US Edition Diageo shares have underperformed other defensives over the past six months, but the company generates good cash flows and its dividend is safe. This has created a buying opportunity.
The shares are currently yielding 4.4pc, but the group has a progressive dividend policy of raising the payout by 5pc each year.
However, there is scope to raise this further. The company has been limiting its dividend growth to 5pc per annum to increase its dividend cover. This now stands at about two times, so it is at a pretty comfortable level.
Questor is not forecasting a change in dividend policy, but is pointing out that the company now has the scope to raise it payout further if it so wishes.
Of course, despite its defensive characteristics, the spirits and beer group has not been immune to the effects of the recession. Destocking has been a major theme – and this has obviously hit sales.
Destocking at retailers and wholesalers is likely to come to an end late this year or early next year – but this does not mean that restocking is going to occur. It is likely that stocks will be kept at a lower level and sales will start to track underlying demand.
The company also has to seize the moment and make some targeted acquisitions in some of its markets. Now is a good time to snap up complementary bolt-on businesses as asset prices have fallen.
Diageo's share price fell earlier this year as it was forced to reduce some ambitious guidance. There have also been difficulties in a number of the group's markets, particularly in Spain, which has suffered one of the worst housing crashes of any Western nation. This has sent shock waves through its economy.
Consumers in many other nations have been switching from premium brands down to cheaper products.
The company's portfolio includes market-leading brands. Four them – Johnnie Walker, Smirnoff, Jose Cuervo and Bailey's – generate more than $1bn (£615m) of revenue a year. Although the Guinness brand is pretty mature in the UK and Ireland, it is also seeing good growth in places like Nigeria.
There is also speculation that the company may increase its 34pc stake in Moët Hennessy to gain overall control of the group.
In the US, where Diageo is the largest player in the industry and it has a dedicated sales team, growth over the next year will probably be modest.
However, it is the emerging markets of India and China that are likely to drive growth over the longer term.
The group is also taking advantage of the downturn to cut costs. It is targeting £100m in savings from its operations.
The shares are trading on June 2010 earnings multiple of 11.9 times and yielding 4.4pc. The company has a strong balance sheet, with a good mixture of debt and equity and a manageable refinancing profile.
The company generates a substantial amount of cash which will support the valuation but don't expect astronomical capital gains.
However, Questor feels that the company is a safe home for your money and the dividend is secure. Buy.
Dignity
596p +1
Questor says BUY
Benjamin Franklin's 1789 letter to French physicist Jean Baptiste Leroy about the US constitution has been quoted many times throughout history. In it he said: "Our Constitution is in actual operation. Everything appears to promise that it will last, but in this world nothing is certain but death and taxes." This is still true today.
Shares in Dignity, the UK's only listed funeral operator, have proved to be some of the most defensive around. Questor expects that will continue to be the case. People still die no matter what the economic backdrop.
The company is recession-resilient, not recession-proof. The majority of funerals are paid out of the estate of the deceased, so this source of income is pretty secure.
The key areas of downside risk for the group are in limousine hire and memorials, but both these areas held up well in the last recession. Sales of pre-arranged funerals also tend to pick up in a recession, which should boost the company's already impressive cash flow. .
The shares were recommended as a buy on May 10 at 538p – and they are up around 11pc since then.
Questor likes the group's long-term strategy of consolidating a fragmented market and the shares remain a buy. The company's approach, snapping up smaller, independent operators and driving efficiencies and synergies, is a sound one. It has also been buying crematoria – and now owns or operates 30 such sites.
Despite the significant amount of debt the company is carrying on its balance sheet – it has net debt of about £250m – the debt profile of the group is relatively conservative.
The company's bonds are fixed at an average 6.7pc interest and are only due to be repaid in 2031.
Although Questor does not expect the shares to rocket any time soon, the company should be regarded as a safe home for your money.
The shares are trading on a December 2009 earnings multiple of 15 times, falling to 13.7 in 2010. They are also trading on a prospective dividend yield of 2pc and the company is extremely cash generative. The shares remain a buy.