1. Peter Clowes and Andrew Corwin

2. What is Diageo (DEO)?
Diageo is the largest premium spirits company in the world with control of 8 of the top 20 liquor brands.
Diageo has a market cap of $27.05 Billion.
Diageo has the largest global presence and established distribution system among premium liquor companies.
Diageo’s high end, branded products yields impressive profit margins.
Best of all, Diageo is undervalued:
Price per share: $41.14 (as of 3/9/09)
Fair Value Estimate: $78.28

3. Diageo’s Top Global Brands

4. A Socially Responsible “Sin” Stock
Social Sustainability
110 responsible drinking programs in 45 countries
1.1% of Operating Profit donated annually to direct investment in local communities
Environmental Sustainability
Goal: Reduce company wide emissions by 5%
Goal: Reduce non-ingredient water used by 50%
95% of solid waste was reused/recycled in past year, goal of 100% by 2015

5. TTM Performance:

6. Holding Period Performance:

7. Industry Overview
In the premium spirits sub-industry, Diageo is the current market leader.
This sub-industry is highly competitive due to the lucrative margins it generates.
There can only be a limited number of “premium” brands.
Distribution and Brand Equity are crucial.

8. 4. Threat of Substitutes: Medium
Porter’s Five Forces:
1. Buyer Power: Low
2. Supplier Power: Low
3. Threat of Entry: Low
4. Threat of Substitutes: Medium
5. Rivalry: High

9. Ratio Analysis Diageo (DEO) Brown-Foreman (BF.A)
Constellation Brands (STZ)
CEDC (CEDC)
Mkt. Cap
34.97B
7.69B
3.43B
0.64B
P/E Ratio
11.75
17.22
(4.71)
5.73
EPS
$4.73
$2.96
($3.33)
$2.41
Dividend Yield
4.83%
2.13% 0%
Dividend Payout Ratio
57.32%
81.06%
ROE
.36
.26
(.26)
0.14
NI/Sales
.18
.17
(.19)
0.09

10. Valuation Overview: Growth Forecast Profitability Free Cash Flows
Access to FCF
Valuation

11. Weighted Contribution
Growth Forecast
Region
Projected GDP Growth
DEO Growth
% of Total Sales
Weighted Contribution
N. America
2.3%
3.1%
28.1%
0.9%
Europe
3.2%
38.3%
1.2%
Asia / Pacific
6.5%
6.0%
11.1%
0.7%
International
4.7%
7.0%
22.5%
1.6%
Total DEO Growth: 4.34%
*Source: IMF (

12. Profitability: Key Drivers
Premium Products:
High Brand Loyalty
High Margins
Unique
Distribution Network:
Efficient Distribution Creates Competitive Advantage
Exclusive Distribution Rights Among Vendors

13. Profitability: Margins
Combining DEO’s growth with its key drivers results in sustainable and defensible profit as evidenced by these margins:
3-yr Trailing Average Gross Margin: 63%
3-yr Trailing Average Operating Margin: 28%
3-yr Trailing Average Profit Margin: 21%

14. FCF Generation 2006 2007 2008 2009 2010 2011 Net Income $3,528 $2,709
$2,976
$3,613
$3,479
$3,734
Free Cash Flows
$1,226
$1,514
$1,179
$2,042
$2,745
$2,702
FCF/NI
35%
56%
40%
57%
79%
72%
Chart: 3back 3 forward w/ NI & FCF,

15. Access to FCF 2006 2007 2008 2009 2010 2011 Net Income $3,528 $2,709
$2,976
$3,613
$3,479
$3,734
Free Cash Flows
$1,226
$1,514
$1,179
$2,042
$2,745
$2,702
Dividends
$1,598
$1,721
$1,706
$1,780
$1,860
$1,946
Divs/FCF
130%
114%
145%
87%
68%
72%
Stock Buyback
$3,329
$4,388
$4,737 -
Price Per Share
$60.85
$77.60
$71.03
$80.74
$90.56
$101.08
*Prices in Millions USD (Except Per Share Data)

16. Valuation Target Price: $78.31 Price as of 3/31/09: $44.75
Model Outputs:
Model Implied Price 6/30/08: $71.04
Actual Price for 6/30/08: $71.03
Per Share Value of Future Dividends: $76.19 (Discounted by Ke at 8.71%)

17. Methodology Growth Forecast: 4.34% fading to 5% after five years.
WACC: 7.69%
Risk Free: 3.25% (adjusted by 50 bps)
Cost of Debt: 7.95%
Cost of Equity: 8.71%
Beta: .77

18. Risk Analysis
Currency exposure due to recent depreciation of the British Pound versus the U.S. Dollar.
When the U.S. enters an inflationary period, due to the large amounts of cash being injected into the economy, Diageo will be protected.
Economic slowdown may result in less high end purchases.
Consumers may trade down, but historically, premium spirits are resilient. Scotch and whiskey have seen an increase during this economic cycle.

19. Sensitivity Analysis:
COGS
Sales
+10%
+5%
Constant
-5%
-10%
-20%
$95.93
$86.74
$78.34
$70.67
$63.68
$51.58
$92.62
$83.69
$75.52
$68.09
$61.32
$49.62
$89.31
$80.63
$72.71
$65.51
$58.96
$47.67
+15%
$85.99
$77.57
$69.90
$62.92
$56.60
$45.71
*The percent changes in this analysis are deviations from near term starting rates. Long term values are held constant. Prices are per share values.

20. Diageo’s Value Proposition:
Sustained Growth and Aggressive Growth Opportunities
Defensible Profit Margins
Stable Earnings and High FCFs
Actual Return of FCFs to Shareholders
Highly Undervalued