compared to Suntory who has a ROCE of 5.27% which shows that capital is more efficiently utilized by Diageo. Return on equity shows the return an investor makes on the money invested by them in Diageo and for this reason it is said to be one of the most important ratio, also because this is also the ratio all potential future investors will look at (Peavler, 2018). Diageo has a 31.9% return on equity ratio which shows that it is effectively earning return for its shareholders and helping the company grow. For every £1, investors are earning 31.9 pence. The return on equity ratio for Suntory is 14.6%.
Another ratio that measures the efficiency is operating ratio which compares operating expenses to sales revenue and again Suntory performs better than Diageo with their ratios being 0.77% and 10.61% respectively as the smaller this ratio is the greater the capability of company to generate profit if revenue decreases. Quality of earnings ratio tells the amount of earnings that are attributable either to higher sales or lower cost so naturally a higher ratio is preferred. Suntory performs slightly better here with their ratio being 1.03 and Diageo’s ratio being 0.98.
Margin Ratios
The gross profit margin ratio presents the cost of products sold as a percentage of sales by Diageo which is of 40.84% which is lower than Suntory who has a gross profit margin of 43.87%. This means that Diageo is retaining 40.84% of its revenue’s as profit after the cost of sales have been paid, although this is a good number the competitor seems to be doing better here by 3%.
Operating profit margin ratio measures overall operating efficiency of a company as it includes all expenses needed to carry out the business activities excluding interest and tax (Peavler, 2018). Here, Diageo outperforms Suntory by almost 10% as it has an operating profit margin of 20.02% whereas Suntory’s operating profit margin is as low as 10.47%. Again, the higher the profit margin the better for the company. This ratio shows that Diageo is managing to retain 20% of its revenues even after paying for its majority expenses putting it far ahead of its competitor whose profit margin has suffered a hard blow due to high expenses.
Net profit margin is the final stage where all expenses and other incomes have been accounted for and shows the ultimate ability of the company to convert revenue into profit (Peavler, 2018). Diageo again has a higher margin at 20.29% than Suntory which is at 9.37%
Efficiency Ratios
These ratios are used to measure how effectively the assets and liabilities of a company are internally utilized. Assets turnover ratio (sales revenue to capital employed) shows the efficiency of asset utilization meaning how quickly the company is able to make sales with the aid of its assets (Woodruff, 2018). Diageo has a total asset turnover ratio of 0.79 which is slightly higher than Suntory that has a total asset turnover ratio of 0.68 their asset turnover ratio is higher than Suntory because of having more sales which shows that Diageo is earning more money for every asset held. Non-Current Asset turnover ratio is very similar as it measures the efficiency of fixed asset utilization only and again the higher the ratio the better. Diageo has a non-current asset turnover ratio of 0.87 which is higher compared to Suntory’s ratio of 0.73. Working capital turnover ratio measures the efficiency of working capital utilization in generating profit and like the other two ratios a higher ratio is preferred. Suntory outperforms Diageo here with their respective ratios being 10.44 and 7.90 respectively.
Inventory turnover period tells how many times the inventory is sold in a particular period by the company, usually one financial year. A higher turnover than the competitors would mean the company is making more sales (Peavler, 2018). Diageo’s turnover is more than double than that of Suntory with both having turnovers of 377.12 days and 136.2 days respectively. This is due to the expansion of Diageo in 180 countries.
Settlement period for trade payables shows the number of days taken by the company to settle its debts with its suppliers and a lower number is preferred here. Diageo’s settlement period is 53.03 days where as Suntory’s settlement period is 59.81 days. Similarly, settlement period for trade receivables shows the number of days taken by a company’s customers to settle the credit sales and like settlement period for trade payables a smaller number is preferred. Diageo has a settlement period for trade receivables of 16.46 days which is extremely low compared to Suntory’s 171.69 days. A working capital cycle shows the time taken by a company to covert its working capital into cash and again the smaller the number the more efficiently the company is performing. Suntory performs better here with their cycle being 24.32 days and Diageo’s cycle at 413.69 days due the movement in working capital. These ratios indicate that Diageo is in a better position to settle the transactions and have a better liquidity even though Diageo have purchased few assets in 2018 in form of computer software and equipment.
Liquidity Ratios
Liquidity ratios help determine a company’s ability to meet its short term debt obligations and one of the most basic calculation done for this purpose is that of working capital because a company having positive working capital has enough assets to pay off its debts whereas and vice versa (Staff, 2011). Diageo and Suntory both have positive working capitals of £2,331 million and £1,576 million (¥231,645 million) respectively, meaning they are both able to pay off their debt obligations if the need arises.
The current ratio simply shows for every current liability held how many current assets are available to be liquidated. Generally, a higher ratio at least above 1 is preferred (Staff, 2011). Diageo has a current ratio of 1.36 and Suntory has a current ratio of 1.22.
The quick ratio also known as the acid test ratio only uses the most liquid assets of a company and measures them against the current liability. Inventory is a harder item to liquidate compared to others such as cash which is why it is left out of this calculation (Staff, 2011). Diageo and Suntory have quick ratios of 0.563 and 0.743 respectively. Although Diageo has a better current ratio, the quick ratio indicates that Suntory would be able to sell its most liquid assets sooner compared to Diageo. Diageo has a lower quick ratio due to lower cash equivalents and other financial assets such as marketable securities in its balance sheet that can easily be liquidated. The reason they have a higher current ratio is that Diageo has high year end inventories as reported in the balance sheet.
Operating cash flow ratio measures the ability of a company to cover its short term liabilities with cash flows from operations. Diageo cash flow is 140 million less from 2017 and a ratio of 0.48 meaning it is not generating enough cash flow and this is due to the purchase of property, plant and equipment and computer software along with the movement in working capital loan and other investments in 2018. Ratio for Suntory could not be calculated due to insufficient data.
Other Ratios & Data
To arrive at a conclusion some further ratios to be considered here are shareholder equity ratio which Diageo has at 39.41% which is higher than 33.75% of Suntory’s. Diageo seems to be doing better in some areas despite having only 1.75% in sales growth compared to 2.62% of Suntory it has a higher 1-year return at 2.05% compared to -12.20% of Suntory. The share price of Diageo is £2,541 with £1.21 earning per share and price earning ratio of 20.94 whereas Suntory has a share price of £30.33 (¥4,460) with an earning per share of £2.10 (¥308.63) with a price earnings ratio of 20.21 (Diageo, 2018) (Suntory, 2018).
Conclusion
Despite the limitation of not having the same accounting period data for both companies the difference in accounting period is only of 6 months and therefore the differences arising are not too much. Diageo is performing quite well in most areas and has operations much larger than Suntory. It outperforms its competitor in important areas such as operating profit margin, net profit margin, return on assets, return on equity, current ratio and even shareholder equity ratio after careful consideration of the financial analysis the bank is advised to invest in Diageo at their current share price of £2,541.
The emphasis of Diageo maintaining its strong position is due to the non-financial programs and benefits it is providing which are as follows.