Are Diageo shares an inflationary hedge?

Shares in Diageo dipped last week after fellow drinks giant Heineken warned that inflationary pressures were “off the charts”. Dolf van den Brink, executive chairman and chief executive of the Dutch brewer, told investors at the full-year results that the “speed of recovery” from the Covid-19 pandemic remained “uncertain”. He also said that the company faces “significant inflationary challenges” due to rising manufacturing and shipping costs.

With input prices expected to rise by a percentage in the mid-teens, van den Brink told the Financial Times that there was now “increased uncertainty” over Heineken’s midterm profit forecasts. Heineken fears that customers could stop drinking as much beer as it is forced to hike prices. “We will offset these input cost increases through pricing in absolute terms, which may lead to softer beer consumption,” the company told investors.

As investors read across to Diageo, the shares fell 1% to 3595p in intraday trading. Numerous other food and drink producers, including Carlsberg, Nestle, Kelloggs and PepsiCo have all recently warned of cost inflation and the need to pass price increases onto consumers.

‘Vice stocks’ like Diageo are a hedge against inflation

However, shares in companies producing consumer staples, such as alcohol, are traditionally a good inflationary hedge because customers are likely to continue to buy their pint or tipple despite cost pressures. Diageo owns 200 alcohol brands, which it sells across 180 countries, including Smirnoff, Guinness, Johnny Walker, Bailey’s and Captain Morgan. It is also enjoying buoyant sales, reporting broad-based growth across most of its brand categories at the recent half-year results, particularly in scotch, beer and tequila. The company is experiencing growth in China and Latin America.

Despite a tough year due to the Covid-19 pandemic, Diageo posted solid half-year results in January, with net sales up 15.8% to £8bn and strong organic growth, despite currency fluctuations. Organic net sales were up 20%, while reported operating profits rose 22.5% to £2.7bn and operating margins increased by 190 basis points thanks to growth in organic operating profit, which rose 24.7%, with growth experienced across all regions.

Premium plus brands generated 56% of reported net sales and delivered 74% of organic net sales growth. “We have made a strong start to fiscal 22,” Diageo’s chief executive Ivan Menezes told investors at the half-year results in January. “While we expect near-term volatility to remain, including potential impacts from Covid-19, global supply chain constraints and rising cost inflation, I am confident in our ability to successfully navigate these disruptions through the remainder of the year.

“Over the medium-term, from fiscal 23 to fiscal 25, we continue to expect organic net sales to consistently grow within a range of 5% to 7% and organic operating profit to grow sustainably within a range of 6% to 9%."

Diageo’s position of strength

The company also boasts a strong balance sheet, with a leverage ratio of 2.5% at the lower end of Diageo’s target range. Net cash flow during the period, while down slightly on the previous year (-£0.1bn), remained strong at £1.9bn, while free cash flow was £1.6bn during the half-year, down £0.2bn due to an exceptionally strong working capital benefit in the comparative period.

Diageo also completed £0.5bn of share buybacks during the half-year to 31st December 2021 as part of a plan to return up to £4.5bn to shareholders. Today it has announced it is buying back another £1.7bn of shares.

The company won’t be immune from inflationary pressures. However, the fact that it has a diverse geographical spread and owns many popular well-known brands should make it less vulnerable than other companies.

Diageo shares are up 22% this year to 3658.5p but are down from the high of 4103.5p they reached in January. Analysts at Barclays have set a price target of 4800p. The share price looks likely to continue to climb, given the flight to quality stocks and rising cost inflation.

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