RELATIVE VALUATION OF DIAGEO PUBLIC LIMITED COMPANY CLARKE BALDWIN A THEMATIC PAPER SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF MANAGEMENT COLLEGE OF MANAGEMENT MAHIDOL UNIVERSITY 2018 COPYRIGHT OF MAHIDOL UNIVERSITY Thematic paper entitled RELATIVE VALUATION OF DIAGEO PUBLIC LIMITED COMPANY was submitted to the College of Management, Mahidol University for the degree of Master of Management on January 6, 2018 ……………….………….…..……… Mr. Clarke Baldwin Candidate ……………………….….…..……… ……………………….….…..……… Asst. Prof. Nareerat Taechapiroontong, Asst. Prof. Piyapas Tharavanij, Ph.D. Ph.D. Advisor Chairperson ……………………….….…..……… ……………………….….…..……… Duangporn Arbhasil, Assoc.Prof. Tatre Jantarakolica, Ph.D. Ph.D. Dean Committee member College of Management Mahidol University ii ACKNOWLEDGEMENTS First, and foremost, I must express gratitude to Miss Wipawee Chaiyaphruk, for without whom, I would never have begun this journey. Thank you for the excitement you showed when you registered for your program and taking the extra time to explore if Mahidol had a program that would interest me. Also, thank you for all the support over the years, from listening to me complain, being a sounding board for ideas, providing suggestions to improve my work, enduring my worst when stressed, and pushing me when I seemed to be unable to find the motivation needed myself. Without your support, this accomplishment would never have been realized. Second, I would like to thank Mister Nikolai Usack and the rest of the Andromeda Simulations International team. They provided me the support and flexibility at work to manage both my professional and academic demands. Third, I would like to thank the professors at Mahidol University. Especially, Ajarn Vasan Siraprapasiri who taught us the various valuation methods required to complete this paper and for guiding us through the thematic paper process; Ajarn Piyapas Tharavanij for making time to answer questions in relation to our papers, providing guidance to improve our work, and making classes on very dry subjects enjoyable; Ajarn Nareerat Taechapiroontong for her role as advisor and valuable suggestions provided; and all the rest of the professors I had over the past two years, they made the overall journey enjoyable. Lastly, I would like to thank the other students of the MMCF program, though we did not grow as close as I had hoped when first beginning, every one of them was supportive and helped get each other to the finish line. Good luck in your next endeavours and may you find much success and happiness throughout your lives. Clarke Baldwin iii RELATIVE VALUATION OF DIAGEO PUBLIC LIMITED COMPANY CLARKE BALDWIN 5949011 M.M. (FINANCIAL MANAGEMENT) THEMATIC PAPER ADVISORY COMMITTEE: ASST. PROF. NAREERAT TAECHAPIROONTONG, Ph.D., ASSOC. PROF.TATRE JANTARAKOLICA, Ph.D., ASST. PROF. PIYAPAS THARAVANIJ, Ph.D. ABSTRACT This thematic paper is the culmination of studying financial management and valuation, applying the various techniques to a publicly traded stock. In particular it focuses on the Diageo Public Limited Company (DGE) and seeks to provide a fair value price for DGE stock on December 31, 2017, through the use of relative valuation techniques. The paper includes a look at Diageo plc’s business, macro-economic analysis, global alcohol beverage industry analysis, competition analysis, investment summary, valuation, financial statement analysis, and investment risk analysis. The valuation method employed is a relative valuation using a simple average of four ratios: trailing P/E ratio, forward P/E ratio, EV/EBITDA, and P/BV. To accomplish this it required forecasting future earnings and calculating last twelve month EPS, next twelve month EPS and next twelve month EBITDA in the context that Diageo’s fiscal year end is June 30, and by UK standards only reports results on the halves (every 6 months). The fair value price found for DGE is 25.934 GBP, less than 1 GBP below the DGE price of 26.895 GBP as of December 22, 2017. In light of the highly conservative approach taken in forecasting, a recommendation to “Hold” is presented. KEY WORDS: Alcohol / Beer / Diageo / Distilled Spirits / Relative Valuation 85 pages iv CONTENTS Page ACKNOWLEDGEMENTS ii ABSTRACT iii LIST OF TABLES vi LIST OF FIGURES ix LIST OF ABBREVIATIONS xi CHAPTER I VALUATION 1 1.1 Highlights 1 1.2 Business Description 4 1.3 Macro-Economic Analysis 8 1.4 Industry Analysis 10 1.5 Competition Analysis 14 1.6 Investment Summary 20 1.7 Valuation: Relative Valuation Model 22 1.8 Financial Statement Analysis 26 1.9 Investment Risks and Downside Possibilities 31 CHAPTER II DATA 38 2.1 Diageo PLC Company Information 38 2.2 Market Share Data 43 2.3 SWOT Analysis 65 2.4 Five Forces Analysis 66 2.5 Pernod Ricard Financial Statements 67 2.6 Financial Statement Analysis 69 2.7 Key Ratios 75 2.8 Pro Forma 76 2.9 Half-Year Calculations 78 2.10 Peer Selection 81 v CONTENTS (cont.) Page 2.11 Sensitivity Analysis 82 REFERENCES 83 BIOGRAPHY 85 vi LIST OF TABLES Table Page 1.1 Diageo Financial Summary 1 1.2 DGE Market Profile 2 1.3 Select Diageo Brands Categorized by Global Giants, Local Stars and 7 Reserve, Including Category Overall Percent of 2017 Net Sales 1.4 Diageo’s Spirit & Beer Brands, Including Percent Market Share and 8 Rank, by Volume, for 2016 1.5 2017 Financial Ratio Comparison of Diageo and Selected Peer Group 23 1.6 Five Year Pro Forma Income Statement for Diageo PLC 24 1.7 EPS and EBITDA Calculations for Last 12 Months and Next 12 25 Months 1.8 Relative Valuation Target Price Calculations 26 1.9 Diageo Return Ratio Analysis for Past Five Years 30 1.10 Diageo Risk Ratio Analysis for Past Five Years 31 2.1 Diageo PLC Officers & Directors 38 2.2 Diageo PLC Top 20 Investors 39 2.3 Diageo PLC Production Capacity vs. Actual Production 40 2.4 Diageo PLC Consolidated Balance Sheets, 2012 – 2017 41 2.5 Diageo PLC Consolidated Income Statements, 2012 – 2017 42 2.6 Diageo PLC Consolidated Statements of Cash Flow, 2012 – 2017 43 2.7 Global Distilled Spirit Market Share Data – Company Percent Market 43 Share, by Volume, 2011 – 2016 2.8 Global Distilled Spirit Market Share Data – Brand Percent Market 47 Share, by Volume, 2011 – 2016 vii LIST OF TABLES (cont.) Table Page 2.9 Global Beer Market Share Data – Company Percent Market Share, by 53 Volume, 2011 – 2016 2.10 Global Beer Market Share Data: Brand Percent Market Share, by 55 Volume, 2011 – 2016 2.11 Pernod Ricard Consolidated Income Statements, 2012 – 2017 67 2.12 Pernod Ricard Consolidated Balance Sheets, 2012 – 2017 68 2.13 Common Size Analysis of Diageo PLC’s Income Statements, 2012 – 69 2017, Compared to Pernod Ricard in 2017 2.14 Common Size Analysis of Diageo PLC’s Balance Sheets, 2012 – 2017, 70 Compared to Pernod Ricard in 2017 2.15 Trend Analysis of Diageo PLC’s Income Statements, 2012 – 2017 71 2.16 Trend Analysis of Diageo PLC’s Balance Sheets, 2012 – 2017 72 2.17 Growth Analysis of Diageo PLC’s Income Statements, 2012 – 2017 73 2.18 Growth Analysis of Diageo PLC’s Balance Sheets, 2012 – 2017 74 2.19 Key Risk Ratios of Diageo PLC, 2013 – 2017 75 2.20 Key Return Ratios of Diageo PLC, 2013 – 2017 75 2.21 Assumptions Used for Creation of Five-Year Pro Forma for Diageo PLC 76 2.22 Support for Assumptions Used to Create Five-Year Pro Forma for 76 Diageo PLC 2.23 Five-Year Pro Forma for Diageo PLC 78 2.24 Key Full-Year Results for Diageo PLC, 2014 - 2017 78 2.25 First-Half Results for Diageo PLC, 2014 – 2017 79 viii LIST OF TABLES (cont.) Table Page 2.26 Calculations of the Percentage First-Half EPS and EBITDA Were of 79 Full-Year Results for Diageo PLC, 2014 – 2015 2.27 EPS and EBITDA Calculations for Last 12 Months and Next 12 Months 80 Using Historical Averages, Most Recent results and Pro Forma Results. 2.28 List of Companies’ and Selected Results Used for Determining Peer 81 Group for Relative Valuation Method 2.29 Diageo PLC Share Price Sensitivity Analysis Looking at Changes in 82 Assumed Growth Rate and Effective Interest Rate ix LIST OF FIGURES Figure Page 1.1 DGE Stock Pricing 1 1.2 Diageo’s Key Income Statement Figures for Past Six Years 2 1.3 Distilled Spirits Production Process 4 1.4 Diageo’s Net Sales Breakdown by Category for Past Three Years 5 1.5 Diageo’s Net Sales Breakdown by Geographic Region for Past Three 5 Years 1.6 Diageo’s Volume Sold Breakdown by Geographic Region for 2017 6 1.7 Select Regions Percent of Diageo’s Sales for Past Five Years 9 1.8 Regional Percent of 2016 Global Consumption of Distilled Spirits, by 11 Volume 1.9 Regional Percent of 2016 Global Consumption of Beer, by Volume 11 1.10 Top Ten Companies’ Percent Share of Global Distilled Spirits Market, 15 by Volume, for 2016 1.11 Pernod Ricard’s Volume Breakdown and Group’s Global Position by 16 Category 1.12 Top Ten Brands’ Percent Share of Global Distilled Spirits Market, by 17 Volume, for 2016 1.13 Top Ten Companies’ Percent Share of Global Beer Market, by Volume, 18 for 2016 1.14 Top Ten Brands’ Percent Share of Global Beer Market, by Volume, 19 for 2016 1.15 2017 Net Sales Breakdown Comparison of Diageo and Select 19 Competitors 1.16 DGE Trailing P/E Band for Past Five Years 22 x LIST OF FIGURES (cont.) Figure Page 1.17 DGE Forward P/E Band for Past Five Years 23 1.18 Diageo and Select Competitors’ Net Revenue for Past Five Years 27 1.19 Diageo and Select Competitors’ Profit for Past Five Years 27 1.20 Diageo and Pernod Ricard’s EBIT for Past Six Years 28 1.21 Diageo and Pernod Ricard’s Finance Charges for Past Six Years 28 1.22 Balance Sheet Common Size Analysis, Diageo’s Past