Financial Analysis of the Company Diageo - Essay Example

?Financial Analysis of the company Diageo This paper is an analysis of the financial performance of the firm Diageo PLC. The financial analysis is conducted in order to serve the investors with accurate information regarding whether investments especially long term investments in Diageo PLC would be profitable for the investors or not. For this purpose, ratio analysis is conducted, especially for five years. To conduct a financial analysis, the first step is to review the profits that the firm has earned. For this, we take into consideration 5 years to be analyzed, which are 2011, 2010, 2009, 2008 and 2007 data reports. Ratio analyses are simply used in accounting to express the relationship in mathematical terms between two related figures of the financial statement. A financial analysis is of the indication that the firm is generating huge businesses and is sure to remain in the industry for a greater length of time coming ahead, even though the future is pretty difficult to predict. Yet the analysis of the previous trends indicates that Diageo is to remain in this industry and has already created its own niche. Therefore, on the basis of the below discussions, it is understood that long term investments in Diageo PLC would be profitable. Background Analysis: Diageo is a leading firm which is spread globally and conducts premium drinks business with a varied collection of outstanding labels. Diageo is mainly concentrated in business regarding beverages. The firm, based in UK, manufactures its products in different countries of the world like Britain, Ireland, United States, Canada, Spain, Italy, Africa, Latin America, Australia, India, and the Caribbean. Based on research, it is seen that they sell their products approximately in 180 markets throughout the world. Diageo is an established firm and, thus, has its own authority in the production and sale of wine. Diageo manages 17 out of 100 of the top world’s spirit brands. The firm emphasizes its prime focus on developing its international brands in order to capture a giant market share. Diageo is listed in the London Stock Exchange (DGE) and for its American depositary receipts it is also listed on the New York Stock Exchange (DEO). The firm survives the competition in the global drinks business on its customer loyalty, the quality of the products and the price which it offers to its customers. Sales, accounts receivable and number of days outstanding or the turnover ratio provides a more or less indication of the firm’s current and future prospects. Economic recession has negatively impacted on the customer’s confidence and, thus, this has brought about a little negative diversion in business and its profits. “Diageo strength has driven competitive advantage in premiumisation” (Premiumisation 2010, p. 19). Even though the firm is into the drinks business, the firm concentrates on the social commitment of promoting healthy drinking to the society. “Drinks Company Diageo is to pay for 10,000 midwives in England and Wales to be trained to offer advice on the dangers of alcohol during pregnancy” (Drinks Firm Diageo Funds Pregnancy Health Initiative 2011). The major competitors of Diageo are Allied Domecq, Pernod Ricard, and Bacardi etc. Diageo faces many problems in the field of marketing of spirits compared to its wine business. The lack of a major global brand prevents Diageo from grabbing the top position in the world. Diageo faces competition from small and artisan wineries which also pose a greater threat to its market. An increasing competition from other drinks outside the wine industry is another threat for Diageo. Analysis of the Key Personnel within the Company: Diageo has more than 20000 talented people working with the firm. Diageo has a diverse workforce which corresponds to its widespread network throughout the globe. The staff of Diageo is committed in serving their customers, as customer satisfaction is the highest priority for Diego. The prime motto among employees is ‘live everyday to serve customers’. ‘Paul Walsh’ is the current CEO, while Deirdre Mahlan is the CFO of the firm Diageo PLC. Paul Walsh has been in the position of CEO of the firm since 2000 and he is also a council member of the Scotch Whisky Association and a non –executive director of FedEx Corporation in the US. Deirdre Mahlan has been in the position of CFO in the firm since 2010; before the present role, she was the head of tax and treasury department in Diageo. The firm also has a number of presidents for their separate markets yet Walsh and Mahlan played a key role since they have a very long and broad association with the firm in terms of years of their personal experience and expertise. Financial Analysis: Here, in this analysis part, financial analysis is included. In this part, the mostly discussed topic is the present financial condition of Diageo. With the help of ratio analysis, this report has discussed what the main financial effect in the Diageo that happens due to the present financial policies. “Diageo plc (Diageo) is one of leading companies in the branded beverage alcohol industry. It is engaged in the production and distribution of branded premium spirits, beer and wine. The key brands offered by the company include Smirnoff, Johnnie Walker, Captain Morgan, Baileys, J&B, Jose Cuervo, Tanqueray, Guinness, Crown royal, Beaulieu vineyards, and Bushmills Irish among others” (Diageo plc – Financial and Strategic Analysis Review 2009). Ratio analyses are simply uses in accounting to express the relationship in mathematical terms between two related figures in the financial statement. Ratios can be expressed in three ways as the quotient of one divided by other. So time, percentage and proportion are the three ways of expressing ratio. The report of financial position gives investors, creditors and analysts the information on company's assets and its equity and liabilities. Financial statement gives information on both of a firm's situation at a point of time and on its process over some past stages. On the other hand, the actual value of financial statements lies in the truth that they can be utilized to assist in calculating future earnings and dividends. From a shareholder’s standpoint, forecasting the future is what financial report analysis is all about. “Financial statement analysis involves analyzing the firm’s financial statements to extract information that can facilitate decision-making” (Lermack 2003). Financial ratios are planned to assist to assess a financial statement. It generally also gives information regarding the future earnings facility of a Diageo’s assets in addition to an indication of cash flows that can come from inventories and receivables. Assets are possessions controlled by the company as an outcome of earlier period’s proceedings, and from which future financial benefits are estimated to flow to the entity. Diageo's sales improved from 2009 to 2010 and starting 2010 to 2011. Operating profit improved from 2009 to 2010 and from 2010 to 2011. Profit before taxation increased from 2009 to 2010 and from 2010 to 2011. Profit from continuing operations refused from 2009 to 2010 other than then improved from 2010 to 2011 more than 2009 level. Profit turned down during the year of 2009 to 2010, whereas it improved from 2010 to 2011 more than 2009 level. Profit for the year attributable to equity shareholders of the parent company turn down from 2009 to 2010 other than improved from 2010 to 2011 exceeding 2009 level. This financial analysis includes 8 ratios, namely Return on Equity, Gross profit ratio, Net profit ratio, Quick ratio, Inventory turnover ratio, Debtors turnover ratio, Debt equity ratio and Working capital turnover ratio (provide complete calculation in the appendix section). Following are the interpretations of these ratios. Return on Equity: A profitability ratio is computed as net revenue divided by shareholders' equity. Diageo PLC's Return on Equity declined from the year 2009 to 2010 and from the year 2010 to 2011. In 2008 Diageo shows higher performance of ROE. Gross Profit Ratio: Gross profit margin indicates the proportion of revenue obtainable to cover operating and other expenses. Diageo PLC's gross profit margin declined from the year 2009 to 2010 but then improved from the year 2010 to 2011 exceeding 2009 level. Net profit Ratio: An indicator of profitability is computed as net profits divided by revenue. Diageo PLC's net profit margin grows weaker from the year 2009 to 2010. Whereas, a better result was recorded during the financial year of 2010 to 2011 and which was higher in profit than the year 2009. Quick Ratio: A liquidity ratio is computed as cash plus temporary marketable funds plus receivables, divided by current liabilities. Diageo PLC's quick ratio shows better performance from the year 2009 to 2010 other than a little deteriorated from the year 2010 to 2011, which is not reaching 2009 stage. Inventory Turnover Ratio: An activity ratio computed as returns divided by inventory. Diageo PLC's inventory turnover is better from the year 2009 to 2010 other than that of the deteriorated considerably from the year 2010 to 2011. Debtor’s Turnover Ratio: An activity ratio is equal to revenue divided by receivables. Diageo PLC's receivables turnover enhanced from the year 2009 to 2010 and from the year 2010 to 2011. Debt Equity Ratio: A solvency ratio computed as total debt divided by total shareholders' equity. Diageo PLC's debt-to-equity ratio is better from 2009 to 2010 and from 2010 to 2011. Working Capital Turnover Ratio: An activity ratio computed as returns divided by working capital. Diageo PLC's working capital turnover is better from the year 2009 to 2010 and from 2010 to 2011. Share Valuation: Share valuation is primarily intended to investors in order to provide them advice regarding whether to invest or not. In this section of the paper, it gives focus on share valuation for Diageo PLC and whether long term investors can invest in the firm. “Share valuation is a complex topic and no single valuation model can truly predict the intrinsic value of a share” (Ranganatham & Madhumathi 2006, p. 140). Share valuation is important, especially for business amalgamations or reconstructions. Similarly, it is also done on the basis of the nature of the business, the demand and supply of its shares. The usual formula for the calculation of the value of 1 equity share (in cases where goodwill value is calculated) is: Goodwill + fixed assets + current assets less liabilities = net assets, which are available for shares. Value of one share is determined by dividing the net assets available for shareholders with the number of equity shares. Another method for computing the value of shares is by obtaining the price earnings ratio of the firm. After obtaining the price earnings ratio of the firm, the total business valuation is calculated by total earnings multiplied by the price earnings ratio. The value per share is obtained by multiplying the earnings per share with the price earnings ratio of the firm. Using this method, Diageo’s share price is calculated as: 0.762 x 1820.9 = ?1388/- Another method is by the computation of the return on capital employed (ROCE). Using this method value of share is calculated as: (Rate of return / market expected rate of return) x nominal value of share From the firm Diageo’s financial results, it is understood that the firm’s 1 yr return is 17.46%. Using this method Diageo’s share price is calculated as: (17.46 / 18.76) x 1385 = ?1289/- At present, the market price of the share is ?1385/-. The firm’s share price has increased in the end month of the year 2011. The share price history chart of the firm is as follows: (Shareprice History 2012). Conclusion: Analyzing the financial results of the firm, it can be seen that the firm’s financial performance has a severe impact on its share price. Financial analysis of the firm shows that the firm’s financial performance has improved. Analyzing from the year 2007 to 2011, it shows that that the firm’s profits saw a dip in the year 2009 and, therefore, its share prices also went down. From 2009, the firm’s share prices increased and in December 2011 the firm’s share prices rose above ?1250/- . Therefore, for a long term investor who needs to invest for more than a year, Diageo is a good firm to invest as the firm’s profits from the year 2009 show an increasing trend. Long term investments are dependent upon steady performance of the firm and the financial results of the firm point out that long term investments can be made in the firm. Appendix: Calculations of Ratio: Name of Ratio Formula used Company/Year Compass 2011 Company/Year Compass 2010 Company/Year Compass 2009 Company/Year Compass 2008 Company/Year Compass 2007 Return on Equity Profit after Tax Equity 3,053/8,427*100 = 36.22% 2,507/6,167 *100 40.65% 2,621 /5,114 *100=50.33% 2,224 /5,114*100 43.48% 2,954/7,881 *100= 37.49% Gross profit ratio Gross profit/ Net sales *100 9,521/21,260*100= 44.79% 8,744 /19,945 *100= 43.84% 8,776 /19,859 *100=44.19% 7,083 /15,560 *100= 45.52% 8,885 /19,677 =45.15% Net profit ratio Current assets/ Current liabilities 7,161,000/4,915,000. =1.46 6,952,000/3,944,000= 1.76 6,067,000/?3,986,000=1.52 5,521,000/4,707,000= 1.17 5,187,000/4,199,000 = 1.24 Quick ratio Total quick assets/ current liabilities. 5,463/7,897=0.69. 5,096/6,070=0.84 4,417/6,446=0.69 3,890/6,855=0.57 5,065/8,331=0.61 Inventory turnover ratio Cost of goods sold/ Average stock 21,260/5,580=3.81 19,945/5,050=3.95 19,859/5,112=3.88 15,560/4,004=3.89 19,677/4,891=4.02 Debtors turnover ratio Net credit sales/ Debtors including B/R 21,260/2,412=8.82 19,945/2,301=8.67 19,859/2,535=7.83 15,560/2,412=6.45 19,677/2,738=7.19 Debt equity ratio External equity/ Internal equity 13,167/8,427=1.56 13,489/6,167 =2.19 13,864/5,208=2.66 10,538/5,114=2.06 11,244/7,881=1.43 Working capital turnover ratio sales/ working capital 3.61 4.5 3.65 1.83 1.98 Note: Report is based on the Diageo PLC's annual reports on June 2007 to 2011 respectively. Reference List Diageo plc – Financial and Strategic Analysis Review. 2009. Pr-Inside.com. [Online] Available at [Accessed on 25 Jan. 2012]. Drinks Firm Diageo Funds Pregnancy Health Initiative. 2011. BBC News Health. [Online] Available at [Accessed on 25 Jan. 2012]. Lermack, hB. 2003. Financial Analysis. Philadelphia University. [Online] Available at [Accessed on 25 Jan. 2012]. Premiumisation. 2010. DIAGEO. [Online] Available at [Accessed on 25 Jan. 2012]. Shareprice History. 2012. DIAGEO. [Online] Available at < http://www.diageo.com/en-row/investor/shareprice/Pages/Shareprice-History.aspx> [Accessed on 25 Jan. 2012]. Ranganatham, M & Madhumathi, R. 2006. Investment Analysis and Portfolio Management. Dorling Kindersley Pvt. Ltd. Available at [Accessed on 25 Jan. 2012]. Read More