Financial Ratio Analysis: Diageo PLC - Essay Example

?Diageo is among the world’s biggest alcoholic beverage companies, heading the worldwide market in flavored alcoholic products. In this view it is tranquil very alike to a number of of its main rival brands, including Allied Domecq and Pernod Ricard all of who dealt in varied alcoholic beverages, here Diageo has be different from its competitors in modern years, on the other hand, is the way in which its wine selling has been rather unnoticed in assessment to the advance of its global precedence brands, which have largely been focused on spirits and flavored alcoholic drinks. The wine industry surroundings, as an entire, is mainly vulnerable to fluctuations in supply resulting from weather connected aspects that persuade the quantity and quality of the grape crush yield. In 2004, a deficiency of wine in Western Europe impacted in enlarged prices, most important to slower quantity growth and customers turning to low priced alcoholic beverages. In the preceding years, on the other hand, inundate had reason the reverse effect, with an excess of wine quantity forceful down prices and worth in the industry. As a consequence, the wine industry wants more effectual harmonization between producers in organize to make sure a steady level of worldwide supply of wine. Celebrity backing, product position in movies and the wide based endorsement of a society of wine are innermost strategies in wine industry. As customers cultivate more and more health aware stipulate for beverages with a elevated alcohol substance continues to lessen. These current wine producers with a chance to highlight the possible health settlement of wine, predominantly when compare to the health risk of soaring alcohol substance spirits that are the normal drink in assured constituency such as Eastern Europe. Financial Ratio Analysis: Turnover Ratios: This set of ratios seeks to evaluate the company’s inventory, receivables, payables and working capital performance as compare to sales. Inventory turnover, Receivables turnover, Working capital turnover should be high which indicated higher level of sales are generated through utilization of these assets. Low payables turnover is better which indicates company is delaying the payments to the suppliers and utilization those cash in its better manner. Turnover Ratios Jun-10 Jun-09 Jun-08 Inventory turnover 3.95 3.88 3.89 Receivables turnover 6.97 6.76 5.47 Payables turnover 9.01 10.12 9.26 Working capital turnover 3.5 3.26 3.01 Diageo PLC's inventory turnover deteriorated from 2008 to 2009 but then improved from 2009 to 2010 exceeding 2008 level. Diageo PLC's receivables turnover improved from 2008 to 2009 and from 2009 to 2010. Diageo PLC's payables turnover increased from 2008 to 2009 but then declined significantly from 2009 to 2010. Diageo PLC's working capital turnover improved from 2008 to 2009 and from 2009 to 2010. The comparison of Turnover Ratios of Diageo to the industry is as follows: Diageo Industry Turnover Ratios Jun-10 Jun-10 Inventory turnover 3.95 10.05 Receivables turnover 6.97 11.52 Payables turnover 9.01 11.93 Working capital turnover 3.5 9.76 Diageo PLC has deteriorated performance as compare to the industry is all the turnover ratios except the Payables turnover ratio. Average No. of Days: This set of ratios evaluates the efficient use o inventory, receivables and payables. Average inventory processing period should be low which indicates that not too much capital is tied up in the inventory. Average receivable collection period should also be high which indicates that company is not delaying to collect its receivables which also increase to chances of fewer bad debts. Operating cycle is the sum of Average inventory processing period and Average receivable collection period and should be low so that less capital should be tied up in its operating cycle. Higher the average payables payment period is better because company can delay its payments so that more of the cash it should retain to it. In the overall Cash conversion cycle should be low. Average No. of Days Jun-10 Jun-09 Jun-08 Average inventory processing period 92 94 94 Add: Average receivable collection period 52 54 67 Operating cycle 144 148 161 Less: Average payables payment period -41 -36 -39 Cash conversion cycle 103 112 122 Diageo PLC's average inventory processing period deteriorated from 2008 to 2009 but then improved from 2009 to 2010 exceeding 2008 level. Diageo PLC's average receivable collection period improved from 2008 to 2009 and from 2009 to 2010. Diageo PLC's operating cycle improved from 2008 to 2009 and from 2009 to 2010. Diageo PLC's average payables payment period declined from 2008 to 2009 but then increased from 2009 to 2010 exceeding 2008 level. Diageo PLC's cash conversion cycle improved from 2008 to 2009 and from 2009 to 2010. The comparison of Average No. of Days of Diageo to the industry is as under: Diageo Industry Average No. of Days Jun-10 Jun-10 Average inventory processing period 92 36 Add: Average receivable collection period 52 32 Operating cycle 144 68 Less: Average payables payment period -41 -31 Cash conversion cycle 103 37 Diageo has deteriorated performance in all the Average No. of Days as compare to the industry. Diageo should consider that its Average inventory processing period and Average receivable collection period is much higher than the industry average. It indicates that a lot of capital which has its opportunity cost is tied up in this area. Hence the working capital strategy of the company is not on merit. Cash conversion cycle is almost three times than the industry which is very serious cause of concern. Liquidity ratios: This set of ratios evaluates the company’s ability to pay its short term obligations from its short term assets. Company should be capable enough to meet its short term obligations in order to remain solvent. The most stringent ratio is the cash ratio among all the liquidity ratios. Liquidity ratios Jun-10 Jun-09 Jun-08 Current ratio 1.74 1.56 1.2 Quick ratio 0.84 0.69 0.57 Cash ratio 0.37 0.23 0.15 Diageo PLC's current ratio improved from 2008 to 2009 and from 2009 to 2010. Diageo PLC's quick ratio improved from 2008 to 2009 and from 2009 to 2010. Diageo PLC's cash ratio improved from 2008 to 2009 and from 2009 to 2010. The comparison of liquidity ratios of Diageo to the industry is as under: Diageo Industry Liquidity ratios Jun-10 Jun-10 Current ratio 1.74 1.09 Quick ratio 0.84 0.69 Cash ratio 0.37 0.29 Diageo is on the better position than the industry in term of fulfilling its short term obligation. Profitability ratios: This set of ratios considers the profitability of the company over the sales, equity and assets. It indicates the how much profit is earned on the assets and equity. profitability ratios Jun-10 Jun-09 Jun-08 Operating profit margin 19.86% 19.89% 20.92% Net profit margin 12.57% 13.20% 14.29% ROE 40.65% 50.33% 43.48% ROA 8.37% 8.96% 9.49% Diageo PLC's operating profit margin deteriorated from 2008 to 2009 and from 2009 to 2010. Diageo PLC's net profit margin deteriorated from 2008 to 2009 and from 2009 to 2010. Diageo PLC's ROE improved from 2008 to 2009 but then deteriorated significantly from 2009 to 2010. Diageo PLC's ROA deteriorated from 2008 to 2009 and from 2009 to 2010. The comparison of profitability ratios of Diageo to the industry is as under: Diageo Industry profitability ratios Jun-10 Jun-10 Operating profit margin 19.86% 7.79% Net profit margin 12.57% 4.93% ROE 40.65% 11.20% ROA 8.37% 3.91% Diageo has much higher profitability than the industry overall. Its Operating profit margin, Net profit margin, ROE and ROA is bigger than the industry. Solvency ratios: Solvency ratios consider the capital structure and level of debt of the company. If company has higher debt its mean its leverage is high. These ratios should not exceed its optimal level. Solvency ratios Jun-10 Jun-09 Jun-08 Debt-to-equity ratio 2.20 2.67 2.06 Debt-to-capital ratio 0.69 0.73 0.67 Interest coverage ratio 3.63 3.63 5.29 Diageo PLC's debt-to-equity ratio deteriorated from 2008 to 2009 but then improved from 2009 to 2010 not reaching 2008 level. Diageo PLC's debt-to-capital ratio deteriorated from 2008 to 2009 but then improved from 2009 to 2010 not reaching 2008 level. Diageo PLC's interest coverage ratio deteriorated from 2008 to 2009 but then slightly improved from 2009 to 2010. The comparison of solvency ratios of Diageo to the industry is as under: Diageo Industry Solvency ratios Jun-10 Jun-10 Debt-to-equity ratio 2.20 0.88 Debt-to-capital ratio 0.69 0.47 Interest coverage ratio 3.63 8.68 Company is highly levered than the industry. Its Interest coverage ratio is lower indicates that EBIT as a percentage of interest payments are less than the industry. Risk analysis of Diageo: The company’s currency exposure by means of recent depreciation of the Pound sterling against the U.S. Dollar has increased. But the company hedges it through derivatives. Economic decelerate might consequence in less demand of its products. Customers may buy down, but in the past, first-class spirits are hard-wearing. Scotch and whiskey have seen an boost during this economic downturn. SWOT Analysis: Strengths: Company’s wide geographical exposure acts as mitigation against economic downturn in any one exacting area. Diageo is suitable more and more recognized for given that a encouraging working environment, and being a superior place to employment. Soaring altitude of staff faithfulness will facilitate the Diageo through hard periods. Diageo realized the significance of structuring global brands, which elevates its sales prospective. Diageo’s acquisition of the Chalone Wine Group inserted numerous best Californian wines to Diageo’s product range, which considerably enhances the company’s shape in the wine market. Diageo controlled of its North American division through disband its joint venture with Moet offers it bigger power over its advertising in this region. Weaknesses: Inadequate promotion capital is being place towards the Diageo’s wine brands in contrasting to its spirits big business. Diageo is short of any major wine policy represents a deficient in of promise to Diageo’s wine products. Diageo has not recognized itself completely in the UK first-class wine industry. Diageo is short of foremost worldwide brand is a separate drawback in a business which is fetching more and more noticed on branding. Diageo’s coverage is partial without acquiring of Australian brands, and as well undergoes from be short of involvement in the south American wine markets, which are more and more well-liked in means markets such as the United Kingdom. Opportunities: The wine industry at United Kingdom is showing to be more pliant alongside classified tag wines than may be recommended by the enlargement of private tags somewhere else in the retail market. The Diageo’s home market, the UK, is a cabinet market where customers are pleased to trial with wines, given that an extensive industry for Diageo’s brands. Sales of red wine are probable to carry on to advantage from health check and systematic research conclusions representative that it provides health reimbursement to usual, reasonable drinkers. There is substantial enlargement possible in Norway. Even though revenues in these regions are rising, they are not up till now at the similar level as other Western European regions. As company is at present healthy represented in Europe, it is in a burly place to added making use of these locations. The tendency towards premium wines provides enlargement possible prospects to more than a few of company’s brands together with Sterling Vineyards. Threats: Unrelenting doubts about the social collision of alcohol cruelty may show the way to the lessening of Diageo’s market as customers are buoyant to spin away from alcoholic beverages. As a U.K based company, with major abroad sales, the Diageo is at the sympathy of changeable exchange rates, when an escalation pound, mainly against the US dollar may brunt unconstructively on sales. Decreasing sales of spirits products could show the way to a worldwide price fighting which could force down the revenues and profits of the Diageo. There is rising rivalry from little wineries all through California, which could crash company’s wines at Californian. Porter’s five forces model: The five forces that Michael Porter determines as influencing and directing competitive strategy are as follows: 1- The threat of the new entrant: Profitable industries that capture large profits will ultimately attract new competitors. The high profitability results in numerous new entrants, which finally will lessen profits for all companies operating in the given industry. The threat of new entrant can be reduced by the existing companies by taking certain actions those hinder the entry of new firms. Such as by increasing the switching costs of customers, by attaining the economies of scale, by enlarging the capital requirements necessary to enter in the market or by crating the brand loyalty among existing customers. In the case of alcoholic industry in which Diageo is operating threat of new entrant is easy but one advantage to the existing companies are that it is very difficult for the new companies to make popular brand image. 2- The bargaining power of buyers: This force reflects the capacity of buyers to place the demands on the company to keep the prices of products at the certain level or keeping the good quality products. The bargaining power of buyers also influences the buyer’s sensitivity to respond the change in prices. If customer’s sensitivity to price changes is high then their bargaining power will also be high. In this case the profits of the company will be tapped in a certain limit. Company will not be able to charge high prices for their products or services. The customers in the alcoholic industry have strong bargaining power because they have low Switching costs. But Diageo has strong brand image so it will retain its customers through customer loyalty. 3- The bargaining power of suppliers: The influence of suppliers in the profitability of the industry is reflected in the industry’s profitability. Suppliers can put forth a power on the industry. For example selling of raw materials at a far above the ground price to confine a quantity of of the industry's profits. Inputs used in the manufacturing of wine, spirit have not stable sources so supply side of alcoholic industry is week. 4- Threat of substitute products: The presence of products those are not the same as the industry products but can be used as the alternative to the industry products. This presence of substitute products will make a ceiling on the profitability of the industry. It is a threat to the Diageo because its customers can switch to less price beverages if it would not be able to continue its brand loyalty and good quality products. 5- Rivalry among competitors: It is the major factor influencing the competitiveness of many industries. It is the reflection of the competitive level among the existing firms. For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry. In alcoholic beverages industry there is intense rivalry especially in the wine segment. Companies are snatching each other’s market share. Diageo positioned itself as a premium brand but its positioning is not perfect right now. It should still promote its products as a premium and high quality products as well as it should maintain and enhance its brand loyalty so it can face intense rivalry. Financial results of Diageo: Diageo declares its semiannual financial results ended 31 December 2010. The Organic revenue growth of 4% is achieved. high volume expansion and better products was served in North America; sustained impetus in worldwide all over again led to double number peak line increase in the constituency and leading line expansion enhanced in Asia pacific region. Performance in Europe was somehow weaker set the challenging economic circumstances. At a grouping stage, top leading development delivered gross margin upgrading. Investments to force augmentation sustained with organic advertising payout up 10% and amplified overhead investments, chiefly in Latin America. Organic operating profit rose 2%. Returns enlarged with continual burly free cash flow of ?750million.Paul Walsh, CEO of Diageo also commenting happily on the six months performance of the company ended 31 December 2010 and seems very satisfied. Diageo is a worldwide company, by means of its products delivering in about 150 markets around the globe. The Diageo’s shares are traded on the LSE with a ticker of DGE and the Company's ADRs are also listed on the NYSE with the symbol of DEO. Company had a market capitalization of about ?25 billion as mid 2010 year. The following are the main points those should be take into account when evaluating Diageo. Positive Negative Sustained burly demand from the U.S. markets is probable to advance pricing power of Diageo The demand failure in European regions has been superior to anticipate. The Diageo declared restructuring plan to bring ?100 million. There leftovers a certain level of issues over the U.S. expenditure in the middle term mainly in the ready-to-drink market. Lessening in the demands of European regions may be counterbalance by cost savings. Fragile pounds sterling against euro and US dollar further noteworthy currency concerns for the Diageo. The Diageo brands are much popular and it is a leading performer in the beverages (alcoholic) industry. Price Mix is probable to carry on deteriorating across few markets. Appendices: Consolidated income statement of Diageo is mentioned below: Notes Year ended 30 June 2010 ? million Year ended 30 June 2009 (restated) ? million Year ended 30 June 2008 (restated) ? million Sales 2 12,958 12,283 10,643 Excise duties 3 (3,178) (2,972) (2,553) Net sales 2 9,780 9,311 8,090 Cost of sales 3,5 (4,099) (3,893) (3,254) Gross profit 5,681 5,418 4,836 Marketing expenses 3 (1,419) (1,327) (1,244) Other operating expenses 3,5 (1,688) (1,673) (1,380) Operating profit 2 2,574 2,418 2,212 Sale of businesses 5 (15) - 9 Interest receivable 6 469 252 153 Interest payable 6 (844) (768) (494) Other finance income 6 4 2 51 Other finance charges 6 (91) (78) (29) Share of associates’ profits after tax 7 142 164 176 Profit before taxation 2,239 1,990 2,078 Taxation 8 (477) (286) (518) Profit from continuing operations 1,762 1,704 1,560 Discontinued operations 9 (19) 2 26 Profit for the year 1,743 1,706 1,586 Attributable to: Equity shareholders of the parent company 1,629 1,605 1,513 Non-controlling interests 114 101 73 1,743 1,706 1,586 Basic earnings per share 10 Continuing operations 66.3p 64.5p 58.0p Discontinued operations (0.8)p 0.1p 1.0p 65.5p 64.6p 59.0p Diluted earnings per share 10 Continuing operations 66.2p 64.3p 57.6p Discontinued operations (0.8)p 0.1p 1.0p 65.4p 64.4p 58.6p Consolidated Balance Sheet of Diageo is as under: 30 June 2010 30 June 2009 (restated) 30 June 2008 (restated) Notes ? million ? million ? million ? million ? million ? million Non-current assets Intangible assets 11 6,726 6,215 5,530 Property, plant and equipment 12 2,404 2,326 2,175 Biological assets 13 30 37 31 Investments in associates 14 2,060 2,041 1,805 Other investments 16 117 231 168 Other receivables 18 115 18 11 Other financial assets 22 472 364 111 Deferred tax assets 26 529 678 593 Post employment benefit assets 4 49 41 47 12,502 11,951 10,471 Current assets Inventories 17 3,281 3,078 2,688 Trade and other receivables 18 2,008 1,977 2,015 Assets held for sale 19 112 - - Other financial assets 22 98 98 104 Cash and cash equivalents 20 1,453 914 714 6,952 6,067 5,521 Total assets 19,454 18,018 15,992 Current liabilities Borrowings and bank overdrafts 21 (587) (890) (1,663) Other financial liabilities 22 (186) (220) (126) Trade and other payables 24 (2,615) (2,172) (2,161) Liabilities held for sale 19 (10) - - Corporate tax payable 8 (391) (532) (685) Provisions 25 (155) (172) (72) (3,944) (3,986) (4,707) Non-current liabilities Borrowings 21 (8,177) (7,685) (5,545) Other financial liabilities 22 (155) (99) (124) Other payables 24 (76) (30) (34) Provisions 25 (318) (314) (329) Deferred tax liabilities 26 (744) (606) (665) Post employment benefit liabilities 4 (1,254) (1,424) (455) (10,724) (10,158) (7,152) Total liabilities (14,668) (14,144) (11,859) Net assets 4,786 3,874 4,133 Equity Called up share capital 28 797 797 816 Share premium 1,342 1,342 1,342 Other reserves 3,245 3,279 3,161 Retained deficit (1,377) (2,249) (1,856) Equity attributable to equity shareholders of the parent company 4,007 3,169 3,463 Non-controlling interests 779 705 670 Total equity 4,786 3,874 4,133 Following are the description of the ratios used in the analysis: Inventory turnover An activity ratio calculated as revenue divided by inventory Receivables turnover An activity ratio equal to revenue divided by receivables Payables turnover An activity ratio calculated as revenue divided by payables. Working capital turnover An activity ratio calculated as revenue divided by working capital. Average inventory processing period An activity ratio equal to the number of days in the period divided by inventory turnover over the period. Average receivable collection period An activity ratio equal to the number of days in the period divided by receivables turnover. Operating cycle Equal to average inventory processing period plus average receivables collection period. Average payables payment period An estimate of the average number of days it takes a company to pay its suppliers; equal to the number of days in the period divided by payables turnover ratio for the period. Cash conversion cycle A financial metric that measures the length of time required for a company to convert cash invested in its operations to cash received as a result of its operations; equal to average inventory processing period plus average receivables collection period minus average payables payment period. Current ratio A liquidity ratio calculated as current assets divided by current liabilities. Quick ratio A liquidity ratio calculated as (cash plus short-term marketable investments plus receivables) divided by current liabilities. Cash ratio A liquidity ratio calculated as (cash plus short-term marketable investments) divided by current liabilities. Operating profit margin A profitability ratio calculated as operating income divided by revenue. Net profit margin An indicator of profitability, calculated as net income divided by revenue. ROE A profitability ratio calculated as net income divided by shareholders' equity. ROA A profitability ratio calculated as net income divided by total assets. Debt-to-equity ratio A solvency ratio calculated as total debt divided by total shareholders' equity. Debt-to-capital ratio A solvency ratio calculated as total debt divided by total debt plus shareholders' equity. 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